International Economics By Robert J Carbaugh 7 th

Tariffs Why restrict trade? w Benefits of free trade come in the long term, and are usually spread widely across society w Costs of free trade are felt rapidly and are usually concentrated in specific sectors of the economy Carbaugh, Chap. 5 2

Tariffs Defining tariffs w A tariff is a tax (duty) levied on products as they move between nations § Import tariff - levied on imports § Export tariff - levied on exported goods as they leave the country § Protective tariff - designed to insulate domestic producers from competition § Revenue tariff - intended to raise funds for the government (no longer important in industrial countries) Carbaugh, Chap. 5 3

Tariffs Types of tariff w Specific tariff § Fixed monetary fee per unit of the product w Ad valorem tariff § Levied as a percentage of the value of the product w Compound tariff § A combination of the above, often levied on finished goods whose components are also subject to tariff if imported separately Carbaugh, Chap. 5 4

Tariffs Effective rate of protection w The impact of a tariff is often different from its stated amount w The effective tariff rate measures the total increase in domestic production that the tariff makes possible, compared to free trade Carbaugh, Chap. 5 5

Tariffs Effective rate of protection (cont’d) w When tariff rates are low on raw materials and components, but high on finished goods, the effective tariff rate on finished goods is actually much higher than it appears from the nominal rate w This is referred to as tariff escalation Carbaugh, Chap. 5 6

Tariffs Avoiding and postponing tariffs (US) w Production sharing and special treatment foreign assembly w Bonded warehouses w Foreign trade zones Carbaugh, Chap. 5 7

Tariffs Tariff welfare effects w Consumer surplus § The difference between the price buyers would be willing to pay and what they actually pay w Producer surplus § The revenue producers receive above the minimum amount required to induce them to produce a good Carbaugh, Chap. 5 8

Tariffs B Consumer surplus A Carbaugh, Chap. 5 Supply (minimum price) Producer surplus A C (actual price) Total expenditure D Price ($) Consumer and producer surplus C (actual price) Total variable cost Demand E (maximum price) B D 9

Welfare effects of tariffs Price ($) Tariff trade and welfare effects Small nation model H g E e a Sd b f G c d Sd+w+t F Sd+w Dd Carbaugh, Chap. 5 10

Welfare effects of tariffs Tariff trade and welfare effects Price ($) Large nation model E 9, 600 8, 800 8, 000 7, 800 Sd Sd+w+t G a b e c d F Sd+w Dd Carbaugh, Chap. 5 11

Tariff effects Who pays for import restrictions? w Domestic consumers face increased costs § Low income consumers are especially hurt by tariffs on low-cost imports w Overall net loss for the economy (deadweight loss) w Export industries face higher costs for inputs w Cost of living increases w Other nations may retaliate, further restricting trade Carbaugh, Chap. 5 12

Reasons for tariffs Arguments for trade restrictions w Job protection w Protect against cheap foreign labor w Fairness in trade - level playing field w Protect domestic standard of living w Equalization of production costs w Infant-industry protection w Political and social reasons Carbaugh, Chap. 5 13

Reasons for tariffs Politics of protectionism w “Supply” of protectionism (trade policy) depends on: § the cost to society of restricting trade § the political importance of the import-competing industries § Magnitude of the adjustment costs from free trade § Public sympathy for those sectors hurt by free trade Carbaugh, Chap. 5 14

Reasons for tariffs Politics of protectionism w “Demand” for protectionism depends on: § The amount of the import-competing industry’s comparative disadvantage § The level of import penetration § The level of concentration in the affected sector § The degree of export dependence in the sector Carbaugh, Chap. 5 15