Charles van Marrewijk Tariff partial equilibrium 1 Countries
Charles van Marrewijk Tariff, partial equilibrium; 1 Countries may restrict trade in several ways. For example, they may • Impose a 100 Euro tax per imported computer (tariff) • Impose a 12% tax per imported computer (ad valorem tariff) • Restrict the number of imported computers (quota) • Subsidize the production of domestically produced computers • Subsidize the export of domestically produced computers • Require a “minimum content” before a computer may be labeled “domestically produced” • Prohibit the sale of computers to certain countries for safety reasons • etc. All of this will affect trade flows in different ways. We will restrict attention mainly to tariffs.
Charles van Marrewijk Tariff, partial equilibrium; 2 We start with a basic partial equilibrium setup; quantity demanded increases and quantity supplied falls as the price falls. In autarky, the equilibrium S price is p 0, with quantity q 0 p D The price in the world market, however, is equal to p 1 p 0 p 1 imports q 1 q 0 q 2 At that price the domestically supplied quantity equals q 1, and the domestically demanded quantity equals q 2. The difference between these two quantities is imported q from abroad.
Charles van Marrewijk Tariff, partial equilibrium; 3 Suppose the government wants to help the domestic suppliers who face a lower price with trade than in autarky. One way to do this is by S imposing a tariff equal to T p D p 1+T p 1 imports q 1 q 3 q 4 q 2 If this is a small country in the world markets this raises the domestic price to p 1+T As a result the domestically produced quantity rises to q 3, and the domestically demanded quantity falls to q 4. The quantity imported from abroad thus falls q
Charles van Marrewijk Tariff, partial equilibrium; 4 We note that the price level has risen from p 1 to p 1+T, which has increased the quantity of domestically produced goods S from q 1 to q 3. Thus, the domestic producers support this policy; indeed their profits have increased by the area: p D The government turns out to be pleased as well; not only has domestic production and profitability increased, they earn a revenue as well equal to: p 1+T p 1 q 3 q 4 q 2 q
Charles van Marrewijk Tariff, partial equilibrium; 5 The only party not in support of this policy are the consumers. They see the price level rise from p 1 to p 1+T. p D S This reduces the consumer surplus considerably, by the area equal to: Indeed, the loss in consumer surplus is so considerable that the total welfare change is negative, equal to the “deadweight loss” triangles: p 1+T p 1 q 3 q 4 q 2 q
Charles van Marrewijk Tariff, partial equilibrium; 6 Is it possible in this analysis that the total welfare change is positive, rather than negative? p Yes, it is. Remember that imposing D S p 2+T a tariff reduces the quantity imported from abroad. If this fall in demand has a substantial impact on the rest of the world it will reduce the world price of this good, say from p 1 to p 2 (large country) This does not mean that domestic prices will be lower than p 1, since the tariff T has to be paid for imports (price wedge). T p 1 p 2 q 1 q 3 q 4 q 2 q
Charles van Marrewijk Tariff, partial equilibrium; 7 The producers gain the area: p The government gains the area: D The consumers lose the area: S The total welfare change is equal to: An omniscient government would set tariffs to maximize this welfare gain, the “optimal” tariff argument, see the sequel. p 2+T p 1 p 2 q 1 q 3 q 4 q 2 q
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