UNIT5 v1

UNIT 5: ANALYSIS OF TARIFFS
Pre-Requisite:Before we begin our analysis on tariffs it is important that you have a Bbasic uUnderstanding of
Supply, Demand, Consumer Surplus and Producer Surplus. Refer to Unit 1 if you need to revise these
concepts.
Unit 5In this unit we analyzes the advantages and disadvantages of tariffs. Except for some recognized
exceptional cases, there is a rare consensus among economists that freer trade is better than protectionism.
In this unit, the economic analysis has consistently demonstrated that there are usually net gains from freer
trade for the nation as well as for the world. A tariff helps import-substituting producers, and the government
collects some tariff revenue (import taxes); however, consumers of the good are unambiguously harmed.
Whether or not a tariff will result in a net gain for the importing country will depend on the size of that
country. If the country levying the tariff is small (meaning that its actions cannot affect the world price of the
good on which the tariff is levied), then the loss to consumers is larger than the sum of gains to producers and
to the government. On the other hand, if the country is large (meaning that, by limiting imports, it can force
down the world price of the good), then levying a tariff may result in a net gain for the country. This will
depend upon the portion of the government’s revenues that are, in essence, extracted from foreign
producers versus the size of the country’s deadweight losses from the tariff. In any case, the world as a whole
always loses from the imposition of a tariff.
At the end of the Unit 5, you should be able to;
1. Identify the advantages and disadvantages of a tariff.

2. Discuss how a tariff lowers the welfare of the world as a whole.
3. Illustrate how demand-supply analysis can be used to assess the gains and losses of a tariff
Important Concepts
Ad valorem tariff: A tariff that is set as a percentage of a value of a good when it reaches the
importing country.
Consumption effect: The welfare loss to consumers in the importing nation that corresponds to
their being forced to cut their total purchases of a good as a result of the
tariff.
Deadweight loss: Consumer loss from a tariff that accrues to neither the government nor
producers.
Effective rate of protection: The percentage by which the entire set of a nation’s trade barriers raises
the industry’s value added per unit of output. (This term is abbreviated as
e.r.p.)
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Nationally optimal tariff: A tariff set at the rate that maximizes the gains for a large country (at the
expense of foreign countries). Technically, the optimal rate, as a fraction of
the price paid to foreigners, equals the reciprocal of the elasticity of supply
of a country’s imports.
Price-taking countries: “Small” countries that cannot affect the world price of the goods and
services they trade. In these countries, the import supply curve is infinitely
elastic.
Production effect: The cost of shifting to more expensive domestic production from an
import-competing sector that is protected by a tariff on foreign goods.
Prohibitive tariff: A tariff set so high that it reduces imports to zero.
Specific tariff: A tariff stipulated as a money amount per physical unit of the import.
World Trade Organization: An international organization of most of the world’s countries; it oversees
governmental policies regarding international trade. The chief purposes of
the WTO are to liberalize trade and limit unfair export policies such as
subsidies.
2.0 Overview
Examining the Effect of an Imposition of Tariffs

Market for Bikes in Tonga: Free Trade Situation
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• In the domestic market initial equilibrium is the intersection of QD=QS.
• Now suppose the Tonga decides to import bikes and imposes no tariff at world price of
$300. With imports and reduced price, the quantity supplied in the domestic market is
reduced to point B and supply is 0.6.
• Now given that demand remains at 1.6, to cater for the excess demand i.e. 1.6-0.6, the
additional demand of 1.0 will be met by foreign producers. In this case the consumer
surplus is greater than producer surplus. The PS=area CBA and CS is CFE.
Markets for Bikes in Tonga: Imposition of Tariffs on Bikes
• Effect of Imposition of Tariffs: As duties are imposed, it means that it is expensive for
foreign exporters to export. In the domestic market, the domestic producers will therefore
increase their production and supply as tariffs have increased prices for motorbikes. As
such the domestic producers will increase the supply of motorbikes from S0-S1. The net
additional gain of the producer is ($30*(S1-S0)*0.5).The producer surplus will increase
to area g+a.
• Effect on Consumers: Import Tariff of $30- QD falls from D0-D1: Net loss to consumers
in shaded area a+b+c+d: Consumer surplus declines from FEC to FGH. Area a+b+c is the
loss of $30 per bike of consumer surplus for those who continue to buy at higher prices.
Area d is the loss of CS for those who stop buying.
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Net National Loss from a Tariff
• Consumer loss- Area a+b+c+d. Producer Gain – Area A. Government Revenue – c. Net
National Loss – b+d.
• Demand Curve: C – Government Revenue, b+d -net national loss, Area d- consumption
effect, Area d is DWL-because what consumer loses no one gains-inefficiency, Area b is
welfare loss as consumers demand is shifted from imports to more expensive domestic
production, Area b- production effect of tariff- is also dead weight loss. (extra cost of
shifting to more expensive production.
Prescribed Readings
Chapter 6: Analysis of a Tariff from Prescribed Text of “ Thomas“Thomas P, 2012, International
Economics, 15th Edition”.
Supplementary Videos:
Introduction to World Trade Organization: https://www.youtube.com/watch?v=jRH5XGyQXow
How Tariffs Works: https://www.youtube.com/watch?v=16b9BX5goe4
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4.0 Review Questions:
1. A tariff increases producer welfare at the expense of consumer welfare and is never
economically “efficient.” But is a tariff ever “equitable?”
5.0 Practical Quiz

1. If a small country imposes a tariff on imported motorcycles, the world price of motorcycles
will _____ and the domestic price of motorcycles will _____.
a. rise; fall
b. fall; rise
c. remain constant; rise
d. remain constant; fall
Answer: C
Explanation: When a small country imposes tariffs it does not have the power to influence the
world market price. As a result the effect will be that the world price for motorcycles will remain
constant and the domestic price of motorcycle will rise. Only in instances where a nation is a
major producer of a good, in such a situation will it be able to influence the world price of a
good.
2. The figure given below shows the market for Canned Tuna in Papua New Guinea. The
domestic price line with tariff lies above the international price line. Dd and Sd are the
domestic demand and supply curves of shoes respectively.
Price
Sd
Domestic price with tariff

a b c d World price
Dd
0 S0 S1 D1 D0 Quantity
Following the imposition of tariff, the domestic producer surplus _____ by the area _____.
a. increases; a
b. decreases; a
c. increases; (a + b)
d. decreases; (a + b)
Answer: A
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3. The figure given below shows the market for Canned Tuna in Papua New Guinea. The
domestic demand and supply curves of canned tuna respectively.
Price
Sd

a b c d World price
Dd
Following the imposition of tariff, the domestic consumer surplus _____ by the area _____.
a. increases; c + d
b. decreases; d
c. decreases; (a + b + c +d)
d. increases; (b + d)
Answer: C
Explanation: Refer to Figure 8.4 on Net National loss from a Tariff in Two Equivalent Diagrams
on page 152 of Chapter 6 on Analysis of a Tariff: 15th Edition, International Economics, Thomas
Pugel.
4. The figure given below shows the market for Canned Tuna for Papua New Guinea. The
domestic demand and supply curves of canned Tuna respectively.
Price
Sd

a b c d World price
Dd
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The tariff revenue of the Papua New Guinea Government is shown by area _____.
a. a
b. (a + b)
c. c
d. (b + c + d)
Answer: C
Pugel.
5. The figure given below shows the market for canned tuna in Papua New Guinea. The
domestic demand and supply curves of Papua New Guinea respectively.
Price
Sd

a b c d World price
Dd
The imposition of a tariff on shoes caused economic welfare in the Papua New Guinea to
_____ by an amount measured by the area _____.
a. fall; c
b. fall; (b + d)
c. rise; (b + c+ d)
d. rise; (a + c)
Answer: B
Pugel.
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6. The figure given below shows the market for canned Tuna in Papua New Guinea. The
Price
Sd

a b c d World price
Dd
The production effect of the tariff on shoes is measured by the area _____.
a. a
b. b
c. c
d. d
Answer: B
Pugel.
7. The figure given below shows the market for canned tuna in Papua New Guinea. The
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Price
Sd

a b c d World price
Dd
The consumption effect of the tariff on shoes is measured by the area _____.
a. a
b. b
c. c
d. d
Answer: D
Pugel.
Case Study
Do you think tariffs as a trade policy measure is an effective tool for the Pacific Island Countries.
Using an example of a commodity discuss the tariffs imposed and its effects on the overall
welfare of the country. (Hint: You can use illustrative diagrams discussed in this unit).
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UNIT 5: ANALYSIS OF TARIFFS

1. Identify the advantages and disadvantages of a tariff.

Prohibitive tariff: A tariff set so high that it reduces imports to zero.

Examining the Effect of an Imposition of Tariffs

Markets for Bikes in Tonga: Imposition of Tariffs on Bikes

5.0 Practical Quiz

Domestic price with tariff

Domestic price with tariff

Domestic price with tariff

Domestic price with tariff

Domestic price with tariff

Domestic price with tariff

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