ANALYSIS OF A TARIFF

• A tariff is a tax on importing a good or service into

a country usually collected by customs officials at
the place of entry
• specific tariff - money amount per unit of import
• ad valorem tariff - percentage of the estimated
market value of the good

A Preview of Conclusions
• A tariff almost always lowers world well-being
• usually lowers the well-being of the nation
imposing the tariff
• “nationally optimal” tariff a possible exception
o Can gain from own at world’s expense
• absolutely helps those groups tied closely to the
production of import substitutes

The Effect of a Tariff on Domestic Producers

• domestic producers that compete against imports
will benefit from a tariff
• The tariff make imports less competitive in the
domestic market
• By raising the price to $300
o Some will continue to buy bikes, paying $30
more per bike.
o Some will decide that a bike is not worth $330 to
them, so they will not buy at the higher price.
• net loss to consumers is area abcd
• consumer surplus from FEC to FGH
o abc is CS loss for buyers, d is loss for nonbuyers
• What domestic consumers lose larger than what
domestic producers gain
• the tariff is definitely a net loss on bicycle
consumers and bicycle producers

The Tariff as Government Revenue

• As long as the tariff is not so high, it also brings
revenue to the country’s government
• total government revenue is the tariff of $30 times
the imports of M1 ($18 million a year)

The Net National Loss from a Tariff

• determine the net effect of the tariff
• impose a social value judgment
o one-dollar, one-vote metric - dollar of gain or
loss is just as important as every other dollar of
• small country – price to pray for imports not
gain or loss
affected o shows clear net loss to the importing country
• producer surplus - above the supply curve and and to the world
below the market price line (CVA)
o other resources used in production may also
share in the producer surplus
o expansion of quantity produced could drive up
wage rates
• net gain (producer surplus) of $90 on this first unit
($310 minus $200)
• tariff of 10 percent
o $300 received by exporters
o domestic price of imported bikes rises to $330
o domestic firms respond by raising their output
o domestic producers expand output by 200,000
units
o MC of each of these units is between $300 and
$330
o domestic producer surplus is g + a (up by a)

The Effect of a Tariff on Domestic Consumers

• Domestic consumers end up paying a higher price,
buying less or both
• consumer surplus - below the demand curve and
above the market price line
• the country’s government gains some tariff revenue
o willing to pay $540 for the first bike
• the dollar value of what the consumers lose
o can buy for $300 for the first, net gain of
exceeds even the sum of the producer gains
$240
o net national loss is area b plus area d
o the entire area (FEC) between the demand
• with free trade, price of imports is $300, imports M0
curve and the $300 price line
bikes
• with tariff, it rises to $330, imports only M1, tariff
revenue equal to area c
• net national loss (right side) is area b + d or $6m
o b imports replaced by domestic production
o d from lower domestic consumption
▪ deadweight loss (nobody else gains)
▪ inefficiency for those consumers
squeezed out of buying bicycles
because the tariff artificially raises the
domestic price
o ΔM: estimated volume by which the tariff
reduces imports
o You can stipulate how much more weight you put
on each dollar of effect on bicycle producers
than on each dollar for consumers
o see whether the net effect of the tariff is still
negative
• We have assumed that the importing nation, here
the United States, cannot affect the world price of
the imported good • national gain, e - b – d, greater than the national
• monopsony power - the country’s buying can affect gain at any other tariff rate
the world price unilaterally • whole world: the nationally optimal tariff is still
• large country can have terms-of-trade effect unambiguously bad
• terms-of-trade effect - the ratio between the index o The United States gains area e but foreign
of export prices and the index of import price suppliers suffer more
• if the United States (now a large country) imposes a o lose area f in additional surplus
o the world loses areas b + d and f
small tariff on bicycles
o likely to lower foreign price a bit and raise the • Foreign governments may retaliate by putting up
domestic price a bit new tariff barriers against our exports
o US imports fewer bicycles because the tariff
increases the domestic price, so foreign firms
export fewer and produce fewer.
o By removing demand pressure on foreign
production, the marginal cost at the smaller
level of foreign production is lower. (We will see
that this is a movement down and to the left
along the foreign export supply curve.)
o With lower marginal cost and weak demand,
foreign firms will compete and lower their
export price.
• lowering of the price paid to foreign suppliers
means it is possible for the United States to gain as
a nation from its own tariff
o discouraging some imports
o shifting some production to higher-cost
domestic producers
o part of those costs is outweighed by the gains
from continuing most of the previous imports at
a lower price paid to foreign exporters
• the foreign supply-of-exports curve slopes upward
• tariff drives a wedge of $6 between the price that
foreign exporters receive and the price that U.S.
buyers of imports pay
o quantity of exports must equal imports
• domestic price of imports now $303, foreign $297
o CS decreases by area a + b + c + d
o PS increases by area a
o tariff revenue (c + e)
• foreign exporters also pay part of the tariff (lower
export price)
• importing country still loses areas b and d
• outweighed by the gain of area e
• For a suitably small tariff imposed by a large
importing country, the importing country gains
national well-being
• With a $6 tariff, net gain to the United States is $2.82
million
o area e ($2.88 million) minus the loss of area b +
d ($0.06 million)
o a prohibitive tariff cannot be optimal
• nationally optimal tariff creates the largest net gain
for the country imposing it
o equals the reciprocal of the price elasticity of
foreign supply of imports
o the lower the foreign supply elasticity, the higher
our optimal tariff rate