Chapter 6 Lecture - The Theory
of Tariffs and Quotas
1
Learning Objectives
• Show a supply and demand diagram to illustrate
consumer and producer surplus.
• Draw a graph that shows the effects of tariffs and
quotas on prices, output, and consumption.
• Explain in words and with a diagram the effects
of tariffs and quotas on resource allocation and
income distribution.
• Differentiate effective from nominal rates of
protection.
• List and discuss at least three dynamic costs of
protection.
2
Analysis of a Tariff
• There are numerous barriers to trade, some are
obvious (transparent), others are not (nontransparent)
– Quotas: direct limit on imports: regulate the
quantity of imports
– Tariffs: indirect limit on imports: impose a tax
on imports
3
Analysis of a Tariff
• Tariffs and quotas encourage
– Consumers to switch to relatively cheaper
domestic goods or to drop out of the market
– Domestic producers to increase their output
as demand switches from foreign to domestic
goods
• We look at a partial equilibrium nalysis of the
effects of tariffs and quotas: Considers only
their impact on the industry on which they are
imposed, rather than their economy-wide
effects
4
Prices, Output, and Consumption
Assume:
1. There is only one price for a good (world
price Pw)
2. Foreign producers are willing to supply
us with all of the units of the good we
want at that price
5
Prices, Output, and Consumption
• Now assume: Government imposes a
tariff of amount “t.” Importers will
still be able to buy the good from
foreign producers for Pw, but they will
have to pay the import tax of “t.”
– The tax is subsequently tacked onto the
price to domestic consumers: price to
them is
Pw+ t=Pt
– The consumption of the imported good
subsequently decreases
6
The Effects of a Tariff
7
Resource Allocation and
Income Distribution
• Tariffs cause the domestic price to rise by the
amount of the tariff,
• Domestic consumption falls,
• Domestic production rises,
• Imports fall.
• But, tariffs have more subtle effects than just a
rise in prices and a fall in imports.
- Inputs in domestic production: increase domestic
production requiring additional resources of land,
labor, and capital to be reallocated from their
prior uses into the industry receiving protection
under the tariff.
8
Resource Allocation and Income Distribution
• When the price changes, consumer and producer
surplus do too
• Deadweight loss- destruction of value that is not
compensated by a gain somewhere else : area d is
this type of loss.
• Efficiency loss- another deadweight loss which
occurs on the production side: area b is this type
of loss
• Summary- the net effect of the tariff on national
welfare = gains to producers + gains to government
- losses to consumers = (a + b + c + d - a - c) = b + d:
9
Economic Effects of a Tariff
10
Effects of a Tariff
11
A Comparison of Tariff Rates
• The Doha Development Agenda of the World Trade
Organization (WTO) is focused on the trade problems of
developing countries
• At issue for many developing countries are the levels of
tariffs and other industrial country barriers that block
access to agriculture, clothing, and textile markets.
• However, developed nations often have highest tariffs in
agriculture, textiles, and other labor-intensive products –
the very products developing nations would like to export
• Industrial countries, the World Bank, and the WTO have
argued major problem facing developing countries is the
relatively high level of protection among themselves
• High tariffs limit the countries’ ability to sell into each
other’s markets—and consequently their ability to follow
their comparative advantage
12
Average Tariff Rates, 1986-2010
United State Trade Commission Database of Tariffs
http://dataweb.usitc.gov/scripts/tariff.asp
13
Other Potential Costs
A tariff may have effects that are less predictable
and harder to quantify
• Retaliation by other countries: adds to the net loss of a
tariff by hurting export markets of other industries; can
escalate rapidly
• Innovation: tariffs reduce competitive pressures on
domestic firms and thus their incentives to innovate and
improve the quality of existing products
• Rent seeking: any activity that uses resources in order
to capture more income without actually producing a
good
(e.g., firms hire lobbyists to maintain tariff protection)
Political systems that do not easily provide tariffs are more
likely to avoid rent seeking
14
The Large Country Case
• Economists distinguish between small and large
countries in analyzing tariffs
– Large country: one that imports enough of a
particular product so that if it imposes a
tariff, the exporting country will reduce its
price of the good in order to keep its share
of the large country's market
• In theory, large countries can improve their
national welfare by imposing a tariff as long as
their trading partners do not retaliate
15
Tariffs in the Large Country Case
16
Effective versus Nominal Rates
of Protection
• The amount of protection given to any one
product depends not only on the tariff rate but
also on tariffs on the inputs used to produce the
good
– Nominal rate of protection: tariff rate
levied on a given product
– Effective rate of protection: nominal
rate + tariffs on intermediate inputs
17
Effective versus Nominal Rates
of Protection
• Value added: price of a good minus the costs of
intermediate goods used to produce it (the
contributions of labor and capital at a given
stage of production
•
In sum, effective rate of protection or
EFP
=
(VA∗ − VA)
VA
where VA = amount of domestic value added under
free trade;
where VA* = domestic value added after taking into
account all tariffs (on both final goods and
intermediate inputs)
18
Nominal and Effective Rates of Protection
(VA∗ − VA)
EFP=
VA
400 −400
=0
400
(VA∗ − VA)
EFP=
VA
600 −400
= 50%
400
(VA∗ − VA)
EFP=
VA
300 −400
= −25%
400
19
The Uruguay Round
20
Analysis of Quotas
• Quota: A quantitative restriction that
specifies a limit on the quantity of imports
• Differences between quotas and tariffs
– Tariff limits imports by imposing a tax on
them
– Unlike tariffs, quotas do not generate tariff
revenue for the government
• Similarities between quotas and tariffs
– Both lead to a reduction in imports, a fall in
total domestic consumption, and an increase
in domestic production
21
Types of Quotas
1) Most transparent type of quota:
– an outright limitation on the quantity of imports
e.g., a limit on the quantity of imports from country x,
or a limit on the quantity of imports from the rest of the
world as a whole
2) Import licensing requirement:
– forcing importers to obtain government licenses for
their imports;
– government regulates the number of licenses available
3) Voluntary export restraint (VER) (or voluntary restraint
agreement, VRA)
– the exporting country “voluntarily” agrees to
limit its exports for a period
22
Types of Quotas: VERs
• VERs have similar effects as quotas
– However, VERs are more popular, as they (1)
do not require domestic legislative action;
and (2) allow politicians to provide protection
for domestic industry and to appear as
proponents of free trade
• The use of VERs increased with the decline in
tariffs that results from the global trade rounds;
however, recent international negotiations have
restricted the use of VERs
http://www.perc.org/articles/voluntary-export-restraints-automobiles
23
The Effect on the Profits
of Foreign Producers
• The main difference between tariffs and quotas
is that there is no government revenue from
quotas.
• In place of tariff revenue, there are greater
profits for foreign producers, called quota rents.
• Two circumstances that can limit quota rents
– If there is a large number of foreign
producers, competition may limit their
ability to increase prices
– The government can extract the extra profits
from foreign producers through an auction
for import licences
24
Quotas
• Effects of a quota
– If permitted quantity is above what
would be imported anyway, then no
effect at all. (True only with perfect
competition)
– Otherwise, quota creates scarcity and
raises price
– Quota raises domestic price above world
price
• For market to clear, domestic price must rise
to the point that desired imports equal the
quota
• See this with supply and demand
• First note example of US quota on sugar..
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Effects of a Quota: Small Country
P
S
Pa
Suppose quota
limits imports to
this amount
Quota
which is less
than initial
imports
PW
D
Quota
QS0
QD0
Q
26
Effects of a Quota: Small Country
P
S
Pa
Then price must rise
until D-S=Quota
PW
D
Quota
QS0
QD0
Q
27
Effects of a Quota: Small Country
P
S
Thus price
is…
Pa
PQ
Quota
PW
D
QS0
QD0
Q
28
Effects of a Quota: Small Country
P
S
Pa
…and
quantities are
PQ
PW
Quota
QS0 QS1
QD1 QD0
D
Q
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Effects of a Quota: Small Country
P
S
Effects on
Welfare
Pa
PQ
PW
Same as tariff,
except c
a
b
c
d
Quota
QS0 QS1
QD1 QD0
D
Q
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Effects of a Quota: Small Country
• Results
P
– Suppliers gain area
+a
PQ
a b
– Demanders lose area
PW
−(a+b+c+d)
– Somebody gets area
c, but who?
S
c
d
D
Q
• Area c is called “quota rents”
– It is the profit from buying at world price,
PW, and selling at higher domestic price,
PQ
31
Effects of a Quota: Small Country
• Who gets quota rents?
• Depends on how quota is administered:
– First-come, first-served: Rents go to whoever
gets there before quota is exhausted
– Sell (or “auction”) import licenses: Rents go
to government as revenue from sale of
licenses
– Give import licenses away to domestic people
or firms: those people or firms then get the
rents
– Give licenses away to foreign firms or
governments: foreigners get the rents
• Most common is the last: Give away to
foreigners in proportion to their historical
exports
32
Effects of a Quota: Rent Seeking
• “Rent Seeking”
– Defined as the use of resources in effort
to get rents
– Examples
• Faster (thus more costly) transport to win
race to border for 1st-come-1st-served quota
• Lobbying legislators to get quota allocations
• Inefficient production intended to get
market-share-based quota allocations
33
Effects of a Quota
• Effects of quota compared to tariff
– Effects on price and quantity are the same
• hence “tariff equivalent”
– Effect on welfare is different if quota rents
are lost to rent seeking and/or accrue to
foreigners:
• In that case, importing country loses more from
quota than from equivalent tariff
• What if country is large?
– Picture is also same as for tariff
– But if quota rent is lost or goes to foreigners,
importing country cannot gain
34
Effects of Quota: Large Country
(if Rent given to foreigners)
Summary:
P
S
a’ b’ c
e’
’
Domestic Country:
• Suppliers gain
+a’
• Demanders lose
−(a’+b’+c’+d’)
• Net effect on country =
−(b’+c’+d’)
Foreign Country:
• License holders gain +(c’+e’)
• (Supplier/Demanders also lose)
d’
D
Q
35
Effects of a Quota
• Other effects of a quota
– Quality upgrading
• Limited to a fixed quantity, foreign
exporters seek higher value by improving
quality
– Like a tariff, quota may induce foreign
firms to produce here
– Unlike a tariff, the quota becomes
more restrictive if foreign supply
increases or world price drops
36
Other NTBs:
Tariff-Rate Quota (TRQ)
• This is two tariffs, separated by a quota
– Low (or zero) tariff applies to imports below the quota
– High tariff applies to
imports above the quota
• Used by US on many
agricultural products
• Effect is like
Tariff
– a low tariff,
– a quota,
– or a high tariff,
depending on levels
of supply and demand
Imports
Quota
37
Other NTBs:
Voluntary Export Restraint (VER) Once More
• Restriction of exports
– At request of importing country
– Usually specified as maximum quantity
• This was the major form of protection for the
US auto industry in the 1980s: US persuaded
Japan to limit exports of cars to US
• Illegal since 1995 under WTO rules
– But how to enforce
– Examples in 2012 that look like VERs
• Effect is exactly like a quota allocated to
foreigners
38
Other NTBs:
Variable Levies
• A tariff that is changed as
necessary to keep domestic price at
a specified level
• These are used extensively by the
European Union as part of its
Common Agricultural Policy (CAP)
• Effects are same as a tariff, except
for behavior over time
39
Other NTBs: Government Procurement Regulations
• Government favors domestic suppliers in buying goods and
services
– Buys only from domestic firms,
or
– Buys from domestic firms unless imports are, say, 10%
cheaper
• US used to have a “Buy American” law
– Some say we need it again, but would violate WTO
• Effect is like a tariff, except that loss to demander is now loss
to government and thus taxpayer
• “Buy American” was part of the Stimulus Package of the US in
2009
– Congress would have imposed broad restrictions
– Obama got them to restrict only when not contrary to US
commitments under trade agreements
– Even so, result was broadly restrictive, because purchasers
were not sure of rules, so avoided imports
– Result was also that other countries included similar
provisions in their stimulus packages
40
Other NTBs: Customs Procedures
• All countries have customs procedures for
maintaining border security and collecting tariffs
• They become NTBs when
– Excessive difficulty, or red tape, limits imports
– Rules impose artificially high valuation for ad
valorem tariffs
Other NTBs: Standards
• All countries also have standards, for
– Health and safety (e.g., no lead paint)
– Compatibility (e.g., 110 volt appliances)
• They become NTBs when biased against imports in
– Substance of the requirement
– Procedures for certifying compliance
41
Other NTBs:
Unfair Trade Laws
• The (legal) threat and use of
– Anti-Dumping Duties
– Countervailing Duties
• We’ll say more about this later, in
lecture about U.S. Trade Policies
• These are NTBs if
– “Unfair trade” is actually normal trade (it
usually is)
– The threat of action discourages trade, even
when duties are not levied (the “chilling
effect”)
42
Other NTBs:
Export Taxes
• Simply a tax on exports, analogous
to tariff on imports
– Effects are similar
– Not common, until recently, because
countries think exports are good
– Became common in mid-2008, as high
world prices for agriculture led food
exporters to protect their own
consumers
43
Subsidies
• Government assistance to producers
– Export subsidy: paid only for exports
– Domestic subsidy: paid for all production
(but increases exports or reduces imports)
• Effect on the subsidizing country
– In competitive industries, country loses
– Subsidies usually are intended to benefit
producers, not country
– In non-competitive industries, result may
be different (recall Boeing-Airbus
example)
44
Effects of a Subsidy
on Foreign Countries
• Effect, if
country is
large, is to
reduce the
world price of
the exported
good
• Subsidy
expands supply
in subsidizing
country (which
is part of SW0)
PW
PW
PW1
0
World
Market
SW 0
SW 1
DW
QW
45
Subsidies: Are They Used?
• YES!!
• US, EU, Japan all have large subsidies on
many agricultural products
• These reduce world prices and hurt
producers of these products in developing
countries
• Examples of US subsidies and whom they
hurt:
– Corn: Mexico
– Sugar: Caribbean countries
– Cotton: Certain African countries
46
Hidden Forms of Protection
• Any trade barrier that reduces imports without
imposing a tax has effects similar to those of a
quota
– Tariffs: impose a tax
– Non-tariff barriers (NTBs): quotas and non-tariff
measures
• Non-tariff measures are hidden, non-transparent
forms of protection, such as:
- excessively complicated customs procedures,
- environmental and consumer health and safety
precautions,
- technical standards,
- government procurement rules,
- limits imposed by state trading companies
47
Intellectual Property Rights and Trade
• Intellectual property (intellectual property rights)
are usually divided into:
– Copyrights and related rights for literary and
artistic work,
– Industrial property rights for trademarks,
– Patents,
– Industrial designs,
– Geographical indications
– Layout of integrated circuits
• There are rules for respecting intellectual property
rights as they relate to trade
• These rules were negotiated during the Uruguay
Round (1986-1994) with the Trade Related Aspects
Intellectual Property Rights (TRIPS) agreement
48