© 2001 J. Douglass Klein Effects of a Tariff Economics 24 Effects of ProtectionCONNECT TO ECO 24 WEB SITECONNECT TO ECO 24 WEB SITE Consider the British corn industry, and suppose, initially, that there is free trade in corn. The situation for the British corn market and a typical British corn farmer are shown in figure 1, below. The world price of corn is PW. SB is the British domestic supply curve, and DB is British demand for corn. The typical farmer produces qf1, and earns zero economic profit, and British consumers import an amount of corn equal to QD1 - QS1. Q P SBSB DBDB q Marginal Cost Average Cost World Supply PWPW PWPW One typical British corn farmerEntire British corn market q f1 Q S1 Q D1

© 2001 J. Douglass Klein Effects of a Tariff Consider the effects of a tariff on the British corn industry. World-wide, the price of corn is Pw. British farmers can produce corn along the supply curve S B. Why is the world supply curve flat? Why does S B have a positive slope? How much corn does Britain import? Why don’t British farmers grow more corn? Q P SBSB DBDB World Supply PWPW Entire British corn market Q S1 Q D1

© 2001 J. Douglass Klein Effects of a Tariff P Q P SBSB DBDB q Marginal Cost Average Cost World Supply PWPW PWPW One typical British corn farmerEntire British corn market q f1 Q S1 Q D1 Suppose the British government imposes a tariff T on imported corn. What happens in the SHORT RUN? What happens in the LONG RUN? Define SHORT RUN and LONG RUN. T Pw + T

© 2001 J. Douglass Klein Effects of a Tariff Q P SBSB DBDB q P Marginal Cost Average Cost World Supply PWPW PWPW One typical British corn farmerEntire British corn market q f1 Q S1 Q D1 NO TARIFF. LONG RUN EQUILIBRIUM. With no trade barriers, British consumers import Q D1 - Q S1 corn. British farmers sell Q S1 units of corn. Typical farmers earn zero excess profit. What does it mean to say that farmers are earning zero profit? Price = Average Cost IMPORTS

© 2001 J. Douglass Klein Effects of a Tariff P What happens in the SHORT RUN? T Pw + T Q P SBSB DBDB q Marginal Cost Average Cost World Supply PWPW PWPW One typical British corn farmerEntire British corn market q f1 Q S1 Q D1 PROFIT q f2 Q S2 Q D2 At the new higher price, British corn farmers make a profit. At the new higher price, British consumers import less corn.

© 2001 J. Douglass Klein Effects of a Tariff P What happens in the LONG RUN? T Pw + T Q P SBSB DBDB q Marginal Cost Average Cost World Supply PWPW PWPW One typical British corn farmerEntire British corn market q f1 Q S1 Q D1 In the LONG RUN, entry can occur. So long as profits exist, entry will continue. How do we show entry on the graph? How far will the British Supply curve shift? S’ S’’ S’’’

© 2001 J. Douglass Klein Effects of a Tariff P T Pw + T Q P SBSB DBDB q MC AC World Supply PWPW PWPW One typical British corn farmerEntire British corn market q f1 Q S1 Q D1 S’’ If Average Costs rise as the industry expands, for example if poorer farm land is put into corn production, then profits of the newest (and least productive) farms will fall to zero at a price higher than Pw. AC’ The more productive farms may still earn the kind of profit called economic rent, profit which cannot be eliminated by entry. P2P2

© 2001 J. Douglass Klein Effects of a Tariff - SUMMARY A tariff raises the price of a good. With higher prices, domestic firms make a greater profit in the short run. The higher profits provide an incentive for domestic entry. As entry occurs, price begins to fall. Whether price will eventually fall to (or below) the world price is hotly debated. One thing is clear. A tariff helps domestic producers, and at least in the short run hurts domestic consumers.