Why restrict trade?
 Benefits of free trade in final goods are
spread widely
 Tariffs on intermediate inputs tend to be low
 Costs of free trade are felt rapidly by
domestic producers
 Costs are usually concentrated in specific
sectors
Carbaugh, Chap. 5
1
Tariffs
Flavors of tariffs
 Tariff: a tax (duty) on internationally traded
products
 Import tariff - levied on imports
 Export tariff - levied on exported goods as they
leave the country … unconstitutional in US
 Protective tariff - insulate domestic producers from
competition
 Revenue tariff - raise funds for government
Carbaugh, Chap. 5
2
Tariffs
 Specific tariff
 Fixed $ / unit
 Ad valorem tariff
 % of product’s value
 Levied “free-on-board” (FOB) as it leaves port
 Levied “cost-insurance-freight” (CIF) as it arrives in port
 Compound tariff
 Combination of fixed and ad valorem tariffs
 Levied on finished goods whose imported inputs are also
subject to tariff
 Fixed portion offsets tariffs on raw materials paid by
domestic producers
 % portion protects domestic producers against finished good
imports
Carbaugh, Chap. 5
3
Tariffs
Effective rate of protection
 For a finished good,
 Effective tariff rate =
 {Nominal tariff – (% value Imports)x(Tariff on Imports)}
(% Domestic Value Added)
 The impact of a tariff is often different from its stated
amount
 Tariff Escalation: If domestic value added (domestic
content) is low and tariffs on imports are also low
Effective tariff >> Nominal tariff.
Carbaugh, Chap. 5
4
Nominal and Effective Tariff Rates
(US and Japan, early 1980s)
US
Japan
Nominal Effective Nominal Effective
Agriculture, fish, forest.
1.8%
1.9%
18.4% 21.4%
Food, beverages,tobacco
4.7
10.6
25.4
50.3
Footwear
8.8
15.4
15.7
50.0
Furniture
4.1
5.5
5.1
10.3
Leather products
4.2
5.0
3.0
-14.8
Paper and paper products
0.2
-0.9
2.1
1.8
Textiles
9.2
18.0
3.3
2.4
Wearing apparel
22.7
43.3
13.4
42.2
Wood products
1.6
1.7
0.3
-30.6
Carbaugh, Chap. 5
5
Tariffs
Avoiding and postponing tariffs
 Production sharing  special treatment for
foreign assembly using domestic inputs
 OAP: Offshore Assembly Provision
 Maquiladoras
 Bonded warehouses
Assemble imported components and reexport duty free
If sell domestically, tariff is levied only on imported value
 Foreign trade zones (FTZ)
Carbaugh, Chap. 5
6
Tariffs
Tariff welfare effects
 Consumer surplus
 What buyers are willing to pay
 Minus
 What they actually pay
 Producer surplus
 What producers receive
 Minus
 Cost
 (Minimum amount to induce them to produce a good)
Carbaugh, Chap. 5
7
Tariffs
Price ($)
Price ($)
Consumer and producer surplus
5
B
4
Consumer surplus
3
2
1
0
5
Supply
(minimum price)
Producer
surplus
4
3
C (actual price)
A
Total
expenditure
D
0
Demand
(maximum
price)
E
2
4
6
8
Gasoline (gallons)
Carbaugh, Chap. 5
A
2
10
C
(actual price)
Total
variable cost
1
B0
D
0
2
4
6
8
10
Gasoline (gallons)
8
Welfare effects of tariffs
Tariff trade and welfare effects
Small nation model
Price ($)
12,000
11,500
Sd
H
11,000
10,500
g
10,000
9,500
E
e
9,000
a
8,500
b
f
G
c
d
Sd+w+t
F
8,000
Sd+w
7,500
7,000
Dd
6,500
6,000
0
10
20
30
40
50
60
70
80
90
100
110
Quantity of autos
Carbaugh, Chap. 5
9
Tariff effects
Costs of import restrictions
Domestic consumers face increased costs
 Low income consumers are especially hurt by tariffs
on low-cost imports
Overall net loss for the economy (deadweight loss)
 Production effect: output that cost more than it has to (b)
 Consumption effect: surplus lost from reduced
consumption (d)
 Export industries face higher costs for inputs
 Cost of living increases
 Other nations may retaliate, further restricting
tradeChap. 5
Carbaugh,
10
Arguments for trade restrictions
 Job protection
 Protect against cheap foreign labor
 Fairness in trade - level playing field
 Protect domestic standard of living
 Equalization of production costs
 Infant-industry protection
 Political and social reasons
Carbaugh, Chap. 5
11