The effective rate of protection

In the real world, output goes through stages of production. At successive stages,
primary factors of production process intermediate inputs. The resulting output sells
for more than the cost of materials, and the difference is called value added:
Value added (VA) = Price of output (P) - Cost of materials (CM).
Nominal tariffs are applied to output prices, but the beneficiaries of tariffs are the
owners of the factors of production used to process inputs. The effective rate of
protection computes the tariff rate as a proportion of the value added by an economic
activity, so it is a much more accurate measure of how a particular stage of production
is affected by nominal tariffs.
Nominal tariff: tn = [(Pt - Pf)/Pf].100
Effective tariff: te = [(VAt - VAf)/VAf].100
Example: Consider purchasing intermediate inputs such as steel to manufacture a
refrigerator:
Situation
Free trade
10% tariff on
refrigerators
10% tariff on
materials
10% tariff
across-the-board

Tariff on
Price of
Tariff on
refrigerators refrigerators (P) materials

Cost of
materials
(CM)

Value
added
(VA)
VAf =
$400

Effective rate of protection

0%

$1,000

0%

$600

10%

$1,100

0%

600$

$500

25% = [(500-400)/400].100

0%

$1,000

10%

$660

$340

-15% = [(340-400)/400].100

10%

$1,100

10%

$660

$440

10% = [(440-400)/400].100

Effective protection is usually higher than nominal protection.