1. The Welfare Effects of Import Tariff and Quota: “Small” Country
This presentation presents the basic analysis of small-country tariff analysis and develops the idea that a tariff is a combination of a consumption tax and a production subsidy. It then shows that a tariff is “third best”: it is worse than a production subsidy even when the interests of the tariff’s beneficiaries are fully protected. Finally, it compares tariffs and quotas.

2. What is a “small” country?
In trade theory, a country is said to be “small” if events in that country can have no effect on worldwide free trade prices

3. What is a Tariff?
A tariff is a tax on imported goods

4. The Effects of a Tariff A tariff is a tax on imported goods
Tariffs raise the price of imported goods above the world price by the amount of the tariff.
This
Reduces consumption, …
Increases production, and thereby …
Reduces the amount imported

5. Effects of a Tariff on Prices and Quantities
of Steel
Domestic
demand
Domestic
supply
Equilibrium
without trade
Price
after tariff Q S Q D
Tariff
Price
before tariff
World
price Q S Q D
Imports
with tariff
Quantity
Imports
under free trade
of Steel

6. Welfare under free trade
Price
of Steel
Domestic
demand
Consumer surplus
before tariff
Domestic
supply
Producer surplus
before tariff
Equilibrium
without trade
Price
before tariff
World
price Q S Q D
Quantity
Imports
under free trade
of Steel

7. Consumer Surplus after Tariff
Price
of Steel A B
Domestic
demand
Consumer surplus
after tariff
Domestic
supply
Equilibrium
without trade
Price
after tariff Q S Q D
Tariff
Price
before tariff
World
price Q S Q D
Imports
with tariff
Quantity
Imports
under free trade
of Steel

8. Producer Surplus after Tariff
Price
of Steel
Domestic
demand
Domestic
supply
Producer surplus
after tariff
Equilibrium
without trade
Price
after tariff C G
Imports
after tariff Q S D
Tariff
Price
before tariff
World
price Q S Q D
Quantity
Imports
under free trade
of Steel

9. Government’s Revenue from Tariff
Price
of Steel
Domestic
demand
Domestic
supply
Tariff Revenue
Price
after tariff
Imports
after tariff Q S D E
Tariff
Price
before tariff
World Q S Q D
price
Quantity
Imports
under free trade
of Steel

10. Effects of Tariff on Social Welfare
Price
of Steel A
Domestic
demand
Domestic
supply
Deadweight Loss B
Price
with tariff C G D F Q S E Q D
Tariff
Price
without tariff
World Q S Q D
Imports
after tariff
price
Quantity
Imports
without tariff
of Steel

11. Welfare Effects of a Tariff
Consumers of the imported good are worse off (compared to free trade)
Producers of the imported good are better off
The government gains some revenue
Total surplus decreases, because the loss to consumers is larger than the gains to the producers and to the government
The decrease in total surplus is called the deadweight loss of the tariff.

12. The Effects of an Import Quota
An import quota is a limit—imposed by the domestic government—on the quantity of a good that can be produced abroad and sold domestically.

13. The Effects of an Import Quota
Price
of Steel
Domestic
demand
Domestic
supply
Equilibrium
without trade
Domestic
supply +
Import supply
Quota
Isolandian
price with
quota
Equilibrium
with quota Q S Q D
World
price
Price
without
quota = Q S Q D
Imports
with quota
Quantity
Imports
without quota
of Steel

14. The Effects of an Import Quota
Because the quota raises the domestic price above the world price,
domestic buyers of the good are worse off, and
domestic sellers of the good are better off.
Import license holders are better off
they make a profit from buying at the world price and selling at the higher domestic price.

15. The Effects of an Import Quota
Price
of Steel A
Domestic
demand
Domestic
supply
Equilibrium
without trade
Domestic
supply +
Import supply
Quota B
Isolandian
price with
quota
Equilibrium
with quota D Q S E' Q D C F
World
price
Price
without
quota =
E" Q S Q D G
Imports
with quota
Quantity
Imports
without quota
of Steel

16. The Effects of an Import Quota

17. The Effects of an Import Quota
With a quota, total surplus in the market decreases by an amount referred to as a deadweight loss.
The quota can potentially cause an even larger deadweight loss, if a political mechanism such as lobbying is employed to allocate the import licenses.