The Instruments of Trade Policy

Reported by: Facundo, Santos and Taruc
Basic Tariff Analysis
Tariff- is a tax impose when a good is imported. It is the simplest and oldest form of trade policy.
It has been used as a source of government income and has the purpose of protecting the
domestic sectors.
Specific tariff- is a fixed charge for each unit of goods imported.
Ad valorem tariffs- taxes that are collected as a fraction of the value of the imported goods.
In the early 19th century the countries used tariffs used to protect the domestic sectors from
import competition. But in the modern times, the importance of tariff has decline, because the
government prefers to use nontariff barriers as a way of protecting the domestic industries.

Cost and Benefits of Trade
Consumer surplus
- measures the amount a consumer gains from a purchase by the difference
between the price he actually pays and the price he would have been willing to
- Consumer surplus is a measure of how much a consumer will give up in terms of
money or alternative purchases to purchase a specified product.
Imagine that you own a mint-condition recording of Elvis Presley’s first album. Because
you are not an Elvis Presley fan, you decide to sell it. One way to do so is to hold an
Four Elvis fans show up for your auction: John, Paul, George and Ringo. Each of them
would like to own the album, but there is a limit to the amount that each is willing to pay
for it.
To sell your album, you begin the bidding at a low price, say P100. Because all four
buyers are willing to pay much more, the price rises quickly. The bidding stops when
John bids P200. At this point, Paul, George and Ringo have dropped out of the bidding
because they are unwilling to bid any more than P200. John pays P200 and gets the
What benefit does John receive from buying the Elvis Presley album? In a sense, John
has found a real bargain. He is willing to pay P250 for the album but pays only at P200
for it. We say that John receives consumer surplus of P50.
Producer surplus
- is the amount a seller is paid minus the cost of production.
- measures the benefit sellers receive from participating in a market.
- the amount a seller is paid for a good minus the sellers cost of providing it.
Imagine now that you are a homeowner and you want to get your house painted. You
turn to four sellers of painting services Mary, Frida, Georgia and Grandma. Each painter
is willing to do the work for you if the price is right. You decide to take bids from the four
painters and auction off the job to the painter who will do the work for the lowest price.

When you take your bid from the painters. an export subsidy can be either specific (a fixed sum per unit) or ad valorem (a proportion of the value exported). This is like an export subsidy except that it takes the form of a subsidized loan to the buyer. A VER is a quota on trade imposed from the exporting country’s side instead of the importer’s. we say that she receives producer surplus of P100. National procurement. Mary. (Note that the job goes to the painter who can do the work at the lowest cost. Voluntary export restraint (VER). Once Grandma has bid P600.) What benefit does Grandma receive from getting the job? Because she is willing to do the work for P500 but gets P600 for doing it. Frida and Georgia are unwilling to do the job for less than a payment to a firm or individual that ships a good abroad. but it quickly falls as the painters compete for the job. The restriction is usually enforced by issuing licenses to some group of individuals or firms. Other Instruments of Trade Policy Export subsidy. An Import Quota in Practice: U. Sugar . Import quota. Case Study #1. Purchases by the government or strongly regulated firms can be directed toward domestically produced goods even when these goods are more expensive than imports. also known as a voluntary restraint agreement (VRA) is a variant on the import a direct restriction on the quantity of some good that may be imported. Grandma is happy to do the job for this price because her cost is only P500. Local content requirement is a regulation that requires some specified fraction of a final good to be produced domestically. Like a tariff. she is the sole remaining bidder. Export credit subsidies.S. the price might start high.

Part of this consumer loss represents a transfer to U. at the expense of a large number of consumers. however. a total of $580 million per year. sugar producers. that is. that removing the quota would not have a significant effect on the price. The net loss to the United States is the distortions (b + d) plus the quota rents (c). the quota is a life-or-death issue. the average American voter is unaware that the sugar quota exists.109 billion) and the consumption distortion d ($0. Notice that most of this net loss comes from the fact that foreigners get the import rights! The sugar quota illustrates in an extreme way the tendency of protection to provide benefits to a small group of producers. however.646 billion. the domestic supply in the United States does not exceed domestic demand. From the point of view of the sugar producers.The U. The . In this case. who then allocate these rights to their own residents. The figure is drawn on the assumption that the United States is "small" in the world sugar market.S. Thus the United States has been able to keep domestic prices at the target level with an import quota on sugar. to 4. rents generated by the sugar quota accrue to foreigners. Unlike the European Union. b. prices above world market levels. sugar problem is similar in its origins to the European agricultural problem: A domestic price guarantee by the federal government has led to U. the yearly consumer loss amounts to only about $6 per capita. free trade would roughly double sugar imports.S.S. Figure 8-13 shows an estimate of the effects of the sugar quota in 1990. and so there is little effective opposition. or perhaps $25 for a typical family. As a result. According to this estimate.395 billion.076 billion). The welfare effects of the import quota are indicated by the areas a. Not surprisingly.13 million tons. equal to $0. who gain the producer surplus a: $1. the price of sugar in the United States was a bit more than 40 percent above that in the outside world.066 billion. Part of the loss represents the production distortion b ($0. with a total value of $1. each of whom bears only a small cost. A special feature of the import quota is that the rights to sell sugar in the United States are allocated to foreign governments. c. Consumers from the United States lose the surplus a + b + c + d. as a result.3 The quota restricted imports to approximately 2. each of whom receives a large benefit.12 million tons. and d. The rents to the foreign governments that receive import rights are summarized by area c.

and foreign consumers. sugar industry employs only about 12. so the producer gains from the quota represent an implicit subsidy of about $90.S.U. A Voluntary Export Restraint in Practice: Japanese Autos For much of the 1960s and 1970s the U. industry would survive. buyers.000. Economists who have studied the sugar industry believe that even with free trade. foreign firms have chosen not to challenge the United States in the large-car market. and. preferred much larger cars than Europeans and Japanese. Thus the consumer cost per job saved is more than $500.000 workers.S. In 1979. It should be no surprise that sugar producers are very effectively mobilized in defense of their protection. living in a large country with low gasoline taxes. only 2000 or 3000 workers would be displaced. Opponents of protection often try to frame their criticism not in terms of consumer and producer surplus but in terms of the cost to consumers of every job "saved" by an import restriction. auto industry was largely insulated from import competition by the difference in the kinds of cars bought by U. U. sharp oil price increases and temporary gasoline shortages caused .000 per employee. #2. most of the U.S.S. however.S. by and large.

fearing unilateral U. in 1981. The U.S. resulted on the protection to provide benefits to small group of producers. Nonetheless. the Japanese industry to some extent responded to the quota by upgrading its quality. industry. sugar producers in the U. agreed to limit their sales. with the rent captured by Japanese firms.S. protectionist measures if they did not do so. A revision raised that total to 1. #2. government estimates the total costs to the United States at S3. Third. cars were clearly not perfect substitutes. In 1985. limited Japanese exports to the United States to 1. Second. Like in the case of America and Japan. Sugar Enforcing the import quota in the U. In the long run countries engaging in VER can also benefit from each other. An Import Quota in Practice: U. selling larger autos with more features. whose costs had been falling relative to their U. at the expense of a large number of consumers.85 million in 1984 to 1985. moved in to fill the new demand. market to shift abruptly toward smaller cars. With the effectivity of the import quota.S. the auto industry is clearly not perfectly competitive. the agreement was allowed to lapse. The effects of this voluntary export restraint were complicated by several factors.2 billion in 1984. the U.the U.68 million automobiles. The first agreement.S. they have export restraint but they can still share the technology and designs that are present in their automobiles. competitors in any case. the basic results were what the discussion of voluntary export restraints earlier would have predicted: The price of Japanese cars in the United States rose.S.S. . As the Japanese market share soared and U. Japanese and U. strong political forces in the United States demanded protection for the U. primarily in transfers to Japan rather than efficiency losses. Case Analysis #1. are effectively mobilized in defense of their protection. First. each of whom bears only a small cost.S. government asked the Japanese government to limit its exports. each of whom receives a large benefit. Rather than act unilaterally and risk creating a trade war.S.S. Japanese producers. A Voluntary Export Restraint in Practice: Japanese Autos A VER is always costly on the importing country as it is imposed on the exporting country. output fell.S.S. The Japanese.