International Economics: Faculty of Economics Kardan University

FACULTY OF ECONOMICS
Kardan University
International Economics
Chapter 6: Trade Restrictions: Tariffs
Book by: Dominick Salvatore
John Wiley & Sons, Inc.
Ahsanullah Mohsen M.Sc.
a.mohsen@Kardan.edu.af
Ahsanullah.Mohsen@rub.de
Kardan.edu.af
In this chapter:
• Introduction
• Partial Equilibrium Analysis of a Tariff
• The Theory of Tariff Structure
• The Optimum Tariff
Introduction
• While it is generally accepted that free trade
maximizes world output and benefits all nations,
most nations impose some restrictions on the free
flow of international trade.
• Trade policies are advocated by special groups that
stand to benefit from trade restrictions.
Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.
Introduction
• Import vs. export tariffs
• An import tariff is a tax or duty levied on
imported commodities.
• This is the most common form of tariff.
• An export tariff is a tax on exported commodities.

• Prohibited by the U.S. Constitution, but occasionally
practiced in developing countries to generate
government revenue.
Introduction
• Ad valorem tariff
• A fixed percentage on the value of the traded
commodity.
• Specific tariff
• A fixed sum per physical unit of a traded
commodity.
• A compound tariff
• A combination of an ad valorem and specific
tariff.
Introduction
• Tariffs have been sharply reduced since
World War II.
• Tariffs average 5 percent or less on industrial

products in developed nations, but are much
higher in developing nations.
Partial Equilibrium Analysis of a Tariff

• Resulting Effects of Tariff
• Consumption effect
Reduction in domestic consumption
• Production effect
Expansion of domestic production
• Trade effect
Decline in imports
• Revenue effect
Revenue collected by the government

• Consumer surplus is the difference between what consumers would be willing
to pay and what they actually pay.
• Imposition of a tariff reduces consumer surplus.
• Increase in producer surplus, is the payment that need not be made in the
long run to induce domestic producers to supply additional goods with the
tariff.
• Also called subsidy effect of tariff.

• Tariff redistributes income -
• From domestic consumers (who pay higher price for
the commodity) to domestic producers (who receive
the higher price)
• From nation’s abundant factor (producing exports) to
the scarce factor (producing imports).
• This leads to inefficiencies, or protection costs
(deadweight losses).
FIGURE 8-1 Partial Equilibrium Effects of a

Tariff.
FIGURE 8-1 Partial Equilibrium Effects of a Tariff. Conti….
Dx and SX represent Nation 2’s demand and supply curves of

commodity X. At the free trade price of PX=$1, Nation 2
consumes 70X (AB), of which 10X (AC) is produced
domestically and 60X (CB) is imported. With a 100 percent
import tariff on commodity X, PX rises to $2 for individuals in
Nation 2.
At PX=$2, Nation2 consumes50X(GH), of which 20X (GJ) is
produced domestically and 30X (JH) is imported. Thus, the
consumption effect of the tariff is (–) 20X (BN); the production
effect is 10X (CM); the trade effect equals (–)30X (BN+CM);
and the revenue effect is $30 (MJHN).
11
FIGURE 8-2 Effect of Tariff on Consumer and Producer

Surplus.
The left panel shows that a tariff that increases the price of commodity X from PX=$1 toP
X=$2 results in a reduction in consumer surplus from ARB=$122.50 to GRH=$62.50, or by
shaded area AGHB=$60. The right panel shows that the tariff increases producer surplus by
shaded area AGJC=$15.
FIGURE 8-3 Partial Equilibrium Costs and Benefits of

a Tariff.
The figure shows that with a 100 percent import tariff on commodity X,PX rises from $1 to $2 in
Nation 2. This reduces the consumer surplus by AGHB=a+b+c+d=$15+$5+$30+$10=$60. Of this,
MJHN=c=$30 is collected by the government as tariff revenue, AGJC=a=$15 is redistributed to
domestic producers of commodity X in the form of increased rent or producer surplus, while the
remaining $15 (the sum of the areas of triangles CJM=b=$5 and BHN=d=$10) represents the
protection cost, or deadweight loss, to the economy

• The more elastic the demand curve, the greater the consumption effect.
• The more elastic the domestic supply curve, the greater the production
effect.
• The more elastic the demand and domestic supply curves, the greater the
trade effect, and the smaller the revenue effect.
Salvatore: International Economics, 10th Edition © 2009 John

Wiley & Sons, Inc.
The Theory of Tariff Structure

• The Rate of Effective Protection
• Indicates how much protection is actually provided to domestic producer of
import-competing commodity.
• When a nation imposes a lower tariff on imported inputs than on the final
commodity produced with the inputs, the rate of effective protection exceeds
the nominal tariff rate.

• Calculated as follows:
t - aiti
g=
1 - ai
g = rate of effective protection
t = nominal tariff rate on final commodity
ai = ratio of cost of imported input to price of final
commodity with no tariff
ti = nominal tariff rate on imported input
Example t - a i ti
• Tariff on final commodity is 10% g=
• Free trade Price of final commodity is 100$ 1 - ai
• Price of input wool is 80$
• Tariff on import of input wool is 0%
• ai = ratio of cost of imported input to price of final
• commodity with no tariff =>
After tariff price of commodity is 110$.

80$ is cost of input, 110-80=20 is value added to input. Tax is 50% of value
added (10/20). Effective rate of tariff is 5 times of nominal.
18

• Calculated as follows:
t - a i ti
g=
1 - ai
Conclusions
 If ai = 0, g = t
 For given values of ai and ti, g is larger the greater is t
 For given values of t and ti, g is larger the greater is ai
 The value of g is >, = or < t, as ti <, = or > t
 When aiti > t, the rate of effective protection is negative
FIGURE 8-4 Pre- and Post-Uruguay Round Cascading Tariff

Structure in Industrial Countries.
The Optimum Tariff

• An optimum tariff maximizes the net benefit resulting from
the improvement in the nation’s terms of trade (ToT)
against the negative effect from declining trade volume.
• As the terms of trade improve for the imposing nation,
those of the trade partner deteriorate, reducing welfare for
the trade partner.
• Trade partner will likely retaliate and impose its own
optimum tariffs.
• World as a whole is made worse off as gains from optimum
tariff are less than losses of trade partner.

International Economics: Faculty of Economics Kardan University

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FACULTY OF ECONOMICS

• An export tariff is a tax on exported commodities.

• Tariffs average 5 percent or less on industrial

Partial Equilibrium Analysis of a Tariff

Partial Equilibrium Analysis of a Tariff

Partial Equilibrium Analysis of a Tariff

FIGURE 8-1 Partial Equilibrium Effects of a

FIGURE 8-1 Partial Equilibrium Effects of a Tariff. Conti….

Dx and SX represent Nation 2’s demand and supply curves of

FIGURE 8-2 Effect of Tariff on Consumer and Producer

FIGURE 8-3 Partial Equilibrium Costs and Benefits of

Partial Equilibrium Analysis of a Tariff

Salvatore: International Economics, 10th Edition © 2009 John

The Theory of Tariff Structure

The Theory of Tariff Structure

After tariff price of commodity is 110$.

The Theory of Tariff Structure

FIGURE 8-4 Pre- and Post-Uruguay Round Cascading Tariff

The Optimum Tariff

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