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The Theory Of Tariffs and

Quotas

Summary
Methods of trade protection and their economic
consequences
Tariffs
Quotas and voluntary export restraints
Dumping and anti-dumping suits
Other non-tariff barriers
Export subsidies

Chapter Readings
Gerber ch. 6
Pugel chs. 8 & 9
Salvatore chs. 5 & 6

Methods of Trade Protection

Tariffs- Taxes imposed on
imported goods

Quotas- Numerical limits

imposed on imported
goods

Methods of Trade Protection

Quotas directly limit the quantity of imports
Tariffs indirectly limit imports by taxing them.
Tariffs and quotas cause consumers to switch to relatively
cheaper domestic goods or to drop out of the market
altogether.

Tariffs

"Here lies Free Trade! Be it understood / He would have liv'd much longer if he could."

Consumer Surplus
An economic measure of consumer satisfaction, which is
calculated by analyzing the difference between what
consumers are willing to pay for a good or service relative to
its market price. A consumer surplus occurs when the
consumer is willing to pay more for a given product than the
current market price.

Producer Surplus
An economic measure of the difference between the amount
that a producer of a good receives and the minimum amount
that he or she would be willing to accept for the good. The
difference, or surplus amount, is the benefit that the producer
receives for selling the good in the market.

 A nation will import a good when the world price is below the
domestic market equilibrium price. This is because the lower
world price has a higher demand. Fewer producers are
willing to supply product at the low rate, which creates a
domestic shortage. A lower world price also reduces
producer surplus and increases consumer surplus. That
means consumers benefit from an import, while producers
are harmed.

 The difference in quantity demanded minus the quantity of

units produced domestically is a shortage. The nation fills
this shortage with imports

 A tariff, increases the price of a good that is internationally

traded. When the price goes up, supply rises, and demand
decreases. The equilibrium created by the world price + tariff
is closer to domestic market equilibrium.
Producer surplus is a little better off and additional
government revenue is generated
However, as you can see by the grey shaded area there is
some deadweight loss involved with a tariff.

Deadweight loss
The costs to society created by market inefficiency. Mainly
used in economics, deadweight loss can be applied to any
deficiency caused by an inefficient allocation of resources.
Price ceilings (such as price controls and rent controls), price
floors (such as minimum wage and living wage laws) and
taxation are all said to create deadweight losses. Deadweight
loss occurs when supply and demand are not in equilibrium.

 Tariffs and quotas encourage

Consumers to switch to relatively cheaper
domestic goods or to drop out of the market
Producers to increase their output as demand
switches from foreign to domestic goods

Short-Run Effects of Tariffs

Government benefits from collecting tax revenues
Raises domestic prices of good/services
Reduce quantity of imports
Decrease welfare of domestic consumers
Increase welfare of domestic producers
Create deadweight loss

Long-Run Effects of Tariffs

Retaliation: A tax that a government charges on imports to punish
another country for charging tax on its own exports. In addition to
deadweight loss caused by tariffs. Domestic economy can
experience net job loss, trade declined and lower standard of living.
Innovation : A costly effect of tariffs is that they isolate domestic
firms from foreign competition and reduce the incentive to introduce
new products or upgrade the quality and features of existing ones.
Imports are often a major point of access to new technologies and
new products.
Rent Seeking: Rent seeking is any activity that uses resources to
try to capture more income without actually producing a good or
service. The problem is that firms with tariff protection can hire
lobbyists and work to keep the protection in place. If it is easier to
lobby a government for protection than it is to become more
competitive, then firms will use rent seeking tactics.

Effective Rate of Protection (ERP)

This is a measure of the total effect of the entire tariff
structure on the value added per unit of output in each
industry, when both intermediate and final goods are
imported used to measure the real amount of protection
afforded to a particular industry by import duties, tariffs or
other trade restrictions.

Example
Cars sell for $1000
Cost of production
input is $400
Value added is $600

Example
Add 40% tariff on foreign cars
Cost of Imported cars is $1400
New Value added is $1400- $400 = $1000
ERP =( New Value- Old Value) / Old Value
=1000-600/600
= 66.6667%
66.667% is greater than tariff of 40%
ERP is higher when tariff are applied only to final goods in a
production process

Quotas

Why do we have quotas ?

Quotas are used to benefit the
producers of a good in a domestic
economy at the expense of all
consumers of the good in that
economy.
Quotas can also be used an
enforcement of sanctions against a
country
E.g
1. United States treat of imposing
tougher sanctions on Russia's
financial, energy and defense
sectors
2. United Nations General Assembly
adopted a voluntary international
oil embargo against South Africa
for apartheid policies

Why do we have quotas ?

To bolster domestic employment: Decreasing imports and
increasing domestic production also increases domestic
employment.
To support infant industry: If foreign imports compete with a
relatively young domestic industry that is neither mature
enough nor large enough to benefit from economies of scale,
then import quotas protect the "infant industry" while it
matures and develops.
To protect strategic industries such as defense and
agriculture

How are quotas met ?

Firms in nationals with quotas could get license to import
License fee could be imposed by domestic government
Profit for a licensed firm equals domestic price minus world
price multiplied by quantity sold
If the government sets the import license fee equal to
difference between domestic price and world price
The entire profit of the firm with an import license is paid to
the government
The import quota works exactly like a tariff

Key Takeaways
A quota is a maximum production quantity, usually set based on
historical production.
A quota restricts the quantity below what would otherwise prevail,
forcing the price up.
A quota transfers wealth from buyers to sellers. No surplus arises
because of the production limitation. Future generations pay for the
program, which provides future sellers no benefits.
Quotas based on historical production have the problem that they
dont evolve in ways that production methods and technology do,
thus tending to become progressively more inefficient. Tradable
quotas eliminate this particular problem, but continue to have the
problem that future generations are harmed with no benefits.

Short term Effects of Quotas

Raises domestic prices of good/services
Reduce quantity of imports
Decrease welfare of domestic consumers
Increase welfare of domestic producers
Create deadweight loss

Long term disadvantages of Quotas

Include long term effects of tariffs
Corruption-Import quotas can lead to administrative
corruption in countries with import quotas as the importers
chosen to meet the quota are the ones who can provide the
most favors to the customs officers
Political Protests and Trade wars between nations- Boston
Tea Party in response to Tea Act of May 10, 1773.

Corruption Case Study

Beef import corruption rocks Indonesian
political party
The chairman of a major political party in
Indonesia has been arrested by corruption
investigators on charges of accepting bribes in
exchange for manipulating Indonesia's beef
import quotas. Luthfi Hasan Ishaaq was
caught accepting a black suitcase stuffed in
bribes from meat importer Indoguna Utama
executives in an attempt to increase its
allowance in response to reduced import
quotas for Australian beef and live cattle.

Trade Wars
A negative side effect of protectionism that occurs when
Country A raises tariffs on Country B's imports in retaliation
for Country B raising tariffs on Country A's imports.
Trade wars may be instigated when one country perceives
another country's trading practices to be unfair or when
domestic trade unions pressure politicians to make imported
goods less attractive to consumers.
Trade wars are also a result of a misunderstanding of the
widespread benefits of free trade.

Deciding between using a Quota vs

Tariff
When an import quota is used, it allows a domestic country
to be sure of the amount of the good imported from the
foreign country.
When there is a tariff, the supply curve of the foreign country
is unknown

Voluntary Export Restraint

voluntary export restraint (VER) or voluntary export
restriction is a government imposed limit on the quantity of
goods that can be exported out of another country during a
specified period of time

1981 Automobile VER

When the automobile industry in the United

States was threatened by the popularity of
cheaper more fuel efficient Japanese cars, a
1981 voluntary restraint agreement limited the
Japanese to exporting 1.68 million cars to the
U.S. annually as stipulated by U.S
Government.
This quota was originally meant to expire
after three years, in April 1984. However, with
a growing trade deficit vis--vis Japan and
under pressure from domestic manufacturers,
the US government saw fit to extend the
quotas for an additional year.
The cap was raised to 1.85 millions cars for
this additional year, then to 2.3 million for
1985. The voluntary restraint was only finally
removed in 1994

Non-tariff barriers
Non-tariff barriers to trade (NTBs) are trade barriers that
restrict imports, but are unlike the usual form of a tariff. Some
common examples of NTB's are anti-dumping measures and
countervailing duties, which, although called non-tariff
barriers, have the effect of tariffs once they are enacted.

Types of NTBs
Specific Limitations on Trade: Import Licensing requirements, Proportion
restrictions of foreign domestic goods (local content requirements)
,Minimum import price limits ,Embargoes
Customs and Administrative Entry Procedures: Valuation systems, Antidumping practices ,Tariff classifications, Documentation requirements,
Fees
Standards: Standard disparities ,Intergovernmental acceptances of testing
methods and standards, Packaging, labeling, and marking
Government Participation in Trade: Government procurement policies,
Export subsidies ,Countervailing duties, Domestic assistance programs
Charges on imports: Prior import deposit subsidies ,Administrative fees,
Special supplementary duties ,Import credit discrimination ,Variable
levies ,Border taxes

Dumping and anti-dumping suits

Dumping
Dumping is a kind of predatory pricing that occurs when
manufacturers export a product to another country at a price
either below the price charged in its home market or below
its cost of production.

Examples of Dumping
Rockefeller receives a message
from Colonel Thompson outlining an
approved strategy where oil in one
market, Cincinnati, would be sold at
or below cost to drive competition's
profits down and force them to exit
the market. In another area where
other independent businesses were
already driven out, namely in
Chicago, prices would be increased
by a quarter
Yorkshire Traction buys out 11
competing bus operators after a
short term cycle of free bus rides.

Anti-Dumping
A country prevents dumping through trade agreements. If
both trade partners stick to the agreement, then they can
compete fairly and avoid dumping. However, violations of the
dumping rules can be difficult to prove and expensive to
enforce.

 Unfortunately, trade agreements don't prevent dumping with

countries outside of the agreements. Therefore, more
extreme measures must be taken

The Uruguay Round

The Uruguay Round was the 7th
round of multilateral trade negotiations
(MTN) conducted within the
framework of the General Agreement
on Tariffs and Trade (GATT), spanning
from 1986 to 1994 and embracing 123
countries as "contracting parties".
The Round led to the creation of the
World Trade Organization, with GATT
remaining as an integral part of the
WTO agreements.

Achievements
The GATT still exists as the WTO's umbrella treaty for trade in goods,
updated as a result of the Uruguay Round negotiations .The GATT
agreements fall into a simple structure with six main parts:
an umbrella agreement (the Agreement Establishing the WTO);
goods and investment (the Multilateral Agreements on Trade in Goods
including the GATT 1994 and the Trade Related Investment Measures
(TRIMS))
services (General Agreement on Trade in Services (GATS));
intellectual property (Agreement on Trade-Related Aspects of
Intellectual Property Rights (TRIPS))
dispute settlement (DSU)
reviews of governments' trade policies (TPRM)

Anti-Dumping Regulations
Anti-dumping duties or tariffs remove the main advantage of
dumping.
A country can add an extra duty, or tax, on imports of goods
that it considers to be involved in dumping.
However, if that country is a member of the WTO or EU, it
must prove that dumping existed before slapping on the
duties. These organizations want to make sure that countries
don't use anti-dumping tariffs as a way to sneak in good oldfashioned trade protectionism.

The Role of the World Trade

Organization in Anti-dumping
Most countries are members of the World Trade
Organization. Member countries adhere to the GATT multilateral trade agreement. Countries agree that they won't
dump, and that they won't enforce tariffs on any one industry
or country. Therefore, to install an anti-dumping tariff, WTO
members must prove that dumping has occurred

WTOs Terms of Anti-Dumping

Tariffs
The WTO is very specific in its definition of dumping. First, a
country must prove that its local industry has been harmed
by dumping. It must also show that the price of the dumped
import is much lower than the exporter's domestic price. The
WTO gives three ways to calculate this price:
1. The price in the exporters domestic market.
2. The price charged by the exporter in another country.
3. A calculation based on the exporters production costs,
other expenses and normal profit margins.

Real cases of Anti-Dumping

Disputes
U.S. shrimpers and processors accused China and five other
countries of dumping farm-raised shrimp in U.S. markets
The ITC's ruling suggested tariffs on Chinese imports could
be as high as 264% while those on Thailand, its principal
competitor in vannamei white shrimp, would be about 58%

Export subsidies
Export subsidy is a government policy to encourage export of
goods and discourage sale of goods on the domestic market
through direct payments, low-cost loans, tax relief for
exporters, or government-financed international advertising.
An export subsidy reduces the price paid by foreign
importers, which means domestic consumers pay more than
foreign consumers.
The WTO prohibits most subsidies directly linked to the
volume of exports

The Case of Agricultural Subsidies

For many years, the governments of wealthy industrial
countries, including the United States, Canada, Japan, and
much of Europe, have subsidized exports of farm products.
These subsidies were initially implemented to bolster
domestic farmers in their competition with farmers from other
wealthy countries, where agricultural production costs tend to
be uniformly high.

 These subsidies have been a source of distress for developing

countries. Although they may have a comparative advantage in
agricultural production, they have difficulty competing on the world
market against subsidized prices.
Developing countries, therefore, have also subsidized their
agricultural sectors, further distorting the market and creating the
protectionist stand-off that has polarized negotiations on the issue.
Reasons that countries may instate export subsidies in the
agriculture sector include make sure that enough food is produced
to meet the countrys needs; shielding farmers from the effects of
the weather and swings in world prices; or preserving rural society.

Keywords
consumer surplus
deadweight loss
effective rate of protection
efficiency loss
intellectual property rights
large country cas
e nominal rate of protection
nontariff barrier (NTB)
nontariff measure
nontransparent
producer surplus
quota rents
transparent voluntary export restraint (VER)

Quiz

Quiz
The figure indicates that when the country moves from
free trade to the tariff equilibrium
a)
b)
c)
d)
e)

Its imports fall by the amount Q1Q1* plus Q2Q2*.

Fall by the amount Q1*Q2*.
Its imports fall by the amount Q2Q2*.
Its imports fall by the amount Q1Q1*.
Change by the net amount Q2Q2* minus Q1Q1*.

Quiz
The figure indicates that when the country moves from free trade to the
tariff equilibrium
a)
b)
c)
d)
e)

The net effect on the countrys welfare is a positive or negative with

magnitude represented by the area [ +(c) - (a)].
The net effect on the countrys welfare is a positive or negative with
magnitude represented by the area [ +(e+f) - (g)].
The net effect on the countrys welfare is a gain whose magnitude is
given by area [+c].
The net effect on the countrys welfare is a loss whose magnitude is given
by the area [- (d)].
The net effect on the countrys welfare is a loss whose magnitude is given
by the area [- (b+d)].

Quiz
Which sets of countries reduced their average tariff rates
between the mid-1980s and 2007.
a)
b)
c)
d)
e)

Low-, Middle- and High-income countries.

High-income and middle-income countries only.
Low-income countries only.
Low- and Middle-income countries only.
High-income countries only.

Quiz
What problems may be created by home country tariff
policies?
a)
b)
c)
d)

Trade policy retaliation by trade partners.

Limited innovation by home firms.
Rent seeking.
All of the above.

Quiz
Compared with free trade, Large countries may increase
national welfare when they place a tariff on imports. What
unique aspect of Large countries, explains this
conclusion? Large countries
a)
b)
c)
d)

Reduce the world price of the import when they levy a tariff.
Have large numbers of domestic producers who can expand
substantially when they are protected by tariffs.
Are less likely to face tariff retaliation by trade partners.
All of the above.

Quiz
Under free trade, a digital SLR camera sells for $1000. If
the U.S. imported the parts to produce a digital SLR, the
free trade price of the parts would be $550. If U.S.
producers produce digital SLRs under these conditions
a)
b)
c)
d)

Their value-added equals $0.

Their value-added equals $550.
Their value-added equals $450.
Their value-added equals $1000.

Quiz
Under free trade, a digital SLR camera sells for $1000. If the U.S.
imported the parts to produce a digital SLR, the free trade price of the
parts would be $550. U.S. digital SLR producers will receive the
highest Effective Rate of Protection if
a)
b)
c)
d)

The U.S. introduces a quota limit on imported parts that are used to
produce digital SLR cameras.
The U.S. introduces a 25% tariff on imported digital SLR cameras.
The U.S. introduces a 25% tariff on imported parts that are used to
produce digital SLR cameras.
The U.S. introduces a 25% tariff on both digital SLRs and on the
imported parts that are used to produce digital SLR cameras.

Quiz
Suppose the Effective Rate of Protection for Brazilian automobile
producers is calculated to be -60%. This result indicates that
a)

b)
c)
d)

Brazilian automobile producers would be better off if Brazil increased its

tariffs on both imported automobile parts and imported cars by 60%
each.
Brazilian automobile producers would be better off if Brazil adopted free
trade for all parts and final goods.
Brazilian automobile producers would be better off if Brazil increased its
tariffs on imported automobile parts.
There is a flaw in the calculation. The effective rate of protection is
always positive.

Quiz
The Uruguay Round of trade talks resulted in
a)
b)
c)
d)

The formation of the World Trade Organization.

New measures for trade dispute settlement.
Measures regulating the treatment of intellectual property.
All of the above.

Quiz
Suppose the U.S. decided to use a quota to limit cell phone imports. Assume
the U.S. is a small country. If the U.S. used an auction to allocate quota rights
a)
b)
c)
d)

The auction would generate much more revenue than would be generated by a
tariff which limited imports to the level allowed under the quota.
The U.S. welfare would be lower than it would be if the exporting countries
used voluntary export restraints instead.
The U.S. welfare would be higher than it would be if U.S. continued to have a
free trade policy.
The auction could generate revenue that was roughly equal to the revenue
generated by a tariff which limited imports to the level allowed under the quota.