CHAPTER 8 – ANALYSIS OF A TARIFF

OVERVIEW

 We begin the analysis of government policies that limit imports, with tariff a government tax on imports.

 Two cases to consider:

o Small importing country: tariffs have no effects on world prices
o Large importing country: tariffs can lower world prices.

 Tariff: a government tax on imports.

Impact of a tariff (for a small importing country) on

• The price of imported goods?
• The price of domestic goods?
• The quantity demanded?
• The quantity supplied domestically?

 Example with a 30$ tariff

The small importing country instaures a

tariff (p22)
1. Imported goods cost $330 with a tariff.
In a competitive market, French
producers can sell as much as they want
at the market price. They will increase
their price to $330 (the single market
price is now $330).
Figure 1 - the small importing country instaures a tariff

2. Consumption falls from D0 to D1

 3. Production increases from S0 to S1

4. Imports fall from M0 to M1

5. Change in 𝐶𝑆 = −𝑎 − 𝑏 − 𝑐 − 𝑑

6. Change in 𝑃𝑆 = +𝑎

7. Government gains c (= 30$×𝑀1)

8. Change in 𝑡𝑜𝑡𝑎𝑙 𝑠𝑢𝑟𝑝𝑙𝑢𝑠 = −𝑏 − 𝑑

The small importing country loses
as a whole with a tariff

9. see definition page 21

10. see definition page 21

11. The demand for imports curve shows the quantity imported at all trade price.

 For example, without a tariff, at a price of 300, the imports are equal to M0. With a tariff at a price of 330
the imports fall to M1. The imports curve goes through M0 and M1. See panel B.

Effects of a Tariff imposed by a Small Country: Producers

• Domestic producers gain:
 They get a higher price,
 They sell a larger quantity (movement along S curve).
 Producer surplus (PS) increases by a.

Can be more complicated if other tariffs raise the cost of materials (producers might gain less if tariffs rates on
inputs exceeds tariffs rates on outputs).

Effects of a Tariff imposed by a Small Country: Consumers

 Domestic consumers lose:
– They must pay a higher price (for both imported and domestically produced good).
– They consume less (movement along D curve) and suffer a loss of consumer surplus (CS) of
𝑎 + 𝑏 + 𝑐 + 𝑑.

Effects of a Tariff imposed by a Small Country: Government

 Government gains:
– It collects 𝒕𝒂𝒓𝒊𝒇𝒇 𝒓𝒆𝒗𝒆𝒏𝒖𝒆 = 𝑡𝑎𝑟𝑖𝑓𝑓 𝑟𝑎𝑡𝑒 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡× 𝑖𝑚𝑝𝑜𝑟𝑡𝑒𝑑 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 = 𝑐

Effects of a Tariff imposed by a Small Country: Country overall

 Country as a whole loses.

 Change in 𝒕𝒐𝒕𝒂𝒍 𝒔𝒖𝒓𝒑𝒍𝒖𝒔 = −𝑎 − 𝑏 − 𝑐 − 𝑑 + 𝑎 + 𝑐 = −𝑏 − 𝑑

Effects of a Tariff imposed by a Small Country: Country overall
• 𝑪𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝒕𝒐𝒕𝒂𝒍 𝒔𝒖𝒓𝒑𝒍𝒖𝒔 = −𝑏 − 𝑑

• 𝐶𝑜𝑛𝑠𝑢𝑚𝑝𝑡𝑖𝑜𝑛 𝑒𝑓𝑓𝑒𝑐𝑡 (−𝑑): deadweight loss comes from the fact that some consumers don’t buy
anymore with the tariffs (they could at the world price).

• 𝑃𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑜𝑛 𝑒𝑓𝑓𝑒𝑐𝑡 (−𝑏): deadweight loss comes from using high-cost domestic production to replace
lower-cost imports (available to the country at the world price).
(High production cost is shown by the height of the S curve.)

Effects of a Tariff imposed by a Large Country: Differences

• Tariff reduces the amount the country wants to import, so foreign exporters lower their price.

Example: with a 6$ tariff

 Import price falls (from $300 to $297) new effect!

 foreign exporters receive ($297)
 but consumers pay ($303) because the government collects $6 tax per unit

12. Before the tariff: 300$ With the tariff: 303$ (imported goods now cost 303$ so they increase their price to
the same level)

13. PS increases by a

14. a. CS falls by 𝒂 + 𝒃 + 𝒄 + 𝒅 b. Government gains 𝒄 + 𝒆

15. Total surplus changes by: 𝒂 − 𝒂 − 𝒃 − 𝒄 − 𝒅 + 𝒄 + 𝒆 = −𝒃 − 𝒅 + 𝒆

The large importing country:
 gains if – 𝑏 − 𝑑 + 𝑒 > 0
 loses if – 𝑏 − 𝑑 + 𝑒 < 0
 16. e is a « terms of trade effect ».
It represents a gain: the foreigners lower their export price.
 consumers save 3 ∗ 0.96 million of dollars

Effects of a Tariff imposed by a Large Country: difference

For the large importing country, the imposition of the tariff causes :

 a national loss (−𝑏 − 𝑑) (comparable to the one shown for the small country)
 but also a national gain (+𝑒) because the price paid to foreign exporters is lowered, for the units that the
country continues to import.

Effects of a Tariff imposed by a Large Country: Gains or Losses

• For a suitably small tariff, −𝑏 − 𝑑 + 𝑒 > 0 : the country as a whole gains.
(losses to consumers are more than compensated by gains for producers and government)

Effects of a Tariff imposed by a Large Country: Optimal Tariff

The country’s optimal tariff:
(i.e. that makes the net gain to the importing country as large as possible)

 = 0 for a perfectly elastic foreign supply.

(case where foreigners do not reduce their price – country lose like a small country)

 > 0 otherwise. The more inelastic the foreign supply, the higher the optimal tariff.
(If foreigners will easily accept to reduce their price without reducing their exports, large country gains and
has the ability to set a high tariff)

 The loss to the foreign exporting country is larger than the net gain to the importing country.

 A country trying to impose an optimal tariff risks retaliation by the foreign countries hurt by the country’s
tariff.
  In sum, a tariff always hurts a small importing country.

 In theory, a tariff can increase or decrease the well being of a large importing country.

 But in practice, because the foreign country will likely retaliate and increase its own tariff, the large country
generally loses.

Europe’s Common Agricultural Policy

 CAP: Common Agricultural Policy

 The CAP began to guarantee high prices to European Farmers, with the Community intervening to buy farm
output when the market price fell below an agreed target level.

 To prevent this policy from drawing large imports, some tariffs were introduced.

EU tariffs
 “EU tariffs on agricultural products average 18%

 over four times more than charges on other goods.

 All EU tariffs greater than 100% relate to agricultural products, with isoglucose hit hardest by a staggering
604% duty.”