ECO2008 International Economics Week 9b PDF

ECO2008 International Economics The Instruments of Trade Policy Week 9b Brian Varian Types of Tariffs A tariff is a tax levied when a good is imported. A specific tariff is levied as a fixed charge for each unit of imported goods. – For example, $3 per barrel of oil....

ECO2008 International Economics The Instruments of Trade Policy Week 9b Brian Varian Types of Tariffs A tariff is a tax levied when a good is imported. A specific tariff is levied as a fixed charge for each unit of imported goods. – For example, $3 per barrel of oil. An ad valorem tariff is levied as a fraction of the value of imported goods. – For example, 25% tariff on the value of imported trucks. Copyright © 2018 Pearson Education, Ltd. All rights reserved. Supply, Demand, and Trade in a Single Industry (1 of 4) Consider how a tariff affects a single market, say that of wheat. Suppose that in the absence of trade the price of wheat is higher in Home than it is in Foreign. With trade, wheat will be shipped from Foreign to Home until the price difference is eliminated. Copyright © 2018 Pearson Education, Ltd. All rights reserved. Supply, Demand, and Trade in a Single Industry (2 of 4) An import demand curve is the difference between the quantity that Home consumers demand minus the quantity that Home producers supply, at each price. The Home import demand curve MD = D − S intercepts the price axis at PA and is downward sloping: – As price increases, the quantity of imports demanded declines. Copyright © 2018 Pearson Education, Ltd. All rights reserved. Figure 9.1 Deriving Home’s Import Demand Curve As the price of the good increases, Home consumers demand less, while Home producers supply more, so that the demand for imports declines. Copyright © 2018 Pearson Education, Ltd. All rights reserved. Supply, Demand, and Trade in a Single Industry (3 of 4) An export supply curve is the difference between the quantity that Foreign producers supply minus the quantity that Foreign consumers demand, at each price. The Foreign export supply curve XS   S   D intersects the price axis PA and is upward  at – As price increases, thesloping: quantity of exports supplied rises. Copyright © 2018 Pearson Education, Ltd. All rights reserved. Figure 9.2 Deriving Foreign’s Export Supply Curve As the price of the good rises, Foreign producers supply more while Foreign consumers demand less, so that the supply available for export rises. Copyright © 2018 Pearson Education, Ltd. All rights reserved. Supply, Demand, and Trade in a Single Industry (4 of 4) In equilibrium, import demand = export supply, home demand − home supply = foreign supply − foreign demand, home demand + foreign demand = home supply + foreign supply, world demand = world supply. Copyright © 2018 Pearson Education, Ltd. All rights reserved. Figure 9.3 World Equilibrium The equilibrium world price is where Home import demand (MD curve) equals Foreign export supply (XS curve). Copyright © 2018 Pearson Education, Ltd. All rights reserved. Effects of a Tariff (1 of 4) A tariff acts like a transportation cost, making sellers unwilling to ship goods unless the Home price exceeds the Foreign price by the amount of the tariff: PT  t  PT  A tariff makes the price rise in the Home market and fall in the Foreign market. Copyright © 2018 Pearson Education, Ltd. All rights reserved. Figure 9.4 Effects of a Tariff A tariff raises the price in Home while lowering the price in Foreign. The volume traded thus declines. Copyright © 2018 Pearson Education, Ltd. All rights reserved. Effects of a Tariff (2 of 4) Because the price in the Home market rises from PW under free trade to PT with the tariff, – Home producers supply more and Home consumers demand less, so – the quantity of imports falls from QW under free trade to QT with the tariff. Copyright © 2018 Pearson Education, Ltd. All rights reserved. Effects of a Tariff (3 of 4) Because the price in the Foreign market falls from PT  with PW under free trade to the – Foreign producers tariff, supply less, and Foreign consumers demand more, so – the quantity of exports falls from QW to QT. Copyright © 2018 Pearson Education, Ltd. All rights reserved. Effects of a Tariff (4 of 4) The quantity of Home imports demanded equals the quantity of Foreign exports supplied when PT  PT   t The increase in the price in Home can be less than the amount of the tariff. – Part of the effect of the tariff causes the Foreign export price to decline. – But this effect is sometimes very small. Copyright © 2018 Pearson Education, Ltd. All rights reserved. Effects of a Tariff in a Small Country When a country is “small,” it has no effect on the foreign (world) price because its demand is an insignificant part of world demand for the good. – The foreign price does not fall, but remains at Pw. – The price in the home market rises by the full amount of the tariff, to PT = Pw + t. Copyright © 2018 Pearson Education, Ltd. All rights reserved. Figure 9.5 A Tariff in a Small Country When a country is small, a tariff it imposes cannot lower the foreign price of the good it imports. As a result, the price of the import rises from PW to PW + t and the quantity of imports demanded falls from D1 − S1Copyright to D2©−2018 S2.Pearson Education, Ltd. All rights reserved. Measuring the Amount of Protection (1 of 3) The effective rate of protection measures how much protection a tariff (or other trade policy) provides. Effective rates of protection often differ from tariff rates because tariffs affect sectors other than the protected sector, causing indirect effects on the prices and value added for the protected sector. Copyright © 2018 Pearson Education, Ltd. All rights reserved. Measuring the Amount of Protection (2 of 3) For example, suppose that automobiles sell in world markets for $8,000, and they are made from factors of production worth $6,000. – The value added of the production process is $8,000 − $6,000 = $2,000. Suppose that a country puts a 25% tariff on imported autos so that home auto assembly firms can now charge up to $10,000 instead of $8,000. Copyright © 2018 Pearson Education, Ltd. All rights reserved. Measuring the Amount of Protection (3 of 3) The effective rate of protection for home auto assembly firms is the change in value added: $4,000  $2,000  100% $2,000 In this case, the effective rate of protection is greater than the tariff rate. Copyright © 2018 Pearson Education, Ltd. All rights reserved. Costs and Benefits of Tariffs A tariff raises the price of a good in the importing country, so it hurts consumers and benefits producers there. In addition, the government gains tariff revenue. How to measure these costs and benefits? Use the concepts of consumer surplus and producer surplus. Copyright © 2018 Pearson Education, Ltd. All rights reserved. Consumer and Producer Surplus (1 of 2) Consumer surplus measures the amount that consumers gain from purchases by computing the difference in the price actually paid from the maximum price they would be willing to pay for each unit consumed. – When price increases, the quantity demanded decreases as well as the consumer surplus. Copyright © 2018 Pearson Education, Ltd. All rights reserved. Figure 9.6 Deriving Consumer Surplus from the Demand Curve Consumer surplus on each unit sold is the difference between the actual price and what consumers would have been willing to pay. Copyright © 2018 Pearson Education, Ltd. All rights reserved. Figure 9.7 Geometry of Consumer Surplus Consumer surplus is equal to the area under the demand curve and above the price. Copyright © 2018 Pearson Education, Ltd. All rights reserved. Consumer and Producer Surplus (2 of 2) Producer surplus measures the amount that producers gain from sales by computing the difference in the price received from the minimum price at which they would be willing to sell. – When price increases, the quantity supplied increases as well as the producer surplus. Copyright © 2018 Pearson Education, Ltd. All rights reserved. Figure 9.8 Geometry of Producer Surplus Producer surplus is equal to the area above the supply curve and below the price. Copyright © 2018 Pearson Education, Ltd. All rights reserved. Measuring the Costs and Benefits of Tariffs (1 of 4) A tariff raises the price in the importing country: – consumer surplus decreases (consumers worse off) – producer surplus increases (producers better off). – the government collects tariff revenue equal to   t QT  PT  PT D2  S2  the tariff rate times the quantity of imports with the tariff. Change in welfare due to the tariff is e − (b + d). Copyright © 2018 Pearson Education, Ltd. All rights reserved. Figure 9.9 Costs and Benefits of a Tariff for the Importing Country The costs and benefits to different groups can be represented as sums of the five areas a, b, c, d, and e. Copyright © 2018 Pearson Education, Ltd. All rights reserved. Measuring the Costs and Benefits of Tariffs (2 of 4) For a “large” country, whose imports and exports affect world prices, the welfare effect of a tariff is ambiguous. The triangles b and d represent the efficiency loss. – The tariff distorts production and consumption decisions: producers produce too much and consumers consume too little. The rectangle e represents the terms of trade gain. – The tariff lowers the Foreign price, allowing Home to buy its imports cheaper. Copyright © 2018 Pearson Education, Ltd. All rights reserved. Measuring the Costs and Benefits of Tariffs (3 of 4) Part of government revenue (rectangle e) represents the terms of trade gain, and part (rectangle c) represents some of the loss in consumer surplus. – The government gains at the expense of consumers and foreigners. If the terms of trade gain exceed the efficiency loss, then national welfare will increase under a tariff, at the expense of foreign countries. – However, foreign countries are apt to retaliate. Copyright © 2018 Pearson Education, Ltd. All rights reserved. Figure 9.10 Net Welfare Effects of a Tariff The colored triangles represent efficiency losses, while the rectangle represents a terms of trade gain. Copyright © 2018 Pearson Education, Ltd. All rights reserved. Measuring the Costs and Benefits of Tariffs (4 of 4) Tariffs can lead trading partners to retaliate with their own tariffs, thus hurting exporters in the country that first adopted the tariff. Tariffs can be hard to remove and large tariffs may induce producers to engage in wasteful activities to avoid paying tariffs. – Ford and Subaru install (then later remove) seats in vans and pickups trucks to avoid U.S. tariff on imports of light commercial trucks. Copyright © 2018 Pearson Education, Ltd. All rights reserved. Summary 1. A tariff increases the home price and the quantity supplied and reduces the quantity demanded and the quantity traded; also decreases the world price when the country is “large.” 2. Tariffs generate government revenue. 3. The welfare effect of a tariff can be measured by – efficiency loss from consumption and production distortions. – terms of trade gain or loss. Copyright © 2018 Pearson Education, Ltd. All rights reserved.