Free Trade – Good
Restriction – Bad
Free Trade: Price = World Price = $8,000
Domestic Production=20; Domestic Consumption=80; Imports=60
Consumer Surplus: a+b+c+d+e+f+g; Producer Surplus = h
Price ($)
12,000
Sd
11,500
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
h
7,500
7,000
Dd
6,500
6,000
0
10
20
30
40
50
60
70
Quantity of autos
80
90
100
110
Free Trade – Good
Restriction – Bad
Tariff: Price = World Price + Tariff = $8,000 + $1,000 = $9,000
Domestic Production=40; Domestic Consumption=60; Imports=20
Reduced Consumer Surplus: a+b+c+d
Increased Tax Revenue = c
Price ($)
12,000
11,500
Deadweight Loss:
Inefficient Production = b
11,000
10,500
g
10,000
9,500
9,000
a
8,500
Deadweight Loss:
Reduced Consumption = d
E
e
b
Sd
f
G
c
d
Sd+w+t
F
8,000
Sd+w
h
7,500
7,000
Dd
6,500
6,000
0
10
20
30
40
50
60
70
80
90
Quantity of autos
Increased Producer Surplus = a (Redistributive Effect)
100
110
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 costs 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
So why restrict trade?
 Benefits of free trade in final goods are spread widely
 Tariffs on intermediate inputs tend to be low so
producers who use them don’t complain much
 Costs of free trade are felt rapidly by domestic
producers  Lobbying by business and labor
“… those persons who demand cheaper coats would be ashamed of
themselves if they could realize that their demands cut the wages of
the women who made those coats.”
Benjamin Harrison, Election Campaign of 1888
 Strategic trade policy
 Reduce demand for foreign stuff
 lower its price a lot  Big gain on what you still buy
 Ways to restrict trade
 Tariffs/Non-Tariff Barriers
Flavors of tariffs
Tariff: a tax (duty) on internationally traded products
 Import tariffs
 Export tariffs … unconstitutional in US
 Raise revenue
 Favor domestic users of exported commodities
 In primary goods exporting countries, favor urban over rural areas




Protective tariff – insulate domestic producers
Revenue tariff – raise funds for government
Specific tariff – Fixed $/Unit
Ad valorem tariff – % of product’s value
 “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 subject to tariff
 Fixed portion offsets tariffs on imports paid by domestic producers 5
 % portion protects domestic producers against finished good imports
Effective rate of protection
 For a finished good, the effective rate of tariff
protection enjoyed by a domestic producer is the net
tariff on the imported product as a fraction of the
producer’s domestic value added.
 Net tariff = tariff on imported product that competes with his
product minus any tariffs he has to pay on imported inputs
 Effective tariff rate =


{Nominal tariff – (Value of Imports/Total Value)x(Tariff on Imports)}
(Domestic Value Added)/Total Value
 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.
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
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 at
time good leave the warehouse
 Foreign trade zones (FTZ)
 Duties imposed like for bonded warehouse
 Greater flexibility to process imported components
Arguments for trade restrictions
 Job protection
… but losses elsewhere
 Protect against “cheap” foreign labor
… but is foreign labor “cheap”?  Worker productivity
 Fairness in trade – “level playing field”
Principles of Fair Trade … Trade Not Aid
 Democratic organization
 Producer cooperatives
 Recognize unions
 No child labor
 Decent working conditions
 Environmental sustainability
 Prices that cover production costs
 Price guarantees irrespective of world prices
 Social premiums
 Pay premiums to organizations  public goods
 Long-term relationships
 Reduce uncertainties
Arguments for trade restrictions
 Job protection
… but losses elsewhere
 Protect against “cheap” foreign labor
… but is foreign labor “cheap”?  Worker productivity
 Fairness in trade – level playing field
… but sacrifice gains from trade
 Equalization of production costs
… but whose costs? [Their low cost producer = Our high cost?]
 Infant-industry protection  Achieve efficient scale
… but protect senile industries too?
 Political and social reasons
 Protect against cultural imperialism
 National defense/Self–sufficiency…reduce dependence
... but could build strategic reserves instead
Non – Tariff Barriers (NTBs)
Import quotas
 Quota: how much can be imported in a year
 Global quotas
 Selective quotas
 Government loses tariff revenue
 Quota is insensitive to demand shifts
 Tariff-rate quota: a two-tiered tariff
 More can be imported if demand increases … but
only at a higher tariff rate
Other NTBs
 Voluntary export restraints (VERs)
 Impose export quota … or else!
 Japanese auto exports  unintended consequences
 Domestic content requirements
 Subsidies
 Domestic subsidy … e.g. R & D
 “Green jobs”
 Export subsidy
 Government procurement policies
 Social regulations (health, environmental and safety
rules)
 Hormones in beef / genetically engineered produce
 Sea transport and freight restrictions
Costs of import restrictions redux
Domestic consumers face increased costs
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
 Retaliation
Problem 4.15
 “Australian market for TVs”
Price
Quantity
Demanded
Quantity
Supplied
Export
(Import)
$500
400
300
250
200
100
0
0
10
20
25
30
40
50
50
40
30
25
20
10
0
50
30
10
(10)
(30)
(50)
 In autarky




Market clearing price
Quantity supplied and bought
Consumer surplus
Producer surplus
Problem 4.15
 “Australian market for TVs”
Price
Quantity
Demanded
Quantity
Supplied
Export
(Import)
$500
400
300
200
100
0
0
10
20
30
40
50
50
40
30
20
10
0
50
30
10
(10)
(30)
(50)
 World price = $100




Quantity bought
Quantity supplied by Australian producers
Consumer surplus
Producer surplus
Problem 4.15
 “Australian market for TVs”
Price
Quantity
Demanded
Quantity
Supplied
Export
(Import)
$500
400
300
200
100
0
0
10
20
30
40
50
50
40
30
20
10
0
50
30
10
(10)
(30)
(50)
 World price = $100 / Tariff = $100







Quantity bought
Quantity supplied by Australian producers
Consumer surplus
Producer surplus
Revenue
Redistributive effect
Protective effect / Consumption effect / Deadweight loss
Problem 5.16
 “Venezuelan market for TVs”
Price
Quantity
Demanded
Quantity
Supplied
Export
(Import)
$100
150
200
300
400
500
900
800
700
500
300
100
0
100
200
400
600
800
(900)
(700)
(500)
(100)
200
700
 World price = $150 / Free trade




Quantity bought
Quantity supplied by Venezuelan producers
Consumer surplus
Producer surplus
Problem 5.16
 “Venezuelan market for TVs”
Price
Quantity
Demanded
Quantity
Supplied
Export
(Import)
$100
200
300
400
500
900
700
500
300
100
0
200
400
600
800
(900)
(500)
(100)
200
700
 World price = $150 / Import quota = 300 TVs






Price in Venezuela … Quantity bought
Quantity supplied by Venezuelan producers
Reduced consumer surplus
Increased producer surplus
Earnings of Venezuelan importers who buy at world price
Net loss to Venezuelans
Problem 5.16
 “Venezuelan market for TVs”
Price
Quantity
Demanded
Quantity
Supplied
Export
(Import)
$100
200
300
400
500
900
700
500
300
100
0
200
400
600
800
(900)
(500)
(100)
200
700
 World price = $150 / Import quota = 300 TVs






Price in Venezuela … Quantity bought
Quantity supplied by Venezuelan producers
Reduced consumer surplus
Increased producer surplus
Earnings of foreign monopolists who sell at Venez’n price
Net loss to Venezuelans
Problem 5.16
 “Venezuelan market for TVs”
Price to
Consumers
Quantity
Demanded
Quantity
Supplied
Export
(Import)
$100
200
300
400
500
900
700
500
300
100
200
400
600
800
1000
(700)
(300)
100
500
900
 World price = $150 / Subsidy to producers = $100/TV






Price in Venezuela … Quantity bought
Quantity supplied by Venezuelan producers
Increased producer surplus
Increased production cost
Cost of subsidy to Venezuelan taxpayers
Net loss to Venezuelans