1. INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY;  Charles van Marrewijk, 2006; 1 A’s offer curve We have seen how to derive an ‘offer curve’, showing combinations of exports offered in exchange for imports at different price levels. “Optimal” tariffs A’s import A’s export

2. INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY;  Charles van Marrewijk, 2006; 2 Look at point C; on the price line it is the best deal available to country A Obviously, if country A would get more imports for the same exports its welfare would rise A’s import A’s export A’s offer curve C “Optimal” tariffs

3. INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY;  Charles van Marrewijk, 2006; 3 U0U0 U2U2 Welfare for country A increases to the north- west: U 0 < U 1 < U 2 A’s import A’s export U1U1 A’s offer curve This implies that through each point on the offer curve we can draw an Iso-welfare curve for country A. This curve must be tangent to the price line from the origin through that point. “Optimal” tariffs

4. INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY;  Charles van Marrewijk, 2006; 4 U0U0 U2U2 Maximizes country A’s welfare given this restriction at point D: no tariffs An omniscient central planner A’s import A’s export U1U1 A’s offer curve If country A is a country ROW offer curve D “Optimal” tariffs smallThe offer curve it faces from the Rest of the World (ROW) is a straight line (country A cannot influence its terms of trade)

5. INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY;  Charles van Marrewijk, 2006; 5 ROW offer curve U0U0 U2U2 does not maximize country A’s welfare given this restriction at point D An omniscient central planner A’s import A’s export U1U1 A’s offer curve If A is a countryThe ROW offer curve is not a straight line (country A can influence its terms of trade) large D “Optimal” tariffs

6. INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY;  Charles van Marrewijk, 2006; 6 U0U0 U2U2 using an “optimal” tariff such that the new offer curve intersects at point E Country A’s offer curve A’s import A’s export U1U1 old A’s welfare the ROW offer curve is maximized at point E This gives the central planner an incentive to manipulate given D ROW offer curve U3U3 E new “Optimal” tariffs

7. INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY;  Charles van Marrewijk, 2006; 7 Through each point on the ROW offer curve is an iso- welfare curve tangent to a line through the origin. ROW export ROW import For ROW, however, the situation is reverse Welfare increases to the south-east “Optimal” tariffs

8. INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY;  Charles van Marrewijk, 2006; 8 ROW export, A’s import ROW import, A’s export ROW, therefore, has an incentive to manipulate D F new “Optimal” tariffs its offer curve through ‘optimal’ tariffs to go from point D to point F

9. INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY;  Charles van Marrewijk, 2006; 9 ROW wants to be clever to move from D to F ROW export, A’s import ROW import, A’s export D F new E G The end result of all this cleverness is a move from D to G; everyone is worse off retaliation “Optimal” tariffs may worsen the situation Further A wants to be clever to move from D to E