1. Carbaugh, Chap. 5 1 Why restrict trade?  Benefits of free trade spread widely  Costs of free trade are felt rapidly  Costs usually concentrated in specific sectors

2. Carbaugh, Chap. 5 2 Flavors of tariffs  Tariff: a tax (duty) on internationally traded products  Import tariff - levied on imports  Export tariff - levied on exported goods as they leave the country  Protective tariff - insulate domestic producers from competition  Revenue tariff - raise funds for government Tariffs

3. Carbaugh, Chap. 5 3  Specific tariff  Fixed $ / unit  Ad valorem tariff  % of product’s value  Compound tariff  Combination of fixed and ad valorem tariffs  Levied on finished goods whose components are also subject to tariff if imported separately  Fixed portion offsets tariffs on raw materials paid by domestic producers  % portion protects domestic producers against finished good imports Tariffs

4. Carbaugh, Chap. 5 4 Effective rate of protection  The impact of a tariff is often different from stated amount  For a finished good,  Effective tariff rate =  {Nominal tariff – (% value Imports)x(Tariff on Imports)} (% Domestic Value Added)  Tariff Escalation : If domestic value added (content) is low and tariffs on imports are also low Effective tariff >> Nominal tariff. Tariffs

5. Carbaugh, Chap. 5 5 Avoiding and postponing tariffs  Production sharing and special treatment for foreign assembly  Bonded warehouses  Foreign trade zones Tariffs

6. Carbaugh, Chap. 5 6 Tariff welfare effects  Consumer surplus  What buyers are willing to pay  Minus  What they actually pay  Producer surplus  What producers receive  Minus  Cost  (Minimum amount to induce them to produce a good) Tariffs

7. Carbaugh, Chap. 5 7 Consumer and producer surplus Tariffs Price ($) A B C DE Demand (maximum price) (actual price) Consumer surplus Total expenditure Price ($) A B C D Supply (minimum price) (actual price) Producer surplus Total variable cost

8. Carbaugh, Chap. 5 8 Tariff trade and welfare effects Welfare effects of tariffs Small nation model Price ($) SdSd F S d+w E H f G S d+w+t ab c d e g DdDd

9. Carbaugh, Chap. 5 9 Costs of import restrictions  Domestic consumers face increased costs  Low income consumers are especially hurt by tariffs on low-cost imports  Overall net loss for the economy (deadweight loss)  Export industries face higher costs for inputs  Cost of living increases  Other nations may retaliate, further restricting trade Tariff effects

10. Carbaugh, Chap. 5 10 Arguments for trade restrictions  Job protection  Protect against cheap foreign labor  Fairness in trade - level playing field  Protect domestic standard of living  Equalization of production costs  Infant-industry protection  Political and social reasons