• , I . .. . .

,
,Appendix , \ 1.

w~
I ,,

t I · l •
_. ,·:; ::"",t\ ... ... !. : ~ 1 ·) ..... L::,:.: ;.:, r; -- ./.,.

o ·· .D' ·· ; · -,-.. 0' ,

· '. .. :.,; ~; -~.: >; . FiGUR~-- 8:.11•! ~Shor~-Run :Etfect .ofTariti· ~--Fac·t~~• lnco~/~ imp~~t tariff imposed by 0
0

• !",. , · , .; . ~ . · :· ._ Nation 2 (Kabundant) usually°increasi:'s Px and shifts the VMPLx curve upward to VMPL'x- The
· : · • ' .·· ' !, ;, " ~wage rate· increases less 'than,proporti~nately, and DD' oflabor (the ~ation's mobile factor) is trans-

.·. :~ ; · c'.; t. ·;; ferred from the production of.Y to the production ofX. The real wage falls in terms of X but rises in
-f;~ · '. · .. , : .··.: • ter~ .of Y: l;'he .r~al return of capital (the nation's immobile factor) rises in terms of X but falls in
·.•• -.,.1,•. ·,;·,·. . ,. .? ~-~_ .. terms of.Y. . ..,. ;,._, . t ~,,_
. l
r t ':~ .' ;_ ., ·-.., •• -~:"·,. ,-~.
~# ,./ • , t '
· . . -) ... _
j'I,
·r-
!-' •'-~
.•
L·_. ;.,
::., '
•
,~
•
- - ,. - - -"

,.'_·=•~ ';· ·.,.:., ._ ',; _,,~i:•f~-

:- ~i·; ,,.,.;,. ~: ··) -. .=-_:; : 1··:.-,;·1 T's::
e

J
• • •

l J. :.,- !.~ .' ,

:;~, - "f__. _'>
•

.7'~ . ,-~,

•··, :: __If Nation 2 .now imposes a tariff on the importation ofcommodity X so that Px rises in
Nation 2, the VMPLx curve shifts upward proportionately, say, to VMPL'x- This increases
the wage ,rate from ED to E'D~ and DD' units oflabor are transferred from the production
of commodity Y to the pr~duction .of commodity X. Since w increases by less than .the
iO:cre~e i~ Px, w falls in terms of X but rises in terms of Y (since Py is unchanged).
Si~~e th,e specific capital in the production .of commodity X has more labor to work
.' with, the real'·
VMPKx and , increase in terms of both comrp.odities X and Y. Ori the
other hand, si~~e le;s-labods :used with the .fixed capitai in the production of commod-
ity Y, VMPKy ail~ fa~ in l erms of commodity X; and therefore in terms ofcominodity r
Y as well. ·. ·< · \ ·, · ,,_ : · ·· · · ' : ·. ', ., ... ' · _i . · .··
Thus, the imposition of an import tariff on commodity X by Nation 2 (the K-abundant
. nation) leads to th~ real inco~e oflabor.,(~e n,iobile factor) falling in terms ofX and -rising
. in terms of Y in both indu~tries of. Nation·.2,,and to ~e -real income and i-eturn to. capital ·
/ (the immobilefactor).risingin the pro~uctiondf?( and f~~g in the.production ofY.These , .:
. results are to be contrasted to those obtained by the Stolper-Samuelson theorem when bbth .
labor and capital are mobile; ~~di)os~ates th·;.t_,an iµiport tariff increases .real ii, and
reduces real r in the K-abundant nation (our Nation 2). ; ·~ ·
• • • . · • ) ,· ~\ •'. •·, , ; • , , ' • ,_ ;-,.,. ~~ • :, . \ .; /,' • • . ·_ . • ' • C

Problem What effect on real w and r will tlie imposition of an import tariff on commod-
ity Y (the K-intensive co~~diT~-~~y~_i2_~a-~~~} J~e L-abunda,nt natio~) if labor is
mobile but capital knot? ;, ,. . ',. , • .• i, r. :: ..:"' . · . • _ -• .· . . .. . ___ _

·,_. i'1 '.:., >·; ! 1 ·,. ,~

•:. ! ,'p , '.~•:1 ' ·· (! '. •• 1 ••-'" ·;r,; •, : : •· ·1·_,,- , -~-•- 1,_ j_!'.• .l'·~·-:1, .' j•; ' : .l •

Me~~·re~e~~ ,t~e T~i~~ - '. :· ~- ; ··.. :.' '_,_~ ·. ., .. :--- ~,

,. .In ~ectio'ri' 8.6A,\~e define~ the optigiu~ tariff as rate of tariff that maximizes the r{et
benefit resulting from the. improvement m the nations terms of trade against the negative
268 Chapter 8. Trade Restrictions:Tarijfs
effect resulting from the reduction in the volume of trade. The reason offer curve 2* in Fi _
urc 8:7 is associated with the optimum ~ifffor_Nation 2 _is tha~ ~oint E" is on the high!,
trade ind!lference curve that Nation 2 can achieve with
. . 1s shown by TI in Figu
any tariff. This
8.12, which is otherwise identical to Figure 8. 7. · ·· · ·
Trade indifference curves were derived for Nation 1 in Section A4.1. Other trade indif_
fercnce curves for Nation 2 have the same general shape as 11in Figure 8.12 but are eithe
to the left of 11 (and therefore refer to a lower welfare for Nation 2) or to the right of
(and, as such, are superior to 11 but cannot be reached by Nation 2). · ,
Thus, the optimum tariff is the tariff rate that the ~tion reach its highest trade makes
indifference curve possible. This is the trade indifference curve that is tangent to the trade
partner's offer cu~e. Thus, TI is _tangent to Nation_1's (~r the rest of the world's) offer curve.
To reach TI and point E", Nation 2 must impose tpat import or export tariff that rotates its
offer curve from 2 to 2*. '., . . ,' '
Nation 2 can cause its offer curve to rotate from 2 to 2* by imposing a 100 percent ad val-
o~em expo~ tariff on commodity Y. Specifically, ~t:eq~~ri:~ poinf .It-.:1'-_ fation 2's exporters
• will export SOY UN), ofwhich 25Y UE") co,llected .b y th~ govei:rune~~ of Nation 2 as an
·. export tax og commodity Y, and the remainder of 25Y (E"Nf goes t9 foreigners in e~change
· for 40X. Note that Nation 2 could also get .its offer curve..to rotateJfrom 2 to 2* with a seem-
ingly much larger import tariff on comm~dity X. In reality, the ~~t:irriwri 'export tariff rate is
equal to the optimum import tariff rate (.even though this does not seem so in Figure 8.12).
This can be proved adequately only witli mathe~tics in more advanced graduate texts.

, .,,)
} 1 ) ,,.;.' !- -

. . /

'. , . .' ,.' ' ·,, .[;'. • .:. , · --,_ . ~- --:': \ / ' :- .., ; ''- ·,. .,:: • • ::.,,, '·: • :,. •: .j . . -~· ·, -.,,·:-. •• • . ,• ,. .

FIGURE 8.12L".. · .NMeasurement

• · · · of ·the
• . Opti~mm
· . ,. Ta~i"ff. uer curve •2·.- • IS." associate
• d WI·th the opti-
1

. , •o~-."'
mum•
tariff rate ,or anon 2 because equilibriwn
• . ·• .
p'om··t· E" 1S· ·on th.c ·high est· - trade m- dirr.
ue rence curve
Nanon 2 can . reach.
. This · by.TI' which is t_
E" IS given ' "t
, .ri_
--e~n 'N anon
. . 1,s ouer
tr. · n z can get
curve. N ano ·t
. o

. ilib num point . on TI by

to equ . imposing a 100 p..ercent ad valorem · export
· tariff(smce c == E'N!·
· ],... ,
Nanon 2 cannot reach a trade indifference'curve higll. than n · 0 ,, d tariff otner
than the optimwn rate of 100 . er . n the other han , any Tl
,•) - . . percent will put the nation.on a trade indifference curve lower than ·
p
Selected Bibliography 269
However, since it is tnore likely for a nation to have some monopoly power over its exports
(for example, Brazil over coffee exports and petroleum-exporting countries over petroleum
exports through OPEC) than it is for a nation to have some monopsony power over its imports,
our discussion of the optimum tariff is perhaps more relevant in terms of exports than imports.
The optimum export or import tariff rate (t*) can also be calculated with the follow-
ing formula:

1
t* -
- -- (8A-6)
e-1
where e is the (absolute value of the) elasticity of the trade partner's offer curve. Thus, when
e is infinite (i.e., when the trade partner's offer curve is a straight line, which also means that
Nation 2 is a small nation), then the optimum tariff for Nation 2 is zero (see the formula) .
On the other hand, when Nation t's (or the rest of the world's) offer curve has some curva-
ture (so that e is less than infinite), t* has a positive value.The lower is the value of e (i.e., the
greater is the curvature of the trade partner's offer curve), the greater is the value oft*. How-
ever, formula 8A-6 is not very operational because in order to use it to calculate the opti-
mum tariff, we -must first identify point E* (see the figure) . ·
As pointed out in Section 8.6B, the gain to a nation from the optimum tariff comes at the
expense of the trade partner, who is likely to retaliate. The process of retaliation may con-
tinue untii" in the end b'o th nations lose all or most of the gains from ~de. The volume of
trade may shrink to zero unless, by coincidence; both nations happen to be imposing their
optimum tariff simultaneously, given the trade partner's tariff.

Problem , (a) Draw a figure analogous to Figure 8.12 showing the optimum export tariff
on comm~dity -X for Nation 1. (Hint: For the general shape of Nation 1's trade indifference
curves, see Figure 4.8.) Can you show on the same figure the optimum tariff for Nation 2
after Nation 1 has 'already imposed its optimum tariff? (Hint: See ·Figure 8.7.) (b) What are
the approximate terms of trade of Nation 1 and Nation 2 after Nation 1 has imposed an
optimum tariff and Nation 2 has retaliated with an optimum tariff of its own? (c) How has
the welfare of each nation changed from the free trade position?