Chapter 6 -- Tariffs

Chapter 6 -- Tariffs • INTERNATIONAL ECONOMICS,ECO 486 • Draft simplified harmonized uniform tariff schedule (HTS) for US:http://www.usitc.gov/sec/I0326w2m.htm

Learning Objectives • Reprise the gains from trade • Become familiar with tariffs • Analyze the welfare cost of tariffs • Determine the optimal tariff • Explain the effective rate of protection • Learn the imperfect substitutes model

Gains from Trade • Static Gains (PPF doesn’t shift) • Consumption gains • Production gains • Dynamic Gains (PPF does shift) • Trade expands resources • Trade may raise productivity • Political Gains

Consumption & Production Gains rF C B CIC2 A CIC1 TEXTILES, T (yards per year) CIC0 X 0 SOYBEANS, S (bushels per year)

Dynamic Gains from Trade • Trade may speed economic growth

Commercial Policy • Governments action that may change the composition and volume of trade flows • Tariffs • Quotas • Subsidies • Other non-tariff barriers • We’ll analyze the cost & benefits of these

Tariffs • Taxes on • Imports • Exports • Subsidies • Components -- See Table 6.1, page 153 • Ad valorem-- % of value • Specific -- flat fee per unit • Compound -- both

Positive Effects of Tariffs • Revenue Effect -- provide tax revenue • Protective Effect -- shelter domestic producers from foreign competition

Tariff Terminology • A pure-revenue tariff is one imposed on a good not produced domestically • A tariff on bananas imported to Iceland • A prohibitive tariff is one that is so high that none of the good is imported • no revenue is collected

Uses of Tariffs • Developing countries may rely on tariffs to provide tax revenue • Developed countries impose tariffs for their protective effect

Tariffs as tools of int’l policy • Most Favored Nation status, MFN • granted as a reward, withheld as a punishment • Generalized System of Preferences, GSP • Most developed countries have GSP as means of helping developing countries • access to markets of developed countries

Welfare Cost Analysis • Use (National) Supply and Demand • Partial equilibrium • One import or export good • Measure Changes in Consumer Surplus and Producer Surplus • Start with a small country • Its trade is too small to affect terms of trade

Gains from free trade -- imports 10 Price ($ per bushel of grapes) 6 3 2 0 4 1 7 10 Quantity (millions bushels of grapes per year)

Welfare of a Move to Free TradeA Small Country’s Imports

Gains from free trade -- exports 10 9 Price ($ per jar of honey) 6 2 0 4 1 7 10 Quantity (millions jars of honey per year)

Welfare of a Move to Free TradeA Small Country’s Exports

Welfare Cost of a Tariffon Imports -- Small Country 10 Price ($ per bushel of grapes) 5 3 2 0 1 3 5 7 10 Quantity (millions bushels of grapes per year)

Welfare Cost of a Tariffon Imports -- Small Country Loss = 0.5 x tariff x change in imports

Welfare Cost of a TariffSmall Country Domestic Supply of grapes 10 Price ($ per bushel of grapes) World price + tariff $2/bu 5 c d b 3 World price of grapes 2 Domestic demand for grapes 0 1 3 5 7 10 Quantity (millions bushels of grapes per year)

Export Tariff -- Small Country Domestic Supply of honey 10 9 Price ($ per jar of honey) 6 2 Domestic demand for honey 0 4 1 7 10 Quantity (millions jars of honey per year)

Welfare Cost -- Export TariffSmall Country Case

Int’l Free Trade Eq. Large Country Price ($ per lb.) PA PB 0 0 Quantity (lb. of Lobster per year)

Learning Objectives • Derive import demand & export supply • Review the welfare cost of tariffs • Learn elasticity of import demand & export supply • Determine the incidence (burden) of a tariff

Import Demand Price ($ per lb.) Price ($ per lb.) A’s Supply of Lobster PA PA PFT PB PB A’s demand for Lobster 0 0 M = QD -QS Quantity (lb. of Lobster per year)

Export Supply Price ($ per lb.) B’s Supply of L PA PB PB B’s demand for L 0 0 QD QS X = QS -QD Quantity (lb. of Lobster per year)

Price ($ per lb.) A’s Supply of Lobster PA PFT A’s demand for Lobster 0 Q1 Q2 Export Supply & Import Demand Price ($ per lb.) Export Supply, X PA PFT PFT PB Import Demand, M 0 0 M = Q2 -Q1 Quantity (lb. of Lobster per year)

Export Supply & Import Demand Price ($ per lb.) B’s Supply of L Export Supply, X PA PFT PFT PB PB Import Demand, M B’s demand for L 0 0 Q1’ Q2’ 0 M = Q2 -Q1 X = Q2‘ -Q1 ‘ Quantity (lb. of Lobster per year)

Optimal Tariffs • Large countries may “export” part of their tariff. • Because they are important customers, they force foreign supplier to cut price. • The optimal tariff maximizes the net welfare change • Retaliation is likely to offset this gain

Equilibrium with a Tariff Large Country Price ($ per lb.) A’s Supply of L B’s Supply of L P” PFT PFT P’ P’ A’s demand for L B’s demand for L 0 0 Q1’ Q3’ Q4’ Q2’ Q1 Q3 Q4 Q2 Quantity (lb. of Lobster per year)

A’s Welfare Cost -- Import TariffImposed by Large Country, A

B’s Welfare Cost from A’s TariffImport TariffImposed by A

World Welfare Cost of A’s Tariff

World Welfare Changes • Tariff raises the price in A to PW + T • Tariff lowers the world price to PW • Tariff reduces the quantity world trade from MFT to MT • Welfare loss area, f = b+d • Welfare loss area, g = i+j

Export Supply + Specific Tariff, T Price ($ per lb.) T Export Supply, X T Import Demand, M 0 MFT Quantity (lb. of Lobster per year)

Graphing Tariffs • Specific tariff raises the y-intercept of the export supply curve, p = a + b q p + T = a + b q + T • Ad-valorem tariff raises the slope and y-intercept of the export supply curve p = a + b q p (1 + t) = (a + b q) (1 + t) = (1 + t) a + (1 + t) b q

Export Supply with Ad-Valorem Tariff, t Price ($ per lb.) X(1+t) Export Supply, X PA PW +T f PFT g PW PB Import Demand, M 0 MT MFT Quantity (lb. of Lobster per year)

Price Elasticity of Demand, ed ed and slope are inversely related.

The Price Elasticity of Supply, es • The formula for price elasticity of supply, es, at a point is shown below. Note that it’s the same as the formula for ed , but lacks the absolute value notation

Import Demand Elasticity, em • The formula for price elasticity of import demand, em, at a point is shown below. Qis the quantity of imports; Pis the price; DP is the change in price;DQis the change quantity imported

Import Demand Elasticity, em • The formula for price elasticity of import demand, em, at a point is shown below Qm is the quantity of imports; Qd is the quantity demanded; Qs is the quantity supplied

Interpreting em • em is directly related to A’s ed and es • em is inversely related to the share of imports in A’s consumption and production

Export Supply Elasticity, ex • The formula for price elasticity of export supply, ex, at a point is shown below. Qis the quantity of exports; Pis the price; DP is the change in price;DQis the change quantity exported

Export Supply Elasticity, ex • The formula for price elasticity of export supply, ex, at a point is shown below. • Qx is the quantity of exports; Qd is the quantity consumed; Qs is the quantity produced

Interpreting ex • ex is directly related to B’s ed and es • ex is inversely related to the share of exports in B’s consumption and production

Export Supply + Specific Tariff, T PA X + TARIFF, T PW +T T f A’s burden, b PFT Export Supply, X g PW PB Import Demand, M 0 MT MFT Quantity (lb. of Lobster per year)

Compare em and exto determine A’s burden, b; 0£b£1 • When em= ex, b = _____ • When em> ex, b _______ • When em< ex, b _______

Differing em PA X + TARIFF, T PW +T T Export Supply, X f A’s burden, b PFT g PW B’s burden, 1- b Elastic M PB Inelastic M 0 MT MFT Quantity (lb. of Lobster per year)

Differing ex PA Inelastic X + T T Elastic X + T Inelastic X PW +T f A’s burden, b PFT Elastic X g PW PB T Import Demand, M 0 MT MFT Quantity (lb. of Lobster per year)

Nominal & Effective Rates of Protection • t = tariff • P = price of good • v = domestic value added with free trade • v’= domestic value added with tariff

Effective Rate of Protection gj = Effective Rate of Protection on final product j tj = nominal tariff rate on final product j ti = nominal tariff rate on imported input I aij = share of I in the total value of J in the absence of tariffs

Chapter 6 -- Tariffs

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