International Economics
Tariffs and Its Implication
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Tariffs
Why restrict trade?
Benefits of free trade come in the long
term, and are usually spread widely across
society
Costs of free trade are felt rapidly and are
usually concentrated in specific sectors of
the economy (in which companies face
losses and workers lose their jobs)
Tariffs
Defining tariffs
A tariff is a tax (duty) levied on products as
they move between nations
Import tariff - levied on imports
Export tariff - levied on exported goods as they
leave the country
Protective tariff - designed to insulate domestic
producers from competition
Revenue tariff - intended to raise funds for the
government (no longer important in industrial
countries)
Tariffs
Types of tariff
Specific tariff
Fixed monetary fee per unit of the product
Ad valorem tariff
Levied as a percentage of the value of the product
Compound tariff
A combination of the above, often levied on finished
goods whose components are also subject to tariff if
imported separately
Effective rate of Protection
The impact of a tariff is often different from its
stated amount. Nominal tariff rate gives only general
idea about protection.
Different tariff rates on raw materials, intermediary
goods and final goods have to be taken into
consideration to understand their combined effect on
the domestic production and to comprehend the
actual level of protection.
The effective tariff rate measures the total increase in
domestic production that the tariff makes possible,
compared to free trade
Tariffs
Effective rate of protection (cont’d)
When tariff rates are low on raw materials
and components, but high on finished
goods, the effective tariff rate on finished
goods is actually much higher than it
appears from the nominal rate
This is referred to as tariff escalation
Effective rate of Protection (cont’d)
Example:
Foreign Radio Import Domestic Competing Radio
Component (cost) $80 $80
Assembly Activity (Vl. Add) 20 30(?)
Nominal tariff 10
Import Price 110 Domestic price 110
The nominal tariff rate is 10% but the country enjoys the protection
level of 50% and hence the effective rate of protection of 50%. How?
Under the protective environment, domestic producers can afford to
pay upto $30 for assembly and total price remains as $110.
So, domestic assembly cost rises up to a level of 50% above in a
protective environment: ($30-$20)/$20=0.5
Effective rate of Protection (cont’d)
Formula:
e= (n-ab)/(1-a), Where
e=effective rate of protection, n= nominal rate on final product,
a= ratio of value of the imported input to the total value of the
product
b= the
Some nominal rate
interesting on input
observations
n a b (n-ab) (1-a) e
0.1 0.8 0 0.1 0.2 0.5
0.1 0.8 0.05 0.06 0.2 0.3
0.1 0.9 0 0.1 0.1 1
0.1 0.9 0.05 0.055 0.1 0.55
Effective rate of Protection (cont’d)
• Higher the import content greater is the effective rate of
protection given a nominal rate.
• Higher nominal tariff rate on the the intermediate
products smaller is the effective rate of protection
• Generally, it has been observed that inputs attract a very
low rate of duty and final products enjoy high duty. This is
called Tariff Escalation.
Avoiding and postponing tariffs (US)
Production sharing and special treatment
for foreign assembly
Bonded warehouses
Foreign trade zones
Tariffs
Tariff welfare effects
Consumer surplus
The difference between the price buyers
would be willing to pay and what they
actually pay
Producer surplus
The revenue producers receive above the
minimum amount required to induce them to
produce a good
Tariffs
Consumer and Producer Surplus
Price ($)
Price ($)
5
Supply
5
B 4 Producer
(minimum price)
Consumer surplus
4 surplus
3
3
C (actual price) 2
A C (actual price)
A 2
Total
expen Demand 1 Total
1 diture (maximum variable cost
D E price) B0 D
0
0 2 4 6 8 10
0 2 4 6 8 10
Gasoline (gallons) Gasoline (gallons)
Tariff, Trade and Welfare effects
12,000 Before Tariff C.S= a+b+c+d+e+f+g
11,500
11,000 After tariff C.S= e+f+g
D Sd
Price ($)
10,500
10,000
9,500
g
9,000 E
8,500
e f G
8,000 Sd+w+t
7,500 a b c d F
7,000 Sd+w
6,500 h
6,000
0 10 20 30 40 50 60 70 80 90 100 D110
d
Quantity of autos
Before tariff P.S= h, after tariff P.S= a+h. Govt. Rev= c
Tariff trade and welfare effects
Revenue Effect= C
Redistributive Effect= a= increase in P.S
Protective Effect= b= loss of domestic economy
resulting from wasted resources used to produce additional
units of the good at increasing cost
Consumption Effect=d= loss in consumer surplus, is
the residual not accounted for. This is a welfare loss
because of the increased price and lower consumption.
Deadweight Loss=b+d
Welfare effects of tariffs
Tariff trade and welfare effects
Large nation model
Price ($)
Sd
E
9,600
G Sd+w+t
8,800
a b c F
8,000
d Sd+w
7,800 e
Dd
0 10 20 30 40 50 60 70 80 90 100 110 120 130 140 150
Quantity of autos
Stolper-Samuelson Theorem
Stolper-Samuelson Theorem demonstrates that the effects of a
tariff are unambiguous within the context of the standard trade
model. Following the Heckscher-Ohlin reasoning, we can say
that a country exports that good which it produces primary with
the help of its abundant factor of production. A tariff will
decrease production of exportables and lead to an increase in
production of the import-competing good, and benefit the scarce
factor-that used intensively in the import sector. Thus a tariff will
benefit a country’s scarce factor of production in an unambiguous
fashion and cause real income of the abundant factor to fall.
Tariff effects
Who pays for 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)
Export industries face higher costs for inputs
Cost of living increases
Other nations may retaliate, further restricting
trade
Reasons for tariffs
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
Reasons for tariffs
Politics of protectionism
“Supply” of protectionism (trade policy)
depends on:
the cost to society of restricting trade
the political importance of the import-
competing industries
Magnitude of the adjustment costs from free
trade
Public sympathy for those sectors hurt by free
trade
Reasons for tariffs
Politics of protectionism
“Demand” for protectionism depends on:
The amount of the import-competing
industry’s comparative disadvantage
The level of import penetration
The level of concentration in the affected
sector
The degree of export dependence in the sector
