UNIT 4

TRADE POLICY INSTRUMENTS

Professor: Álvaro de la Barra Croquevielle

October, 2023
 INTRODUCTION TO TRADE
POLICY
Until now:
Free Trade compared with autarky
- reasons to trade
- Model of Ricardo, interindustrial trade, scale
economies for Intraindustrial trade
• Without the analysis of governmental policies
Now:
• Free Trade and Autarky
- Caused by government intervention
• Winners and Losers
- consumers, producers, tax payers
• Political Economy
- Reflects political power of winners and losers
• Institutions of trade policy
- Affects the economic policy
 Unit Discussion

• Interventions, Barriers, Distorsions

• Trade Policy Instruments: Tariffs and
Quotas.
• Evaluate the costs and benefits of
tariffs, their welfare effects, and
winners and losers of tariff policies.
 TRADE POLICY INSTRUMENTS
• Government can use many tools to affect the equilibrium prices of traded goods and the
quantities of the traded good produced and consumed
• Most cases of such interventions involve the restriction of imports, but governments also
tax or subsidize exports
• Basic Distinction:
Tariffs versus No Tariff Measures (tax/subsidies versus other forms of non tariff intervention).

• Tariffs (import tax)

a) Specific: levied as a fixed charge for each unit of goods imported ($ per unit)
b) Ad valorem: are levied as a fraction of the value of the imported.

• Quotas or voluntary export restrictions

• Non Tariff Measures: Regulations (testing, customs, labeling, domestic content requirement)

• To analyze further definitions, see, http://tao.wto.org/site/glossary/en/T.htm

 WORLD TARIFFS EVOLUTION

Tariffs (%)
25

20

15

10

MFN Simple Average (%) Applied Tariffs (%)

https://www.wto.org/english/res_e/booksp_e/world_tariff_profiles23_e.pdf
 TRADE POLICY INSTRUMENTS
Non Tariff Measures (NTM’s)
• Policy interventions other than tariffs that can potentially affect the quantities and the
prices of internationally traded goods.
• NTMs can be diverse and may target very different objectives. Import licenses or quotas
aim to complement or substitute for tariffs, while sanitary and phytosanitary (SPS)
measures or technical barriers to trade (TBT) often have non-trade objectives and aim
to correct for market failures (e.g. health and consumer safety, and pollution and the
environment). Despite the absence of trade objectives, SPS measures and TBTs may
affect trade costs through associated procedural requirements.
• NTMs are playing an increasing role in international trade because of the reduction in
tariffs worldwide via successive agreements under the General Agreement on Tariffs and
Trade/World Trade Organization (GATT/WTO), and due to growing consumer concerns
about food safety and quality, and environmental protection.
• https://www.wto.org/english/res_e/booksp_e/non_tariff_measures_e.pdf
 TRADE POLICY INSTRUMENTS
Quotas
Export Quotas:
Restrictions or ceilings imposed on the total value or volume of certain exports. They are
designed to protect domestic producers and consumers from temporary shortages of these
products or to improve the prices of specific products on world markets by shortening their
supply.
Import Quotas:
Restrictions or ceilings imposed by an importing country on the value or volume of certain
products that may be bought from abroad. They are designed to protect domestic
producers from the effects of lower-priced imported products. Import quotas are a form
of quantitative restrictions.
Fixed Quota: A quota set for the volume of import of goods that may not be exceeded in
set period.
Global Quota: Limits on the value or quantity of a good which can be imported or exported
during a period, on a global basis.
Import Demand and Export
Supply
 Equilibrium Trade Price
Precio (P)

XS
PA
Pw (World Price) is in
between the 2 autarky prices
and determines the pattern of
comparative advantage.
Pw

PA* MD

YA Q
 Small Economies

• Small economies are price takers, so we can model domestic

supply and demand, along with the exogenous world price.
 The Effects of an Import Tariff for a
Large Country

• A tariff is a tax on imports, We aseme a “specific tariff”, “t”)

• The tariff raises the price of a good above its free trade level (pw) and reduces its
imports.
• There is a reduction in the world trade price. (terms of trade effect). The price rises by
less than the full amount of the tariff.
 The Effects of an Import Tariff for a
Small Country

• The tariff does not affect the world trade price.

• The price will rise by the full amount of the
tariff.
 BASIC DIAGRAMS OF A SMALL ECONOMY
P
Sd

PA

Dd

YA Y
Consumer Surplus

Producer Surplus
 PARTIAL EQUILIBRIUM
P
Sd

PA

PW
Dd

YA Y
Assumption: Small Economy. Actions of this country does not
affect the world price.  PW is the world supply
 PARTIAL EQUILIBRIUM
Changes in production and consumption
P
Sd

PA

PW
Dd

YP YA YC Y
 PARTIAL EQUILIBRIUM
Level of Imports
P
Sd

PW
Imports Dd

YP YC Y
 PARTIAL EQUILIBRIUM
Changes in Surplus

P
Sd

PA

PW
Dd

YP YA YC Y
 P
PARTIAL EQUILIBRIUM
Changes in Welfare Sd

PA

PW
Dd
YP YA YC Y
Consumer gains, because consumers replace expensive goods
produced locally with import goods produced abroad.
Consumer gains, because consumers consume more of that
good (and less of others) when the price changes from autarky
 PARTIAL EQUILIBRIUM WITH A TARIFF
($ by unit imported)
P Changes in consumption and production
due to the tariff Sd

PA

PW+ t
t
PW
Dd
YP YA YC Y
t = tariff
 PARTIAL EQUILIBRIUM
P Equilibrium with a tariff
Sd

PA

PW+ t
t
PW
Dd
YP YP YA YC YC Y
(tariff) (tariff)
 PARTIAL EQUILIBRIUM WITH A TARIFF
($ by unit imported)
P Import levels
Sd

P W+ t
Imports
(tariff)
PW
Imports
(free trade)
Dd
Y
YP YP YC YC
(tariff) (tariff)
 PARTIAL EQUILIBRIUM WITH A TARIFF
($ by unit imported)
P Government revenues from the tariff
Sd

PW+ t
Imports t
PW
Dd
YP YP YC YC Y

revenues = (tax)·(imports)
 PARTIAL EQUILIBRIUM WITH A TARIFF
($ by unit imported)
P
The increase in producer surplus
Sd

Producers
produce
more
PW+ t

PW
Dd
YP YP YC YC Y
 PARTIAL EQUILIBRIUM WITH A TARIFF
($ by unit imported)
P The reduction in consumer surplus
Sd

The
reduction in
consumption

PW+ t

PW
Dd

YC Y
YP YP YC
 PARTIAL EQUILIBRIUM WITH A TARIFF
($ by unit imported)
Changes in Net Economic Welfare
P Sd

PW+ t
I III IV
II
PW
YP
Dd
YP YC Y
YC
 PARTIAL EQUILIBRIUM WITH A TARIFF
($ by unit imported)

I + II + III +IV = reduction in consumer surplus

I = increases in producer surplus
III = increases in fiscal revenues

II + IV = welfare losses
(reduction in economic efficiency)
(reduction in net economic welfare)
 CONCLUSIONS

I.- Conclusions:
•Trade reduction
•Aggregate economic welfare reduction
•Consumers’ loss
•Producers' gains
•Government gains

II.-Important Considerations of Political Economy

•The tariff is “hidden” in the price of the goods
•Consumers and producers organize politically
-Producers: few, but interested.
-Consumers: Many, but not so interested.
 PARTIAL EQUILIBRIUM WITH A QUOTA
P (limited quantity)
Sd

PW
Imports Dd
YP Y
•Initial Free Trade Equilibrium
Y C
•After, there is a quota: “you can’t import more than the “QUOTA”
expressed in units of Y"
0 Y
QUOTA
 PARTIAL EQUILIBRIUM WITH A QUOTA
P (limited quantity)
Sd

Equilibrium Condition:
• Quantity demanded
domestically minus the
quantity offered is equal
to the QUOTA

QUOTA
PW
Imports
Dd
Y
Y
P
Y
C
 PARTIAL EQUILIBRIUM WITH A QUOTA
P (limited quantity)
Sd

The diagram is almost

identical to the diagram of
the tariff, when the Quota
is equal to the level of
imports with the tariff
YP (Quota) = YP (tariff),
PW + t = P q
Pq YC (Quota) = YC (tariff).
Quota
PW
Import. Dd
Y
YP YP YC YC
(Quota) (Quota)
 PARTIAL EQUILIBRIUM WITH A QUOTA
(limited quantity)
Changes in Net Economic Welfare
P
Sd

Pq
I III IV
II
PW
Dd
YP YP YC YC Y
(Quota) (Quota)
Import. (Quota)
 CONCLUSIONS

Changes in Net Economic Welfare

I + II + III +IV = reduction in consumer surplus

I = increases in producer
surplus
¿What is III now? = (Pq – PW)·(size of the Quota)
= additional return for importers (rents)
II + IV = Deadweight loss
 CONCLUSIONS

Implications when comparing tariffs and Quotas

For each tariff and an equivalent Quota, and can have direct effects
over:
• The Domestic Production
• Domestic Consumption
• Domestic Price
• Import quantity
• Welfare losses to Consumers respect with the case of Free Trade
• Welfare gains to producers compared to the Free Trade Scenario
¿What is the difference?
• (Pq – PW) = t
• With tariff, the government revenues = $t·(YC – YP)
• With a Quota, importers have: $(Pq – PW)·(YC – YP)
- “Quota rents"
The Political Economy of the tariff versus the Quota:
• Citizens prefer tariffs and importers prefer quotas