LECT 9: TRADE RESTRICTIONS: TARIFF



LECT 9: TRADE RESTRICTIONS: TARIFF

Definitions

Tariff

• A tax imposed by government on either imports or exports

• For what purpose?

􀂾 Revenue Effect: mechanism for raising government revenue

􀂾 Protective Effect: protect domestic industries against foreign competition

Tariffs

Types of Tariffs

• Ad Valorem tariff — a tax equal to a certain percentage of the good’s selling price.

􀂾 For example, 25% tariff on the value of imported cars.

• Specific tariff — a tax equal to a fixed amount of money per unit sold.

􀂾 For example, $1 per kg of cheese

• Compound tariff — a tax with both ad valorem and specific components

PARTIAL EQM ANALYSIS OF A TARIFF

Analyzing Tariff Effects

• In order to analyze the effects of international policies on trade, we will abstract from general equilibrium and focus on the market for a specific product (partial equilibrium!)

-ILLUSTRATION:

[pic]

DX IS THE DEMAND CURVE AND SX IS THE SS CURVE OF X IN NATION 2.

ASSUMPTN. NATION 2 IS SMALL AND SO IS INDUSTRY X

• IN THE ABSENCE OF TRADE:

INTERSECTION OF DX AND SX GIVES THE EQM POINT-30X IS DDd AND SSd AT PX =$3 IN NATION 2.

• W FREE TRADE:

NATION 2 WILL CONSUME 70X (AB) OF WHICH 10X IS PRODUCED DOMESTICALLY AND 60X IS IMPORTEDâ‹„THE HORIZONTAL DASHED LINE REPRESENTS THE INFINTELY ELASTIC FREE-TRADE FOREIGN SS CURVE OF X TO NATION 2

• W TARIFF: NATION 2 NOW IMPOSES A 100% AD VALOREM TARIFF ON THE IMPORTS OF X.

PX IN NATION 2 WILL RISE TO $2 AND CONSUME 50X OF WHICH 20X IS PRODUCED DOMESTICALLY AND THE REMAINDER 30X IS IMPORTED. THE HORIZONTAL DASHED LINE SF+T REPRESENTS THE NEW TARIFF INCLUSIVE FOREIGN SS CURVE OF X TO NATION 2.

• HENCE THE CONSUMPTION EFFECT (REDUCTN IN DOMESTIC CONSUMPTION=20X(BN))

• THE PRODUCTION EFFECT (THE EXPANSION OF DOMESTIC PRODUCTION= 10X (CM))

• THE TRADE EFFECT (DECLINE IN IMPORTS=30X(BN+CM))

• THE REVENUE EFFECT (REVENUE COLLECTED BY GOVT=$30 ($1 ON EACH OF THE 30X IMPORTED(MJHN))

• THE EFFECT OF TARIFF ON CONSUMER AND PRODUCER SURPLUS

[pic]

Consumer Surplus

• Consumer surplus measures the amount that a consumer gains from a purchase by the difference in the price he pays from the price

he would have been willing to pay.

􀂾 The price he would have been willing to pay is determined by a demand (willingness to buy) curve.

􀂾 When the price increases, the quantity demanded decreases as well as the consumer surplus.

Producer Surplus

• Producer surplus measures the amount that a producer gains from a sale by the difference in the price he receives from the price he would have been willing to sell at.

􀂾 The price he would have been willing to sell at is determined

by a supply (willingness to sell) curve.

􀂾 When price increases, the quantity supplied increases as

well as the producer surplus.

THE INCREASE IN THE PRICE OF X FROM PX=$1 TO PX=$2 AS A RESULT OF THE 100 PERTCENT TARIFF THAT NATION 2 IMPOSES ON THE IMPORTATION OF X LEADS TO A REDUCTION IN CONSUMER SURPLUS AND AN INCREASE IN PRODUCER SURPLUS

• COSTS AND BENEFITS OF TARIFF

[pic]

• THE REDUCTION IN CONSUMER SURPLUS OF AGHB=a+b+c+d=$60, MJHN =C=$30 IS COLLECTED BY THE GOVT AS TARIFF REVENUE

• AGJC=A=$15 IS REDISTRIBUTED TO DOMESTIC PRODUCERS OF X IN THE FORM OF INCREASED PRODUCER SURPLUS OR RENT, WHILE THE REMAINING $15 (CJM=b=$5 + BHN =d=$10) REPRESENTS THE PROTECTION COST OR DEADWEIGHT LOSS TO THE ECONOMY

• DW LOSS ARISES BECAUSE SOME DOMESTIC RESOURCES ARE TRANSFERRED FROM THE MORE EFFICIENT PRODUCTION OF EXPORTABE COMM Y TO THE LESS EFFICIENT PRODUCTION OF IMPORTABLE COMM X OF NATION 2.

• THE TARIFF ARTIFICAILLY INCREASES PX IN RELATION TO PY AND DISTORTS THE PATTERN OF CONSUMPTION IN NATION 2.

• Definition: Deadweight Loss/Cost —value of wasted resources devoted to expanded domestic production and expenditures devoted to less-desired substitutes brought about by a tariff

[pic]

THE THEORY OF TARIFF STRUCTURE

Effective Rate of Protection

• The amount of protection provided to the domestic content of a product by the tariff structure of a country.

• Nominal rate of protection — equals the tariff on the final good divided by the free-trade price of the product.

􀂾 Nominal Rate of Protection (NRP) = t/P

• Effective rate of protection - measures how much protection a tariff or other trade policy provides domestic producers.

• In this case, the effective rate of protection is greater than the tariff rate.

E.G:

$80 OF IMPORTED WOOL GOES INTO THE DOMESTIC PRODUCTN OF A SUIT.

FREE TRADE PRICE OF EACH SUIT IS $100

NATION IMPOSES A 10% NOMINAL TARIFF ON EACH IMPORTED SUIT

THEREFORE PRICE OF SUIT TO DOMESTIC CONSUMERS IS $110- OF THIS, $80 REPRESENTS THE IMPORTED WOOL, $20 IS DOMESTIC VALUE ADDED, AND $10 IS THE TARIFF

-THE $10 TARIFF COLLECTED ON EACH IMPORTED SUIT REPRESENTS A 10% NOMINAL TARIFF RATE ($10/$100=10%) BUT CORRESPONDS TO A 50% EFFECTIVE TARIFF RATE BECAUSE THE EFFECTIVE TARIFF IS CALCULATED ON THE VALUE ADDED DOMESTICALLY TO THE SUIT ($10/$20=50%)

-PRODUCERS VIEW THE $10 TARIFF AS BEING 50% OF THE $20 PORTION OF THE SUIT PRODUCED DOMESTICALLY. THAT IS, THE $10 TARIFF PROVIDES 50% OF THE VALUE OF DOMESTIC PROCESSINGâ‹„INDICATING A MUCH GREATERC DEGREE OF PROTECTION.

PARTIAL EQUILIBRIUM ANALYSIS-SMALL VS LARGE COUNTRY

The welfare effect of an import tariff

• Once the tariff is imposed the price of the imported good rises.

• Domestic producers increase their prices as well. They also expand their output.

• Higher prices reduces consumption.

• Lower consumption and higher domestic production reduces imports.

Small country:

– The decrease in imports does not affect the world price of the good if the country is small.

-The country pays the same price in the world markets.

– A country is small if it takes the world price as given.

– A small country cannot affect the world prices by its supply and/or demand.

The net welfare effect of an import tariff

• The net welfare effects can now be divided into two components:

– Efficiency loss:

• Loss caused to society by the distortion of the price signals for consumers and producers as a result of the imposition of a tariff.

• The two Triangles

– Gain in welfare:

• based on the terms of trade effect of the imposition of a tariff.- Area ______

– The ultimate net wealth effect for a large economy is the balance of the negative effects, b + d, and the positive effect e.

– Since a change in the level of the tariff level does not cause areas b + d to change to the same extent as e, there is a tariff level at which the positive net welfare effect is maximized.

(Optimum tariff).

– For a small country which cannot influence the world market price no improvement in the terms of trade is possible.

• The optimum tariff is zero.

Small Country Case

Large Country Case

GENERAL EQM ANALYSIS OF A TARIFF IN A SMALL COUNTRY

-GEA TO STUDY THE EFFECTS OF A TARIFF ON PRODUCTION, CONSUMPTION, TRADE, AND WELFARE WHEN THE NATION IS TOO SMALL TO AFFECT WORLD PRICES

-THE IMPOSITION OF TARIFF WILL AFFECT THE DOMESTIC PRICE- PRICE OF IMPORTABLE COMMODITY WILL RISE BY THE FULL AMOUNT OF THE TARIFF FOR BOTH INDIV. PRODUCERS AND CONSUMERS BUT ITS PRICE REMAIN CONSTANT FOR THE SMALL NATION AS A WHOLE SINCE THE NATION ITSELF COLLECTS THE TARIFF

-E.G: IF THE PRICE OF IMPORTABLE X IS $1 PER UNIT ANDIF NATION IMPOSE 100% AD VALOREM TARIFF ON IMPORTS OF Xâ‹„DOMESTIC PRODUCERS CAN COMPETE WITH IMPORTS AS LONG AS THEY CAN SELL X AT A PRICE NO HIGHER THAN $2.

-CONSUMERS WILL HAVE TO PAY $2 PER UNIT OF X WHETHER IMPORTED OR DOMESTICALLY PRODUCED. HOWEVER, SINCE THE NATION ITSELF COLLECTS THE $1 TARIFF ON EACH UNIT OF X IMPORTED, THE PRICE OF COMMODITY X REMAINS AT $1 AS FAR AS THE NATION AS A WHOLE IS CONCERNED.

ILLUSTRATION:

-NATION 2 IS THE K-ABUNDANT NATION SPECIALIZING IN THE PRODUCTION OF Y (THE K-INTENSIVE COMMODITY) WHICH IT EXPORTS IN EXCHANGE FOR IMPORTS OF X.

WITH FREE TRADE

-PX/PY=1 ON THE WORLD MARKET, IT PRODUCES AT B, EXCHANGING 60Y FOR 60X WITH THE REST OF THE WORLD, AND CONSUMES AT E ON ITS IC III

W/O FREE TRADE (TARIFF);

- A 100% AD VALOREM TARIFF ON IMPORTS OF Xâ‹„ PX/PY=2 FOR DOMESTIC PRODUCERS AND CONSUMERS BUT REMAINS AT PX/PY=1 ON THE WORLD MARKET AND FOR THE NATION AS A WHOLE.

- FACING PX/PY=2, DOM. PRODUCERS WILL PRODUCE AT F, WHERE PRICE LINE PF=2 IS TANGENT TO NATION’S 2 PPF⋄THUS NATION 2 PRODUCES MORE OF IMPORTABLE COMM X AND LESS OF EXPORTABLE COMM Y AFTER THE IMPOSITION OF TARIFF

- FOR EXPORTS OF ‘FG’ OR 30Y, NATION 2 DEMANDS IMPORTS OF ‘GH’’ OR 30X OF WHICH ‘GH’ OR 15X GOES DIRECTLY TO THE NATION’S CONSUMERS AND ‘HH’’ IS COLLECTED IN KIND BY THE GOVT IN THE FORM OF THE 100% IMPORT TARIFF ON COMM. X

- IC II’ IS TANGENT TO THE DASHED LINE PARALLEL TO PF=2 BECAUSE INDIV CONSUMERS IN NATION 2 FACE THE TARIFF-INCLUSIVE PRICE OF PX/PY=2. HOWEVER SINCE THE GOVT COLLECTS AND REDISTRIBUTES THE TARIFF IN THE FORM OF PUBLIC CONSUMPTION, IC II’ MUST ALSO BE ON THE DASHED LINE PARALLEL TO PW=1 (SINECE THE NATION AS A WHOLE FACES THE WORLD PRICE OF PX/PY=1)

- THE NEW CONSUMPTION POINT H’ IS DEFINED BY THE INTERSECTION OF THE TWO DASHED LINES.

- WITH PRODUCTN AT F AND CONSUMPTN AT H’, THE NATION EXPORTS 30Y FOR 30X AFTER THE IMPOSITION OF TARIFF

[pic]SSUMMARY:

- NATION 2 PRODUCES AT B W FREE TRADE AND EXPORTS 60Y FOR 60X AT PW=1.

- WITH 100% IMPORT TARIFF ON X, PX/PY=2 FOR INDIV. PRODUCERS AND CONSUMERS IN THE NATION BUT REMAINS AT PW=1 ON THE WORLD MARKET AND FOR THE NATION AS A WHOLEâ‹„PRODUCT IS AT F (INCREASE IN DOMESTIC PRODUCTN OF IMPORTABLE COMM X) 30Y IS EXCHANGED FOR 30X.

- CONSUMPTN TAKES PLACE AT H’ ON IC II’ AFTER THE IMPOSITION OF TARIFF. THIS PT IS BELOW THE FREE TRADE CONSUMPTN PT E ON IC III BECAUSE WITH TARIFF SPECIALIZATION IN PRODUCTION IS LESS AND SO ARE THE GAINS FROM TRADE.

THE STOLPER-SAMUELSON THEOREM

-THE SST POSTULATES THAT AN INCREASE IN THE RELATIVE PRICE OF A COMMODITY AS A RESULT OF TARIFF RAISES THE RETURN OR EARNINGS OF THE FACTOR USED INTENSIVELY IN THE PRODUCTN OF THE COMMODITY.

-E.G: WHEN NATION 2 (K-ABUND) IMPOSES AN IMPORT TARIFF ON COMM. X (ITS L-INTENSIVE COMM)â‹„PX/PY RISES FOR DOMESTIC PRODUCERS AND CONSUMERS AND SO WILL THE REAL WAGE OF L.

-WHY?

AS PX/PY RISES, NATN 2 WILL PRODUCE MORE OF X AND LESS OF Y (COMPARE PT F TO PT B)â‹„INCREASE IN PRODUCTN OF X (L-INT) REQUIRES L/K IN A HIGHER PROPORTION THAN IS RELEASED BY REDUCING THE O/P OF COMMODITY Yâ‹„W/r RISES AND K IS SUBSTITUTED FOR L SO THAT K/L RISES IN THE PRODUCTION OF BOTH COMMODITIES. AS EACH UNIT OF LIS NOW COMBINED WITH MORE K, THE PRODUCTIVITY OF L RISES AND THEREFORE W RISES.

-SINCE THE PRODUCTIVITY OF L INCREASES IN THE PRODUCTN OF BOTH COMMODITIES, NOT ONLY THE MONEY WAGE BUT ALSO THE REAL WAGE RISES IN NATION 2.

GENERAL EQM ANALYSIS OF A LARGE COUNTRY

-NATION IS LARGE ENOUGH TO AFFECT INTERNATIONAL PRICES BY ITS TRADING.

-WHEN A NATION IMPOSES TARIFF, ITS OFFER CURVE SHIFTS TOWARD THE AXIS MEASURING ITS IMPORTABLE COMM. BY THE AMT. OF IMPORT TARIFF. (FOR ANY AMT OF EXPORT COMM., IMPORTERS NOW WANT SUFFICIENTLY MORE OF THE IMPRT COMM.)

-IMPOSTION OF TARIFF REDUCES THE VOLUME OF TRADE BUT IMPROVES THE NATION’S TOT.

⋄THE REDUCTION IN THE VOL OF TRADE REDUCES THE NATION’S WELFARE.

⋄IMPROVEMENT IN TOT INCREASES THE NATION’S WELFARE

⋄WHETHER THE NATION’S WELFARE INCREASES OR DECLINESDEPNEDS ON THE NET EFFECT OF THESE TWO OPPOSING FORCES.

-ILLUSTRATION:

[pic]

-THE IMPOSITION BY NATN 2 OF A 100% AD VALOREM TARIFF ON ITS IMPORTS OF X IS REFLECTED IN NATION 2’S OC ROTATING TO OC 2’ IN FIG 8-5.

-W FREE TRADE:

THE INTERSECTION OF OC2 AND OC1 DEFINES EQM PT E AT WHICH NATION 2 EXCHANGED 60Y FOR 60X AT PX/PY=PW=1

-W/O FREE TRADE:

THE INTERSECTION OF OC2’ AND OC1 DEFINES NEW EQM PT E’ AT WHICH NATION 2 EXCHANGES 40Y FOR 50X T THE NEW WORLD PEICE OF PX/PY=PW’=0.8

-THUS THE TOT OF NATION 1 DETERIORATES FROM PX/PY=PW=1 TO PX/PY=PW’=0.8. THE TOT OF NATION 2 IMPROVES FROM PY/PX=1 /PW=1 TO PY/PX=1/PW’=1/0.8=1.25

-THUS WHEN LARGE NATION 2 IMPOSES A TARIFF, THE VOL. OF TRADE DECLINES BUT ITS TERMS OF TRADE IMPROVES BUT HOW ABOUT ITS WELFARE?

THE OPTIMUM TARIFF

-THE OPTIMUM TARIFF IS ONE THAT MAXIMIZES THE NET BENEFIT RESULTING FROM IMPROVEMENT IN NATION’S TOT AGAINST THE NEGATIVE EFFECT RESULTING FROM REDUCTN IN THE VOLUME OF TRADE.

-SINCE NATION’S BENEFIT COMES AT THE EXPENSE OF OTHER NATIONS, THE LATTER ARE LIKELY TO RETALIATE, SO THAT IN THE END ALL NATIONS USUALLY LOSE.

 

-----------------------

1

................
................

In order to avoid copyright disputes, this page is only a partial summary.

Google Online Preview   Download