Chapter Six

1
Chapter Six

• Tariffs

2
Chapter Six Outline

• Introduction
• Why Would a Country Impose a Tariff?
• Types of tariffs and Ways to Measure Them
• What Happens when a Small Country Imposes an
  Import Tariff?
• What Happens when a Large Country Imposes an
  Import Tariff?

3
Chapter Six Outline

• How Does a Tariff Affect Factor Prices?
  Specific Factors and Stolper-Samuelson
• Tariffs and Economies of Scale
• The Effective Rate of Protection
• Off-Shore Assembly Provisions
• Taxing Exports

4
Introduction

• The policies countries use to restrict trade are
  called Barriers to Trade.
• Tariff is the most common.
• Tax imposed on a good as it crosses a national
  boundary.
• Use of tariffs has been declining recently due to
  international negotiations conducted under the
  WTO (successor to GATT).

5
Why Would a Country Impose a Tariff?

• Countries impose tariffs for
  any of four reasons
• Tariff can discourage consumption of a particular
  good (oil).
• Generate revenue for government of
  tariff-imposing country.
• Fig. 6.1 shows decline of U.S. tariff revenues.
• Discourage imports in order to lower balance of
  trade deficit.
• Carry out a protectionist policy a way to
  insulate domestic industries from foreign
  competition.

6
Figure 6.1 Tariff Revenue as a Share of Total
U.S. Federal Government Receipts, 18301990
Percent
100
90
80
70
60
50
40
30
20
10
0
80
1830
40
50
60
70
80
90
1900
10
20
30
40
50
60
70
1990
Year
7
Types of Tariffs

• Specific Tariffs
• Charge a specified amount for each unit of the
  tariffed good imported.
• Example 1.09 per live goat.
• Ad Valorem Tariffs
• Charge a specified percentage of the value of the
  tariffed good.
• Example 2.4 of a dog leashs value.

8
Measurement of Tariffs

• U.S. tariff code contains 8,753 categories, on
  which tariffs range from 0 to 458.
• Tariff rates vary across goods.
• Example 200 different rates apply to watches
  and clocks.
• How do you measure a countrys level of tariff
  protection?
• One technique simple unweighted average of
  industry tariff rates.
• Country A imports two goods, X (25 tariff rate)
  and Y (50 tariff rate) average equals 37.5.

9
Measurement of Tariffs

• Most common way to measure tariffs is using a
  weighted-average.
• It involves weighting the tariff rate for each
  industry by that industrys share of total
  imports.
• Example If Country A imported 50 of X and 50
  of Y, then As weighted-average tariff rate would
  equal (50/100)(0.25) (50/100)(0.50)
  37.5.
• Main problem with both types of average tariffs
  is that they ignore trade foreclosed by the
  tariff.
• An extreme case a prohibitive tariff is one high
  enough to halt trade in a product.
• In general, non-WTO members and developing
  countries impose higher tariffs.

10
Tariffs in various countries

• Tariff rates have fallen in most countries over
  the past few decades
• Tariff rates are highest in South Asia and lowest
  in industrial countries.
• South Asia has rates close to 30 on average
• Industrialized countries average closer to 5

11
Figure 6.2 Average Unweighted Tariff Rates by
Region
12
What Happens when a Small Country Imposes an
Import Tariff?

• In analyzing the effects of a tariff, the size of
  the country imposing it matters.
• First, look at case of small country.
• Small refers to economic size in world markets.
• Small countrys terms of trade are determined
  exogenously and the country makes its production
  and consumption decisions based on those terms of
  trade.

13
Figure 6.3 What Happens When a Small Country
Imposes an Import Tariff?
P
Y
S
d
E
P
0
Y
G
t
P
1
S
w
t
Y
F
P
1
S
w
Y
D
d
0
Y
Y
2
Y
4
Y
0
Y
3
Y
1
14
What Happens when a Small Country Imposes an
Import Tariff?

• Effects on production, consumption, and price.
• Figure 6.3 clearly shows that the tariff
  increases the price of the good by the amount of
  the tariff, reduces domestic consumption,
  increases domestic production, and decreases
  imports.
• Effects on welfare
• Useful to separate effects on consumers from
  those on producers.
• Need to analyze consumer surplus and producer
  surplus.

15
Consumer and Producer Surplus

• Consumer surplus measures the satisfaction
  consumers receive from a good beyond what they
  pay to obtain it.
• Producer surplus measures the revenue producers
  receive beyond the minimum required to induce
  them to supply the good.
• Figure 6.3 illustrates both of these measures.

16
Figure 6.4 Consumer and Producer Surplus
P
Y
P
Y
S
E
Y
Consumer
F
Surplus
C
P
0
P
0
Y
Y
Producer
Surplus
Expenditure
on Y
G
Costs
D
0
Y
Y
Y
0
0
Y
0
(a) Consumer Surplus
(b) Producer Surplus
17
Tariffs Effect on Consumer and Producer Surplus

• Figure 6.5 shows the welfare effects of a tariff
  on imports by a small country as changes in
  consumer and producer surplus.
• Rectangle n is tariffs revenue effect.
• Transfer from consumer surplus to the government
  that collects the tariff revenue.
• Area j is the tariffs redistribution effect.
• Consumer surplus transferred to domestic
  producers.

18
Figure 6.5 How Does an Import Tariff by a Small
Country Affect the Countrys Welfare?
P
Y
S
d
H
E
P
0
Y
G
V
t
P
1
S
w
t
Y
j
n
r
m
P
1
S
w
Y
F
Z
D
d
Y
2
Y
4
Y
0
Y
3
Y
1
Y
0
19
Tariffs Effect on Consumer and Producer Surplus

• Triangle m is the tariffs production effect.
• Units Y2 through Y4 are now (with the tariff)
  produced domestically rather than imported.
• Area m is a deadweight loss.
• Loss to the small country of consumer surplus not
  transferred to another group in the country, but
  lost through inefficient domestic production.
• Triangle r represents another deadweight loss.
• This consumption effect is the loss of consumer
  surplus that occurs because consumers can no
  longer obtain Y3 through Y1 at the pre-tariff
  price.

20
Tariffs Effect on Consumer and Producer Surplus

• Net welfare loss to the small country as a whole
  from the import tariff equals the sums of areas m
  and r in Figure 6.5.
• The tariff taxes trade, encourages domestic
  production, and discourages domestic consumption
  and imports.
• Volume of trade falls under the tariff.

21
What Happens when a Large Country Imposes an
Import Tariff?

• Large country constitutes a share of the world
  market sufficient to enable it to affect its
  terms of trade.
• Tariff may be used to improve its terms of trade.
• Effects on production, consumption, and price.
• Figure 6.5 illustrates the upward sloping total
  supply curve for a large country.
• Slopes upward because the large country, as it
  buys more of good Y, pushes up the world price.

22
Figure 6.6 Total Supply Equals Domestic Supply
Plus Supply by the Rest of the World
P
P
P
Y
Y
Y
S
d
S
w
S
d w


0
0
0
Y
Y
Y
(a) Domestic Supply
(b) Supply by Rest of World
(c) Total Supply
23
Figure 6.7 How Does an Import Tariff by a Large
Country Affect the Countrys Welfare?
P
Y
d
S
E
d w
S
t
H
I
d w
t
S
1
P
Y
m
j
n
r
0
P
C
Y
s
F
2
P
Y
d
D
G
0
2
3
1
Y
0
Y
Y
Y
Y
24
What Happens when a Large Country Imposes an
Import Tariff?

• As shown in Figure 6.7, the tariff reduces
  consumption from Y0 to Y2, increases domestic
  production from Y1 to Y3, and decreases imports.
• The price domestic consumers pay rises, and the
  price foreign producers receive falls.
• Area j is a transfer from domestic consumers to
  domestic producers.
• Areas m and r are deadweight losses reflecting
  inefficient production and consumption,
  respectively.
• Area n is a transfer from domestic consumers to
  the government.
• Area s is a transfer from foreign producers to
  the domestic government.

25
What Happens when a Large Country Imposes an
Import Tariff?

• When foreign producers face a substantially lower
  quantity demanded for their product, their
  opportunity costs of production fall, and so does
  price.
• This effect of the tariff is called the
  Terms-of-Trade Effect.
• Tariff has redistributive effect among countries.
• All of large-country gains comes at expense of
  trading partner, which must accept lower prices
  for its exports.
• Tariff has negative effect on world welfare
  regardless of the size of the countries involved.

26
Optimal Tariffs and Threat of Retaliation

• Imposition of tariff by a large country has 2
  effects
• Volume-of-trade effect occurs when tariff lowers
  welfare by discouraging trade.
• By lowering the price foreign producers receive,
  the tariff enhances welfare in tariff-imposing
  country.
• Optimal tariff is rate that maximizes net
  benefits to tariff-imposing country.
• Policies such as optimal tariffs that try to
  improve the welfare of the domestic country at
  the expense of others are called
  beggar-thy-neighbor polices.

27
How Does a Tariff Affect Factor Prices?

• In the long run, when all factors are mobile
  among industries, the tariff has the effects
  predicted by the Stolper-Samuelson theorem.
• A tariff, by raising the domestic price of the
  import good, tends to raise the real reward to
  the scarce factor and lower the real reward to
  the abundant factor.

28
Tariffs and Economies of Scale

• Tariffs can interfere with economies of scale.
• With widespread tariffs, each country must
  produce small quantities of all the goods
  domestic consumers want to consume, instead of
  specializing in the export good and producing a
  large quantity of it, thereby achieving economies
  of scale.
• This implies that the costs of tariffs can be
  even higher in industries characterized by
  economies of scale.

29
Effective Rate of Protection

• Relationship among tariffs in related markets and
  industries is called Tariff Structure.
• Cascading tariffs raw materials tend to have
  lower tariff rates that the finished products
  ultimately produced with them.
• Figure 6.8 points this out -- in most countries,
  finished products face higher tariffs than do raw
  materials.

30
Figure 6.8 Tariffs Increase with the Level of
Processing
10
Percent
9.1
Product category
8
6.2
6
5.4
Pre-Uruguay Round
Post-Uruguay Round
4
2.8
2.1
2
0.8
0
Semi-
Finished
Raw materials
manufactures
products
31
Effective Rate of Protection

• By ignoring the effect of tariff structure, the
  tariff rate on a final good may provide an
  inaccurate measure of the effective protection
  provided to domestic production.
• Effective Rate of Protection alternative measure
  that accounts for the role of tariff structure.
• Takes Domestic Value-Added into account
  difference between the world price of the
  finished good and the cost of the imported raw
  materials.

32
Effective Rate of Protection

• Effective rates of protection differ greatly from
  actual or nominal tariff rates for many
  industries.
• Actual tariff rates significantly underestimate
  the effective protection received by many
  industries.
• Trade barriers on inputs always lower the
  effective protection given to finished-goods
  producers.

33
Off-Shore Assembly Provisions

• Many countries have special tariff provisions
  that make tariff rates more complicated.
• Most common are off-shore assembly provisions.
• Allow reduced tariffs on goods assembled abroad
  from domestically produced components.

34
Taxing Exports

• Sometimes a country places taxes on its own
  exports.
• In the U.S., export taxes are unconstitutional.
• Two basic reasons for these taxes
• Response to pressure by domestic consumer groups
  to keep domestic price of a good low.
• Second reason applies only to large countries
  may endeavor to exploit their own market power by
  using export taxes to raise the prices foreign
  buyers must pay.

35
Export Tax Imposed by a Small Country

• Figure 6.9 shows that the export tax encourages
  domestic consumption and discourages domestic
  production and exports.
• Consumers gain at the expense of domestic
  producers.

36
Figure 6.8 What Happens When a Small Country
Imposes an Export Tax?
X
P
S
d
E
P
1
D
w
g
j
X
h
f
t

t
D
w

t
P
1
X
P
0
X
D
d
1
3
4
2
X
X
X
X
X
0
37
Export Tax Imposed by a Large Country

• Figure 6.10 graphically depicts that the
  tax-imposing country suffers deadweight losses
  equal to area hj and enjoys a gain in revenue
  from foreign consumers equal to are k.
• If (hj) gt k, the country suffers a net welfare
  loss from the tax.
• If (hj) lt k, the country enjoys a net welfare
  gain.

38
Figure 6.10 What Happens When a Large Country
Imposes an Export Tax?
P
X
S
d
P
2
X
k
P
0
j
X
h
f
g
P
1
D
d w
X
t
D
d w

t
D
d
X
1
X
3
X
2
X
0
X
0
39
Note for Case Three China, Tariffs and the WTO

• Figure 6.11 indicates the regional sources of
  Chinese imports in 1996.
• Most Chinese imports come from Asia, including
  Hong Kong.

40
Figure 6.11 Regional Sources of Chinese
Imports, 2000 (Billions )
29.04
7.68
18.66
9.14
3.94
4.72
107.72
Asia (including Hong Kong)
41
Appendix A Offer Curves and Tariffs

• Effects of an import tariff by Country A
• Figure 6A.1 shows that an import tariff of t
  imposed by A reduces the volume of trade in which
  A wants to engage and shifts As offer curve
  inward to At.
• In exchange for Y0 units of imports, A reduces
  the amount of good X it is willing to export from
  X0 to X1.
• The difference goes to the government as tariff
  revenue.

42
Figure 6A.1a Effect of an Import Tariff
by Country A
Imports of
A
A
t
Y by A
Y
C
0
(a) Tariff Shifts Country As Offer Curve
t
0
X
X
Exports of
0
1
X by A
43
Figure 6A.1b Effect of an Import Tariff by
Country A
Exports of Y by B,
A
B
Imports of Y by A
A
t
Y
2
(b) Effect of Tariff by a Small Country
Y
3
0
X
X
Exports of X by A,
2
3
Imports of X by B
44
Appendix A Offer Curves and Tariffs

• In panel (b) of Figure 6A.1, Country As
  smallness is represented by the straight-line
  shape of trading partner Bs offer curve.
• The slope of Bs offer curve determines the
  equilibrium terms of trade regardless of As
  action.
• The tariff imposed by A reduces the volume of
  trade from X2 and Y2 to X3 and Y3, but has no
  effect on the equilibrium terms of trade.

45
Appendix A Offer Curves and Tariffs

• Effects of an import tariff by large country.
• Figure 6A.2 shows that As large size is
  represented by curved shape of trading partner
  Bs offer curve.
• In panel (a), imposition of tariff by A raises
  the relative price of X, As export good, as
  shown by the increased slope of straight line
  from origin through intersection of the two
  countries offer curves.

46
Figure 6A.2a Effect of an Import Tariff by a
Large Country
Exports of Y by B,
A
Imports of Y by A
tt
(P
/P
)
X
Y
1
A
tt
(P
/P
)
t
X
Y
0
B
(a) Tariff By Country A
Exports of X by A,
0
Imports of X by B
47
Appendix A Offer Curves and Tariffs

• Retaliation by country B
• B may choose to impose an import tariff, shifting
  its offer curve to Bt, in panel (b).
• Retaliation further reduces the volume of trade.
• Net effect on terms of trade depends on relative
  sizes of the two countries tariffs and on the
  shapes of their offer curves.
• As drawn, Bs retaliatory tariff is too low to
  restore the terms of trade to their original,
  pre-tariff level.

48
Figure 6A.2b Effect of an Import Tariff by a
Large Country
Exports of Y by B,
A
Imports of Y by A
A
(P
/P
)
tt
t
X
Y
post-retaliation
B
B
t
(b) Retaliation By Country B
Exports of X by A,
0
Imports of X by B
49
Appendix B General-Equilibrium Tariff Effects in
a Small Country

• As shown in Figure 6B.1, an import tariff imposed
  by a small country causes a loss of efficiency
  and a decrease in welfare.
• Consumption is inefficient, causing a further
  reduction in welfare.

50
Figure 6B.1 General-Equilibrium Effects of an
Import Tariff by a Small Country
Y
c
0
c
1
U
c
2
0
U
1
p
U
1
2
Slope

P
w
/(P
w
t)
X
Y
Slope
p
0

(P
/P
)
w
X
Y
0
X
51
Key Terms in Chapter 6

• Barriers to trade
• Tariff
• Protectionist policy
• Specific tariff
• Ad valorem tariff
• Prohibitive tariff
• Consumer surplus

52
Key Terms in Chapter 6

• Producer surplus
• Revenue effect
• Redistribution effect
• Production effect
• Deadweight loss
• Consumption effect
• Terms-of-trade effect

53
Key Terms in Chapter 6

• Volume-of-trade effect
• Optimal tariff
• Beggar-thy-neighbor policy
• Tariff structure
• Cascading tariff
• Effective rate of protection (ERP)
• Domestic value-added (V)
• Off-shore assembly provision (OAP)