Tariff, general equilibrium

1
Tariff, general equilibrium
We consider the situation for a
country faced with the production possibility
frontier as drawn in the figure below.
small
At the given world price pworld it would produce
at point Q and trade at world prices to consume
at point C
Q
C
2
Tariff, general equilibrium
If the country imposes a tariff, t, on its import
good (good X) this rotates the price line for
domestic producers clockwise to pworld(1t)
pworld
pworld(1t)
Q
They will start to produce at point Q2
Q2
C
U
3
Tariff, general equilibrium
Despite the tariff the country can still trade
with ROW at the price pworld
pworld
pworld(1t)
So the income available to the economy is
represented by an income line parallel to the
initial income line through the new production
point
Q
Q2
C
U
4
Tariff, general equilibrium
Consumers, like producers, face the price
pworld(1t)
They equalize the marginal rate of substitution
with the distorted price line along the new
income line a point like C2
pworld
pworld(1t)
Q
Q2
We assume that this is redistributed lump-sum to
the consumers
C
C2
U
U2
5
Tariff, general equilibrium
Tariffs result in a double distortion. First,
producers change production and thus income.
pworld
pworld(1t)
Welfare U1 at point C1 is still attainable.
Q
Q2
C
C1
C2
U
U1
U2
6
Tariff, general equilibrium
Here is an enlargement of the welfare loss
arising from the tariff
First, the production (income) loss
Second, the consumption loss
Check for yourself that the second loss does not
arise if a production subsidy is given, rather
than a tariff imposed.
C2
C
C1
U
U2
U1