International Trade Theory 6 - Tariffs

Nontariff Barriers

A wide range of government policies other than tariffs designed to affect the volume or composition of a country's international trade. Includes health and safety standards, government procurement policy.

Effects of a Tariff Imposed by a Large Country

Because of its market power, the large country will shift part of the burden of the tariff onto the smaller country, lowering the pre-tariff price. The loss of the consumer surplus a+b+c+d will therefore be smaller, as will the gain in consumer surplus a, but the change in government revenue c+e will be larger.

Static Gains from Free Trade

Consumption gains - Movement to a higher CIC. Production gains - Allocation of resources to a country's comparative advantage.

Under What Conditions will a Tariff Raise a Country's Welfare?

1) The country must have market power (it is an important participant in the world market). 2) A country's imposition of a tariff does not lead to retaliation by trading partners.

Total Deadweight Cost

1/2 x Tariff x Reduction in Imports

Trade War (Tariff War)

A general reduction in world trade brought about by retaliation and increases in trade barriers around the world.

Subsidy

A government payment to a domestic industry to encourage exports or discourage imports

Quota

A government-imposed limit on the value or quantity of an import or export good.

Types of Tariffs - Ad Valorem Tariff

A tax equal to a certain percentage of the good's selling price.

Types of Tariffs - Specific Tariff

A tax equal to a fixed amount of money per unit sold.

Tariff

A tax imposed by a government on either imports or exports.

Types of Tariffs - Compound Tariff

A tax with both Ad Valorem and specific components.

Commercial Policy

Actions taken by a government to influence the country's volume and composition of trade. Includes tariffs, quotas, subsidies, and nontariff barriers.

Free Trade with a Large Country

Equilibrium world price is price at which the quantity consumers in the large country import is equal to the quantity the producers in the small country export. Price is below autarky in the large country and above autarky in the small country.

Summary 3

In general, tariffs lower the standard of living of a country relative to free trade, because they hurt consumers more than they help producers.

Economic Gains from Free Trade

Increase in standard of living and economic growth that results from a country's engaging in free international trade. Includes static and dynamic gains.

Dynamic Gains from Free Trade

Increases in economic well-being that accrue to a country because trade expands the country's productive resources or raises resource productivity.

Political Gains from Free Trade

Increases in well-being that accrue to a country because expanded trade and economic interdependency help reduce international hostility.

Relationship between International Trade and Economic Growth

International trade enhances economic growth through imports of capital goods, enhances international diffusion of technology, is pro-competition, expands the market size if economies of scale exist, and can enlarge the pool of savings necessary for investment spending.

U.S. Tariff Schedule Column 1 - General Rates of Duty

Most Favored Nation (MFN) Status - A country confers MFN status upon another by agreeing not to charge tariffs on that country's goods which are no higher than those it imposes on the goods of any other country.

Effects of an Export Tariff Imposed by a Small Country

Price decreased below world price. Gain in consumer surplus of f and government revenue of h, but loss of producer surplus of f+g+h+k.

Effects of an Import Tariff Imposed by a Small Country

Price increased above world price. Loss of consumer surplus a+b+c+d, increase in producer surplus a and government revenue c (net welfare decrease).

U.S. Tariff Schedule Column 2 - Rates of Duty

Tariffs applied to goods from countries (Cuba and North Korea) without U.S.-granted MFN status. These rates are substantially higher than MFN rates.

U.S. Tariff Schedule Column 1 - Special Rates of Duty

Tariffs applied to goods from many developing countries or from countries with special trade agreement with the U.S. Includes the Generalized System of Preferences (GSP) - a system in which developed countries charge preferential lower tariffs on goods from certain developing countries.

Summary 1

Tariffs are taxes imposed by countries on either imports or exports. This form of commercial policy is probably the most commonly used tool by governments around the world to regulate their trade flows.

Summary 4

Tariffs can increase a country's standard of living if that country has market power in world markets. This result does not apply for most countries and for most products. Even when the requisite conditions hold, improvements in welfare depend crucially on foreign countries not retaliating with increases in their own tariffs.

How High are Tariffs?

Tariffs for individual products may be different than the average rates shown. The tariffs differ by product (tariffs on agricultural goods exceed those of manufactured goods). Tariffs on manufactured final goods are higher than those on intermediate goods (tariff escalation by stages of processing). Tariffs are generally lower for high-income countries.

Tools for Analyzing Tariff Effects - Consumer Surplus

The difference between the amount consumers are willing to pay to purchase a given quantity of good and the amount they have to pay to purchase the good. The area under the demand curve above the price.

Tools for Analyzing Tariff Effects - Producer Surplus

The difference between the price paid in the market for a good and the minimum price required by the industry to produce and market the good. The area above the supply curve under the price.

Summary 2

The effect of import tariffs is to raise the price of these goods and hence discourage their consumption. At the same time, domestic producers of substitute goods find it easier to raise prices and profits. Thus, tariffs are said to protect domestic producers.

Production Deadweight Cost

The protective effect of the tariff which allows domestic firms to increase production above free trade levels (area b - area under supply curve between world price and tariff price)

Optimal Tariff

The size of a tariff that raises the welfare of a tariff-imposing country by the greatest amount relative to free-trade welfare levels.

Effects of the Smoot-Hawley Tariff Act of 1930

The tariff act resulted in average tariff levels rising to almost 60% and covered more than 12,000 products. Other countries retaliated by raising their tariff levels. World trade and U.S. Export dropped. (1929-1933)

Consumer Deadweight Cost

The value of lost consumer satisfaction due to a shift in consumption to less-desired substitutes brought on by the higher price (area d - the area under the demand curve between world price and tariff price).

Deadweight Cost

Value of wasted resources devoted to expanded domestic production and expenditures devoted to less-desired substitutes brought about by a tariff.

Gains from Free Trade for Small Countries - Exports Side

World price is higher than autarky price. Loss of consumer surplus of e+f but gain in producer surplus of e+f+g (net welfare effect). Quantity of exports equal to distance from intersection of price line and demand and supply curves.

Gains from Free Trade for Small Countries - Imports Side

World price is lower than autarky price. Loss of producer surplus of a but gain in consumer surplus of a+b+c (Net welfare effect). Quantity of imports equal to distance from intersection of price line and demand and supply curves.