Chapter 9.

Instruments of Trade Policy

9.1 Basic Tariff Analysis (基本的關稅分析)

 Tariff (關稅): a tax levied on an imported good

- Specific tariffs(從量稅): a fixed change for each unit of goods imported

- Ad valorem tariffs(從價稅): a fraction of the value of the imported goods.

Oldest form of trade policy
 Importance of tariffs is declining
a source of government income
- Import quotas: Limitations on the quantity of imports

- Export restraints: limitations on the quantity of exports-usually imposed by the exporting

country

<Supply, Demand & Trade in a Single Industry>

 Assumptions

- H-F, No transaction cost, perfect competitions.

- The exchange rate between two countries is fixed and ignored.

- Suppose that the price of wheat is higher in Home in the absence of trade.

- The producers in Foreign begin to move wheat from F to H, until the differences in prices
has been eliminated

 Analysis of Home import demand & Foreign export supply

The price in
H is higher &
that in F is P
P lower From P
S Foreign
XS
*
Pa Pa S

Pb Pb

PW

From
Home
*
D MD D

Sb Db Q (Db–Sb) Q (S *–D *) Q * * Q
W b b Db Sb
Home Foreign
<Fig 9-1&2: Deriving Home’s Import Demand and Foreign’s Export Supply Curve>
 Home demand - Home Supply = Foreign Supply - Foreign demand

Home demand + Foreign demand = Home Supply + Foreign supply

<Effects of a Tariff>

With the tariff in place, shippers are not

willing to move wheat from Foreign to
Home unless the Home price exceed the
Foreign price by at least $t

P P XS P
S XS
’ *
S

2 t
PT
1
PW

t 3 *
PT

*
D MD D
Q QT QW Q Q
Home Foreign

<Fig 9-4: Effects of a Tariff>

 From viewpoint of someone exporting goods, a tariff is just a cost of transportation.

- If Home imposes a tax of $2 on every bushel of wheat imported, shippers will unwilling to
move the wheat unless the price difference between the two markets is at least $2

 Tariff raise the price in Home to Pt and Lowers the price in Foreign to Pt* = Pt - t.

- Home : producers supply more at the higher price Fewer import demand
consumers demand less

- Foreign : Reduced supply at the lower price

Smaller export supply!
increased demand

- Traded volume : Qw  Qt

- price changes after tariff
In Home, Pt - Pw < t
Pw - Pt* is often very small
When a small country imposes a tariff, its
share of the world market for the goods is
usually minor to begin with, so that its
import reduction has very little effect on
the world (foreign export) price.
  When a small country cannot affect foreign export prices, a tariff raises the price of imported
good by the full amount of the tariff

P
S

PW + t
Imports before tariff: D1 – S1
PW
Imports after tariff: D2 – S2

S1 S2 D2 D1 Q
<Fig 9-5: A Tariff in a Small Country>

<Measuring the Amount of protection>

 In analyzing trade policy in practice, it is important to ask how much protection a tariff or other
policy actually provides.

- Some effects of a tariff is to lower foreign export prices

- Tariffs may have very different effects on different stages of production of a good

 Example of tariff effect

- Sps completed automobile price $8,000

costs of parts
parts out of which that automobile is made sell for $6,000

H: the first country wants to develop an auto assembly industry

① Domestic auto industry

- tariff of $2,000 on imported autos -> Domestic assemblers change $10,000

(25% tariff) $8,000 (instead of $8,000)

- Before tariff, Domestic assembly would take place if it could be done for $2,000 or less

- Now it will take place even if it costs as much as $4,000

Effective rate of protection = 100%

The Second country wants to encourage domestic protection of parts.

② In order to encourage domestic production of parts, imposes a 10% tariff on imported parts.
Raising the cost of parts of domestic assemblers from $6,000 to $6,600

- The tariff on parts, while providing positive protection to parts manufacturers, provides negative
effective protection to assembly industry at the rate of -30%(-600/2,000)

 Definition of the effective rate of protection

PA: world price of an assembled automobile

Value added in Value added in PC: world price of its components

the presence of the sector at
trade policies world prices tA: tariff on imperted autos

tc: tariff on components

① PA = $8,000, tA = 0.25

PC = $6,000, tc = 0

(VT – VW)/ VW = 0.25 + $6,000

= 1.00

② tA = 0, tC = 0.10

(VT – VW)/ VW = 0+ $6,000

= -0.30

9.2. Cost & Benefits of a Tariff  ToT gains

RS2 • Tariff raises the price of a good in the

PC/PF importing country & lowers it in the
RS1
exporting country

2
2 - Importing country: Consumers lose &
(PC/PF)
producers gain. Gov’t’s Tariff revenue!

- Exporting 〃 : Consumer gain &

1 1 2
producers lose
(PC/PF) RD

1
RD
<Consumer & Producer Surplus>

<Measuring the Cost & Benefits>

P
S • Changes in Consumer Surplus: CS falls by the
areas of a, b, c, & d

• Producer Surplus: PS increases by a

PT • Tariff Revenue: c & e
a b c d
PW
*
e
PT
D

S1 S2 D2 D1 Q

<Fig 9-9: Cost and Benefits of a Tariff

for the Importing Country>

Net effect of a tariff on welfare

CS Loss – PS gain – Gov’t Revenue

= (a+b+c+d) – a – (c+e)
=b+d–e

b: production distortion loss (The tariff leads domestic producers to produce too much)

d: consumption distortion loss (The tariff leads consumers to consume too little)

e: terms of trade gain (The tariff lowers foreign export prices)

(If a small country cannot affect foreign prices, this last effect drops out)

 Some complications

- What if the good is a luxury for the affluent, but is produced by low-wage workers?
What if the producer gain accrues to wealthy owners of resources, while consumers are poor
than average?

- What if the tariff revenue is used for public services for poor?
 9.3. Other Instruments of Trade Policy
輸出補助金  ToT loss
<Export Subsidies : Theory>

PC
/P RS1
F
P P
R XS
S S
1 XS
(P /P )
C F
1
2 ’
3 PS
a b c
2
1
1 d
2 RD PW
(P /P )
C F e f g
2
RD *
PS
subsidy 2

MD D
Q Q
Exports

<Fig 9-11: Effects of an Export Subsidy>

 The effects of export subsidy on prices are exactly the reverse of those of a tariff

 In exporting country, consumers are hurt, but producers gain, and gov’t loses because it must
expend money on the subsidy.

- Consumer loss: a + b

- Producer gain: a + b + c (producers find it more profitable to export)

- Gov’t Subsidy: b + c + d + e + f + g (cost)

- Net welfare loss: b + d + e + f + g = (a + b) – (a + b + c) + (b + c + d + e + f + g)

b: consumption distortion loss

d: production distortion loss
e + f + g: terms of trade loss

(The export subsidy worsen the terms of trade

by lowering the export price in the foreign
market from PW to Ps*)
<Import Quotas(數量割當): Theory>

 An import quota is a direct restriction on the quantity of some good that may be imported

- Licenses to some group are issued

P P
S S

Pq
Pq
a a b c d
b c d PW
PW
*
Pq
D D

D2 D1 S1 S2 D2 D1 Q
S1 S2 Q

소국경제  대국경제

 An import quota always raises the domestic price of the imported good.

- When imports are limited, the demand exceeds domestic supply plus imports. This causes the
price to be bed up until the equilibrium.

 With a quota, the gov’t receives no revenue

- License holders are able to buy imports and resell them at a higher price in the domestic
market

- The profits received by the holders of import licenses are known as quota rents

- When the rights to sell in the domestic market are assigned to gov’t of exporting countries,
the transfer of rents abroad makes the cost of a quota higher than the equivalent tariff.

 Welfare Effects

- CS loss: a+b+c+d

- PS gain: a

- quota rents: c

- Net effects = (a + b + c + d) – a – c = b + d (quota rent is in domestic importers)

- if the license is in foreign gov’t, = (a + b + c + d) – a = b + d + c

<Voluntary Export Restraints(自律的輸出規制)>

 VER : A quota on trade imposed from the exporting country’s side instead of the importer’s

- Certain political & legal advantages have made VER preferred instruments.

- From an economic point of view, VER is exactly like an import quota where the licenses are
assigned to foreign gov’ts & is therefore very costly to the importing country

- VERs are always more costly to the importing country than tariffs that limits imports by the
same amount.

Some specified fraction of a final good

<Local Content Requirements(國內化率規制)> to be produced domestically

 Local content laws have been widely used by developing countries trying to shift their
manufacturing base from assembly back into intermediate goods.

- For the domestic producers of parts, a local content regulation provides protection in the
same way an import quota does.

- From the viewpoint of the firm that must buy locally, local content does not place a strict
limit on imports. It allows firms to import more, provided that they also buy more
domestically.

 The local content does not produce either government revenue or quota rents

- The difference b/w the prices of imports & domestic goods in effect gets averaged in the
final price & is passed on to consumers.

<Other Trade Policy Instruments>

 Export credit subsidies: 輸出信用補助金

This is like an export subsidy except that it takes the firm of a subsidized loan to the buyer
EX – IM Bank (輸出入銀行)

 National Procurement: 國産購入

Purchases by the government or strongly regulated firms can be directed forward domestically
produced goods even when those goods are more expensive than imports.

 Red-tape barriers: 行政的進入障壁

Health, Safety, & Customs procedures

Sometimes a government wants to restrict imports without doing formally.
 Table 9-1: Effects of Alternative Trade Policies

Voluntary Export
Tariff Export Subsidy Import Quota
Restraint
PS + + + +
CS - - - -
Gov’t rev. + - + -
Overall welfare ? - ? -
(falls for small country) (falls for small country)

9.4. The Effects of Trade Policy: A Summary

 All four trade policies benefit producers and hurt consumers.

- The effects of the policies on economic welfare are at best ambiguous; two of the policies
definitely hurt the nation as a whole, while tariffs and import quotas are potentially beneficial
only for large economies that can drive down world prices.

9.5. Appendix: Tariffs & Import Quotas in the Presence of Monopoly

 Assumptions : Int’l trade limits monopoly power

<The Model with Free Trade>

P
Before trade, the monopolist changes PM,
producing QM. After trade, he has to accept PW,
where imports are available in unlimited
MC
PM quantities.
The domestic monopolist produce Qf at PW.

Remember Belgium, Sweden & Norway cases!

Consumer gain
PW
D
MR

Qf QM Df Q

Imports under
free trade

<Fig 9A-1: A Monopolist Under Free Trade>

 <The Model with a Tariff>

After tariff, the best the monopolist can

do is to set price equal to marginal cost
MC at Qt.
PM

PW + t
PW
D
MR

Qf Qt QM Dt Df Q

<Fig 9A-2: A Monopolist Protected by a Tariff>

<The Model with an Import Quota>

The demand facing the monopolist will be

domestic demand minus allowed imports,
MC the post-quota demand curve is Dq; it is
Pq parallel to the domestic demand curve D,
but shifted units to the left.

The license to import one unit of the good

will therefore yield a rent of Pq - PW

The Monopolist is now free to raise prices,

PW D
knowing that the domestic price of imports
Dq
will rise too.

Qq Q
Qq+ MRq

<Fig 9A-3: A Monopolist Protected by an Import Quota>

 <Comparing a Tariff & a Quota>

P
At PW + t, import amount is , which is the
same with quota.

MC
Pq

PW + t

PW D
Dq
MRq
Qq Qt Q +
t

<Fig 9A-4: Comparing a Tariff and a Quota>

 To make comparison, we see a tariff & a quota that lead to the same level of imports

( The tariff level t leads to a level of imports ; we ask what would happen if instead of a tariff the
government simply limited imports to )

- Tariff: Qt, PW + t

- Quota: Qq, Pq

 When protected by a tariff the monopolistic domestic industry behaves as if it were perfectly
competitive; Protected by quota it clearly does not.

- An import quota creates more monopoly power than a tariff