Nations and firms in the global economy; Cambridge University Press, 2006
© Charles van Marrewijk, 2005; 1
Tariff, partial equilibrium; 1
Countries may restrict trade in several ways. For example, they may
•Impose a 100 Euro tax per imported computer (tariff)
•Impose a 12% tax per imported computer (ad valorem tariff)
•Restrict the number of imported computers (quota)
•Subsidize the production of domestically produced computers
•Subsidize the export of domestically produced computers
•Require a “minimum content” before a computer may be labeled
“domestically produced”
•Prohibit the sale of computers to certain countries for safety reasons
•etc.
All of this will affect trade flows in different ways. We will restrict
attention mainly to tariffs.
Nations and firms in the global economy; Cambridge University Press, 2006
© Charles van Marrewijk, 2005; 2
Tariff, partial equilibrium; 2
We start with a basic partial equilibrium
setup; quantity demanded increases and
quantity supplied falls as the price falls.
In autarky, the equilibrium
S
price is p0, with quantity q0
p
D
The price in the world market,
however, is equal to p1
p0
p1
imports
q1
q0
q2
At that price the domestically
supplied quantity equals q1,
and the domestically demanded
quantity equals q2.
The difference
between these two
quantities is imported
q from abroad.
Nations and firms in the global economy; Cambridge University Press, 2006
© Charles van Marrewijk, 2005; 3
Tariff, partial equilibrium; 3
Suppose the government wants to help
the domestic suppliers who face a lower
price with trade than in autarky.
One way to do this is by
S
imposing a tariff equal to T
p
D
p1+T
p1
imports
q1 q3
q4
q2
If this is a small country in the
world markets this raises the
domestic price to p1+T
As a result the domestically
produced quantity rises to q3,
and the domestically demanded
quantity falls to q4.
The quantity
imported from
abroad thus falls
q
Nations and firms in the global economy; Cambridge University Press, 2006
© Charles van Marrewijk, 2005; 4
Tariff, partial equilibrium; 4
We note that the price level has risen
from p1 to p1+T, which has increased the
quantity of domestically produced goods
S from q1 to q3.
Thus, the domestic producers
support this policy; indeed
their profits have increased by
the area:
p
D
The government turns out to be
pleased as well; not only has
domestic production and
profitability increased, they
earn a revenue as well equal to:
p1+T
p1
q1 q3
q4
q2
q
Nations and firms in the global economy; Cambridge University Press, 2006
© Charles van Marrewijk, 2005; 5
Tariff, partial equilibrium; 5
The only party not in support of this
policy are the consumers. They see the
price level rise from p1 to p1+T.
p
D
S
This reduces the consumer surplus
considerably, by the area equal to:
Indeed, the loss in consumer
surplus is so considerable that
the total welfare change is
negative, equal to the
“deadweight loss” triangles:
p1+T
p1
q1 q3
q4
q2
q
Nations and firms in the global economy; Cambridge University Press, 2006
© Charles van Marrewijk, 2005; 6
Tariff, partial equilibrium; 6
Is it possible in this analysis that the total welfare
change is positive, rather than negative?
p
Yes, it is. Remember that imposing
D
S
p2+T
a tariff reduces the quantity imported
from abroad. If this fall in demand has
a substantial impact on the rest of the
world it will reduce the world price of
this good, say from p1 to p2 (large
country)
This does not mean that
domestic prices will be
lower than p1, since the
tariff T has to be paid for
imports (price wedge).
T
p1
p2
q1 q3
q4
q2
q
Nations and firms in the global economy; Cambridge University Press, 2006
© Charles van Marrewijk, 2005; 7
Tariff, partial equilibrium; 7
The producers gain the area:
p
The government gains the area:
D
The consumers lose the area:
S
The total welfare change is equal to:
An omniscient government
would set tariffs to maximize
this welfare gain, the “optimal”
tariff argument, see the sequel.
p2+T
p1
p2
q1 q3
q4
q2
q