1. Eco 3024F Krugman & Obstfeld Ch 8
Tariff Instruments
Eco 3024F
Krugman & Obstfeld
Ch 8

2. Outline LATER: Introduction: Relevance of tariffs Types of tariffs
Partial equilibrium analysis of tariffs
Costs and benefits of tariffs
LATER:
Analysis of Tariffs (GE framework)
Trade policy in presence of monopolies
8-2

3. “Trade theory is about identifying whose hand is in whose pocket
“Trade theory is about identifying whose hand is in whose pocket. Trade policy is about who should take it out” (Finger, 1981).
“Tariff -- A scale of taxes on imports, designed to protect the domestic producer against the greed of his consumer”.
From Ambrose Bierce, The Devil's Dictionary:

4. Why do we need to worry about tariffs and tariff policy?
Tariffs a key policy instrument used for industrial development
Department of trade and industry’s “National Industrial Policy Framework”
Trade negotiations
WTO negotiations
African countries negotiating new “economic partnership agreements” (EPAs) with EU
Regional integration schemes (SADC Customs union by 2010)
3. Business operations: imported goods used in production and consumption

5. Tariffs & other charges
Goods imported into most countries are subject to different charges
Customs duties
Excise duties
Levies
Flue cured tobacco: 3.3c/kg c/kg (special levy)
Lentils: 9.60 R/T R/T (special levy)
VAT or sales tax

6. Types of import tariffs (Customs duties)
Ad valorem tariff : PD = PW (1 + t)
Levied as a constant percentage of the monetary value of 1 unit of the imported good.
Oranges: 5%
But because it is based on the value of the good, an importer may understate the value while customs may overvalue as a counter measure.
Specific tariff: PD = PW + t
Import duty that assigns a fixed monetary (Rand) tax per physical unit of the good imported.
Blue veined cheese: 500c/kg
It may be collected with ease because only physical quantity of imports needs to be known and not their monetary value
However, protection varies with value of imported good. So inflation lessens strength of tariff

7. Types of import tariffs (Customs duties)
Compound tariffs
Ad valorem PLUS specific tariff
E.g. wheat flour :10% plus 29.4c/kg
Mixed tariff
Either ad valorem OR specific (normally the one which yields higher protection)
E.g. Fish, fresh or chilled: 25% or 70c/kg

9. Supply, Demand & Trade in a Single Industry
Assume
Perfect competition in mkt for laptops.
Two countries in world producing laptops – SA & US
Initially No trade
Price of laptops in US lower than in SA
With trade SA will import laptops
Import demand curve for laptops from SA
With trade, US will export laptops
Export supply curve for laptops from US
8-9

10. Import demand curve Import demand curve (MD):
SA demand –SA supply= Import demand by SA (from US)
Import demand curve is downward sloping....why?
What happens if P is above A?
8-10

11. Export supply curve Export supply curve (XS):
US supply – US demand = Exports supplied to SA (by US) B
Export supply curve is upward sloping....why?
What is happening at point B?
8-11

12. World Equilibrium At Pw , XS=MD in SA
Will Pw be the mkt clearing price in US as well?
8-12

13. Partial equilibrium analysis of impact of tariffs

14. The Effects of a Tariff Suppose SA imposes tariff on computer imports
This is like a tax on the price of good imported or like the effect of transport costs (Imported price=foreign price + tariff)
Will introduce price wedge between domestic price (PT) and foreign price (P*T)
PT – P*T = t
What price adjusts, (PT) or (P*T)?
As domestic price increases, quantity demanded falls in SA
As quantity demanded falls, so quantity supplied by US falls leading to possible foreign price decrease
8-14

15. The Effects of a Tariff (cont.)
Price of the good in foreign (US) markets should fall if there is a significant drop in the quantity demanded of the good caused by the domestic (SA) tariff.
Extent of decline in foreign price depends on elasticity of foreign export supply and elasticity of import demand
8-15

16. The Effects of a Tariff (cont.)
Domestic price rises and quantity of imports demanded falls
Foreign price falls and quantity of exports supplied falls
Gap between domestic and international price equals tariff wedge
8-16

17. Welfare: Who wins and who loses?

18. Welfare: Who wins and who loses?

20. Cost and Benefit using a small country model
Assumptions
Small country is unable to influence world price Pworld through changes in production and/or consumption
Implies: small countries face horizontal (infinitely elastic) Export supply curves

21. Small country supply and demand
Consumer surplus, no tariffs
Consumer surplus, with tariffs
Consumer surplus loss
Price D S
PW (1+t) Q3 Q2 B A D C PW Q4 Q1
Quantity
Imports at PW

22. Small country supply and demand
Producer surplus gain
Price D
Government revenue gain S
PW +t Q3 Q2 B A D C
Dead weight loss PW Q4 Q1
Quantity
Consumer loss-producer gain - government revenue
= dead weight loss (B+D)

23. Small country: conclusion
Tariffs raise domestic production by raising the price received
Consumers pay for this through higher prices
Governments gain from tariff revenue, which they can transfer back to consumers
But price distortions lead to inefficient allocation of resources for consumers and producers
Whose hand is in whose pocket?
Tariffs lead to a transfer of surplus from consumers to producers
8-23

24. Tariffs in large countries
Price
Consumer surplus loss D S
PW* +t Q3 Q2 B A D C t PW Q4 Q1
PW* E
Quantity

25. Tariffs in large countries
Producer surplus gain
Price D
Government revenue gain S
PW* +t Q3 Q2 t A B C D PW Q4 Q1
PW* E
Quantity
Consumer loss - producer gain - government revenue
= B+D-E

26. Large country: conclusion
Tariffs lower the world price
Foreign producers bear some of cost of tariff through lower world prices
Terms of trade improvement for Home
Tariffs still cause production and consumption efficiency losses
BUT, if terms of trade improvement are large enough (area E), then the economy can gain
Would you advise such a strategy? Why not?