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What are tariffs?

DEF1: Tariffs are taxes that are imposed on nations’ import goods and/or export goods

DEF2: Tariffs are taxes or duties levied on the traded commodity as it crosses a national boundary

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Types of tariffs Import tariff – A tax or duty on import

commodity Export tariff – A tax or duty on export

commodity Ad valorem tariff – a tariff expressed as

a fixed percentage of the value of a traded commodity

Specific tariff – A tariff expressed as a fixed sum per unit of a traded commodity

Compound tariff – A combination of an ad valorem and a specific tariff

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Explanation cont’d Prohibitive tariff – A tariff sufficiently

high to stop all international trade so that the nation returns to autarky

Optimum tariff – A tariff that maximizies the welfare of a nation

Scientific tariff – the tariff rate that would make the price of imports equal to domestic prices so as to allow domestic producers to meet foreign competition

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Explanation cont’d

Nominal tariff – A tariff calculated on the price of a final commodity

Effective tariff – A tariff calculated on the domestic value added in the production of a commodity

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Arguments pro

Infant industry argument Financial aid to the budget (rent) Political reasons

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Arguments contra

Consumers pay higher price of imports

Reduced welfare

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Small vs. Large nation

What is the difference between small and large nation?

Small nation cannot change world prices (price taker)

Large nation CAN change world prices (price maker)

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Repetition

Consumer surplusis the difference between what consumers are willing to pay for each unit of the commodity and what they actually pay

Rent or producer surplusis a payment that need not to be made in the long run in order to induce producers to supply a specific amount of a commodity

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Import tariff (small nation case)

QX

PX

0

SX

DX

EPA

PW

C D

imports

PW+tG F

a b c dH I

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The effects of import tariff in small nation Ad valorem import tariff in 100%

amount doubled the domestic price of commodity X in small nation (Pw to Pw+t)

Did the world price change? Did consumers’ & producers’ surplus

change? Who collects the revenue from an

import tariff and in what amount?

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DWL

Dead-weight loss (protection costs) arise from the imposition of import tariff in small nation

DWL=CS+PS+GR==DWL=-(a+b+c+d)+a+c==DWL=-(b+d)

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Costs and benefits for a small nation? Import tariff in small nation redistributes

income from… …domestic consumers (who pay higher

price for the commodity) to domestic producers of the commodity (who receive the higher price)

This leads to inefficiencies (protection costs) of the tariff

Small nation always loses from the imposition of the import tariff

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Quotas

DEF: A quota is a direct quantitative restriction on the amount of a commodity allowed to be imported or exported in a nation

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Types of quotas

Import quotas (most common) Export quotas (in form of VERs) Reasons to use quotas?

To protect domestic industry Balance of payment reasons Improve nation’s terms of trade (only

in large nation case)

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Effects of an import quota in small nation (Q=40)

0 QX

PX

SA

100

DA

SA+Q

80604020

2

3

4

1

C D

A F G BHPw

Pw+Q

Small Nation A

quota

a b c d

E

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What are the effects of an import quota in a small nation?

Import quota has the same effects as an equivalent import tariff for the nation

Try to determine equivalent ad valorem import tariff?

Who gains quota revenues?

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What if we used offer curves?

Using the offer curve for small Nation A, show graphical demonstration of an import quota in the same nation

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Problem set Lets assume that Nation A is a small

nation and imports commodity X from the RoW at the price Pw=10

Supply and demand curves are given:

PD

PS

10400

550

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Give solution to the followinga) Determine autarchy price and quantityb) Determine production, consumption and

import quantitiesc) If import quota is imposed in the amount of

Q=50, calculate the followingd) Domestic price after imposing import quotae) Change in consumer surplusf) Change in producer surplusg) Quota revenuesh) Consumption costs (consumers’ DWL)i) Production costs (producers’ DWL)j) Small nation’s total DWL

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Review questions

Answer the following questions (only one answer is correct)

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Question #1

1. Which of the following will occur as a result of a tariff on an imported good in a small nation?

a) The price of the imported good and the domestic competing good will increase

b) The quantity consumed by domestic consumers will increase

c) Domestic consumers will gaind) The nation will gain

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Question #2

2. If a prohibitive tariff is imposed on imports of textiles, then

a) Imports will be zerob) Consumer surplus will be zeroc) Domestic production will fall to zerod) Domestic consumption will fall to

zero

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Question #3

3. If the consumption effect of a tariff was 50 units and the production effect of a tariff were 40 units, then imports would

a) Increase by 10 unitsb) Increase by 90 unitsc) Decrease by 90 unitsd) Decrease by 10 units

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Question #4

4. If tariff in a small country produces a dead-weight loss of $60, reduces consumer surplus by $200, and increases producer surplus by $40, which of the following is correct?

a) National welfare falls by $220b) National welfare falls by $160c) Tariff revenues equal $100d) The price of the imported good must have

fallen

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Question #5

5. Which of the following will occur if each nation imposes a scientific tariff on its imports?

a) Trade will occur on a fair basisb) Poor countries will gain more from

tradec) No trade will occurd) Rich nations will dominate trade

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Correct answers

1. a2. a3. c4. c5. c

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