What are tariffs? DEF1: Tariffs are taxes that are imposed on nations’ import goods and/or export goods DEF2: Tariffs are taxes or duties levied on the traded commodity as it crosses a national boundary

Types of tariffs Import tariff – A tax or duty on import commodity Export tariff – A tax or duty on export commodity Ad valorem tariff – a tariff expressed as a fixed percentage of the value of a traded commodity Specific tariff – A tariff expressed as a fixed sum per unit of a traded commodity Compound tariff – A combination of an ad valorem and a specific tariff

Explanation cont’d Prohibitive tariff – A tariff sufficiently high to stop all international trade so that the nation returns to autarky Optimum tariff – A tariff that maximizies the welfare of a nation Scientific tariff – the tariff rate that would make the price of imports equal to domestic prices so as to allow domestic producers to meet foreign competition

Explanation cont’d Nominal tariff – A tariff calculated on the price of a final commodity Effective tariff – A tariff calculated on the domestic value added in the production of a commodity

Arguments pro Infant industry argument Financial aid to the budget (rent) Political reasons

Arguments contra Consumers pay higher price of imports Reduced welfare

Small vs. Large nation What is the difference between small and large nation? Small nation cannot change world prices (price taker) Large nation CAN change world prices (price maker)

Repetition Consumer surplus is the difference between what consumers are willing to pay for each unit of the commodity and what they actually pay Rent or producer surplus is a payment that need not to be made in the long run in order to induce producers to supply a specific amount of a commodity

Import tariff (small nation case) PX SX E PA G F PW+t a b c d C H I D PW imports DX QX

The effects of import tariff in small nation Ad valorem import tariff in 100% amount doubled the domestic price of commodity X in small nation (Pw to Pw+t) Did the world price change? Did consumers’ & producers’ surplus change? Who collects the revenue from an import tariff and in what amount?

DWL Dead-weight loss (protection costs) arise from the imposition of import tariff in small nation DWL=CS+PS+GR= = DWL=-(a+b+c+d)+a+c= =DWL=-(b+d)

Costs and benefits for a small nation? Import tariff in small nation redistributes income from… …domestic consumers (who pay higher price for the commodity) to domestic producers of the commodity (who receive the higher price) This leads to inefficiencies (protection costs) of the tariff Small nation always loses from the imposition of the import tariff

Quotas DEF: A quota is a direct quantitative restriction on the amount of a commodity allowed to be imported or exported in a nation

Types of quotas Import quotas (most common) Export quotas (in form of VERs) Reasons to use quotas? To protect domestic industry Balance of payment reasons Improve nation’s terms of trade (only in large nation case)

Effects of an import quota in small nation (Q=40) Small Nation A PX SA SA+Q E 4 C D 3 Pw+Q a b c d A F G H B 2 Pw 1 quota DA 20 40 60 80 100 QX

What are the effects of an import quota in a small nation? Import quota has the same effects as an equivalent import tariff for the nation Try to determine equivalent ad valorem import tariff? Who gains quota revenues?

What if we used offer curves? Using the offer curve for small Nation A, show graphical demonstration of an import quota in the same nation

Problem set Lets assume that Nation A is a small nation and imports commodity X from the RoW at the price Pw=10 Supply and demand curves are given:

Give solution to the following Determine autarchy price and quantity Determine production, consumption and import quantities If import quota is imposed in the amount of Q=50, calculate the following Domestic price after imposing import quota Change in consumer surplus Change in producer surplus Quota revenues Consumption costs (consumers’ DWL) Production costs (producers’ DWL) Small nation’s total DWL

Review questions Answer the following questions (only one answer is correct)

Question #1 Which of the following will occur as a result of a tariff on an imported good in a small nation? The price of the imported good and the domestic competing good will increase The quantity consumed by domestic consumers will increase Domestic consumers will gain The nation will gain

Question #2 If a prohibitive tariff is imposed on imports of textiles, then Imports will be zero Consumer surplus will be zero Domestic production will fall to zero Domestic consumption will fall to zero

Question #3 If the consumption effect of a tariff was 50 units and the production effect of a tariff were 40 units, then imports would Increase by 10 units Increase by 90 units Decrease by 90 units Decrease by 10 units

Question #4 If tariff in a small country produces a dead-weight loss of $60, reduces consumer surplus by $200, and increases producer surplus by $40, which of the following is correct? National welfare falls by $220 National welfare falls by $160 Tariff revenues equal $100 The price of the imported good must have fallen

Question #5 Which of the following will occur if each nation imposes a scientific tariff on its imports? Trade will occur on a fair basis Poor countries will gain more from trade No trade will occur Rich nations will dominate trade

Correct answers a c