1. Chapter 6 -- Tariffs INTERNATIONAL ECONOMICS, ECO 486
Eastwood's ECO486 Notes
Chapter 6 -- Tariffs
INTERNATIONAL ECONOMICS, ECO 486
Draft simplified harmonized uniform tariff schedule (HTS) for US:
Tariffs

2. Learning Objectives Reprise the gains from trade
Eastwood's ECO486 Notes
Learning Objectives
Reprise the gains from trade
Become familiar with tariffs
Analyze the welfare cost of tariffs
Determine the optimal tariff
Explain the effective rate of protection
Learn the imperfect substitutes model
Tariffs

3. Learning Objectives Reprise the gains from trade
Eastwood's ECO486 Notes
Learning Objectives
Reprise the gains from trade
Become familiar with tariffs
Analyze the welfare cost of tariffs
Determine the optimal tariff
Explain the effective rate of protection
Learn the imperfect substitutes model
Tariffs

4. Gains from Trade Static Gains (PPF doesn’t shift)
Eastwood's ECO486 Notes
Gains from Trade
Static Gains (PPF doesn’t shift)
Consumption gains
Production gains
Dynamic Gains (PPF does shift)
Trade expands resources
Trade may raise productivity
Political Gains
Tariffs

5. Consumption & Production Gains
Eastwood's ECO486 Notes
Consumption & Production Gains rF C B
CIC2 A
CIC1
TEXTILES, T (yards per year)
CIC0 X
SOYBEANS, S (bushels per year)
Tariffs

6. Consumption & Production Gains
Eastwood's ECO486 Notes
Consumption & Production Gains
(PS/PT )F = rF = |slope of terms of trade line| rF C
A to B shows consumption gains
B to C shows production gains B
CIC2 A
CIC1
TEXTILES, T (yards per year)
CIC0 X
SOYBEANS, S (bushels per year)
Tariffs

7. Dynamic Gains from Trade
Eastwood's ECO486 Notes
Dynamic Gains from Trade
Trade may speed economic growth
Tariffs

8. Dynamic Gains from Trade
Eastwood's ECO486 Notes
Dynamic Gains from Trade
Trade may speed economic growth
When more K goods are imported than produced in autarky, PPF shifts out.
Trade diffuses new technology.
Trade raises real income. Savings rise.
Free trade an effective anti-trust policy
Trade expands the market, allowing firms to exploit IRS.
When trade spurs development, decreasing-costs may occur.
Tariffs

9. Learning Objectives Reprise the gains from trade
Eastwood's ECO486 Notes
Learning Objectives
Reprise the gains from trade
Become familiar with tariffs
Analyze the welfare cost of tariffs
Determine the optimal tariff
Explain the effective rate of protection
Learn the imperfect substitutes model
Tariffs

10. Eastwood's ECO486 Notes
Commercial Policy
Governments action that may change the composition and volume of trade flows
Tariffs
Quotas
Subsidies
Other non-tariff barriers
We’ll analyze the cost & benefits of these
Tariffs

11. Tariffs Taxes on Components -- See Table 6.1, page 153 Imports Exports
Eastwood's ECO486 Notes
Tariffs
Taxes on
Imports
Exports
Subsidies
Components -- See Table 6.1, page 153
Ad valorem-- % of value
Specific -- flat fee per unit
Compound -- both
Tariffs

12. Positive Effects of Tariffs
Eastwood's ECO486 Notes
Positive Effects of Tariffs
Revenue Effect -- provide tax revenue
Protective Effect -- shelter domestic producers from foreign competition
Tariffs

13. Eastwood's ECO486 Notes
Tariff Terminology
A pure-revenue tariff is one imposed on a good not produced domestically
A tariff on bananas imported to Iceland
A prohibitive tariff is one that is so high that none of the good is imported
no revenue is collected
Tariffs

14. Eastwood's ECO486 Notes
Uses of Tariffs
Developing countries may rely on tariffs to provide tax revenue
Developed countries impose tariffs for their protective effect
Tariffs

15. Tariffs as tools of int’l policy
Most Favored Nation status, MFN
granted as a reward, withheld as a punishment
Generalized System of Preferences, GSP
Most developed countries have GSP as means of helping developing countries
access to markets of developed countries

16. Learning Objectives Reprise the gains from trade
Eastwood's ECO486 Notes
Learning Objectives
Reprise the gains from trade
Become familiar with tariffs
Analyze the welfare cost of tariffs
Determine the optimal tariff
Explain the effective rate of protection
Learn the imperfect substitutes model
Tariffs

17. Welfare Cost Analysis Use (National) Supply and Demand
Partial equilibrium
One import or export good
Measure Changes in Consumer Surplus and Producer Surplus
Start with a small country
Its trade is too small to affect terms of trade

18. Gains from free trade -- imports
Eastwood's ECO486 Notes
Gains from free trade -- imports 10
Price ($ per bushel of grapes) 6 3 2 1 4 7 10
Quantity (millions bushels of grapes per year)
Tariffs

19. Gains from free trade -- imports
Eastwood's ECO486 Notes
Gains from free trade -- imports
Domestic Supply
of grapes 10
Price ($ per bushel of grapes) 6 a b c 3
World price of grapes 2
Domestic demand for grapes 1 4 7 10
Quantity (millions bushels of grapes per year)
Tariffs

20. Welfare of a Move to Free Trade A Small Country’s Imports
Eastwood's ECO486 Notes
Welfare of a Move to Free Trade A Small Country’s Imports
Tariffs

21. Welfare of a Move to Free Trade A Small Country’s Imports
Eastwood's ECO486 Notes
Welfare of a Move to Free Trade A Small Country’s Imports
Tariffs

22. Gains from free trade -- exports
Eastwood's ECO486 Notes
Gains from free trade -- exports 10 9
Price ($ per jar of honey) 6 2 1 4 7 10
Quantity (millions jars of honey per year)
Tariffs

23. Gains from free trade -- exports
Eastwood's ECO486 Notes
Gains from free trade -- exports
Domestic Supply
of honey 10 9
World price of honey
Price ($ per jar of honey) g e f 6 2
Domestic demand for honey 1 4 7 10
Quantity (millions jars of honey per year)
Tariffs

24. Welfare of a Move to Free Trade A Small Country’s Exports
Eastwood's ECO486 Notes
Welfare of a Move to Free Trade A Small Country’s Exports
Tariffs

25. Welfare of a Move to Free Trade A Small Country’s Exports
Eastwood's ECO486 Notes
Welfare of a Move to Free Trade A Small Country’s Exports
Tariffs

26. Welfare Cost of a Tariff on Imports -- Small Country
Eastwood's ECO486 Notes
Welfare Cost of a Tariff on Imports -- Small Country 10
Price ($ per bushel of grapes) 5 3 2 1 3 5 7 10
Quantity (millions bushels of grapes per year)
Tariffs

27. Welfare Cost of a Tariff on Imports -- Small Country
Eastwood's ECO486 Notes
Welfare Cost of a Tariff on Imports -- Small Country
Domestic Supply
of grapes 10
Price ($ per bushel of grapes) 5
World price + tariff $2/bu c a b d 3
World price of grapes 2
Domestic demand for grapes 1 3 5 7 10
Quantity (millions bushels of grapes per year)
Tariffs

28. Welfare Cost of a Tariff on Imports -- Small Country
Eastwood's ECO486 Notes
Welfare Cost of a Tariff on Imports -- Small Country
Loss = 0.5 x tariff x change in imports
Tariffs

29. Welfare Cost of a Tariff on Imports -- Small Country
Eastwood's ECO486 Notes
Welfare Cost of a Tariff on Imports -- Small Country
Loss = 0.5 x tariff x change in imports
Tariffs

30. Welfare Cost of a Tariff Small Country
Eastwood's ECO486 Notes
Welfare Cost of a Tariff Small Country
Domestic Supply
of grapes 10
Price ($ per bushel of grapes) 5
World price + tariff $2/bu c b d 3
World price of grapes 2
Domestic demand for grapes 1 3 5 7 10
Quantity (millions bushels of grapes per year)
Tariffs

31. Welfare Cost of a Tariff on Imports -- Small Country
Eastwood's ECO486 Notes
Welfare Cost of a Tariff on Imports -- Small Country
Domestic Supply
of grapes 10
Price ($ per bushel of grapes) 5
World price + tariff $2/bu a2 c a1 b d 3
World price of grapes 2
Domestic demand for grapes 1 3 5 7 10
Quantity (millions bushels of grapes per year)
Tariffs

32. Export Tariff -- Small Country
Eastwood's ECO486 Notes
Export Tariff -- Small Country
Domestic Supply
of honey 10 9
Price ($ per jar of honey) 6 2
Domestic demand for honey 1 4 7 10
Quantity (millions jars of honey per year)
Tariffs

33. Export Tariff -- Small Country
Eastwood's ECO486 Notes
Export Tariff -- Small Country
Domestic Supply
of honey 10 9 PW d b c
Price ($ per jar of honey) a
PW -T 6 2
Domestic demand for honey 1 4 7 10
Quantity (millions jars of honey per year)
Tariffs

34. Welfare Cost -- Export Tariff Small Country Case
Eastwood's ECO486 Notes
Welfare Cost -- Export Tariff Small Country Case
Tariffs

35. Welfare Cost -- Export Tariff Small Country Case
Eastwood's ECO486 Notes
Welfare Cost -- Export Tariff Small Country Case
Tariffs

36. Learning Objectives Reprise the gains from trade
Eastwood's ECO486 Notes
Learning Objectives
Reprise the gains from trade
Become familiar with tariffs
Analyze the welfare cost of tariffs
Determine the optimal tariff
Explain the effective rate of protection
Learn the imperfect substitutes model
Tariffs

37. Int’l Free Trade Eq. Large Country
Eastwood's ECO486 Notes
Int’l Free Trade Eq. Large Country
Price ($ per lb.) PA PB
Quantity (lb. of Lobster per year)
Tariffs

38. Int’l Free Trade Eq. Large Country
Eastwood's ECO486 Notes
Int’l Free Trade Eq. Large Country
Price ($ per lb.)
A’s Supply
of L
B’s Supply
of L PA
PFT
PFT PB
A’s demand for L
B’s demand for L
Q1’
Q2’ Q1 Q2
Quantity (lb. of Lobster per year)
Tariffs

39. Learning Objectives Derive import demand & export supply
Eastwood's ECO486 Notes
Learning Objectives
Derive import demand & export supply
Review the welfare cost of tariffs
Learn elasticity of import demand & export supply
Determine the incidence (burden) of a tariff
Tariffs

40. Import Demand Price ($ per lb.) Price ($ per lb.)
Eastwood's ECO486 Notes
Import Demand
Price ($ per lb.)
A’s Supply
of Lobster
Price ($ per lb.) PA PA
PFT PB PB
A’s demand for Lobster
M = QD - QS
Quantity (lb. of Lobster per year)
Tariffs

41. Import Demand Price ($ per lb.) Price ($ per lb.)
Eastwood's ECO486 Notes
Import Demand
Price ($ per lb.)
A’s Supply
of Lobster
Price ($ per lb.) PA PA
PFT PB PB
A’s demand for imported lobster (excess demand); |slope| = rise/(sum of runs)
A’s demand for Lobster
M = QD - QS
Quantity (lb. of Lobster per year)
Tariffs

42. Export Supply Price ($ per lb.) Quantity (lb. of Lobster per year)
Eastwood's ECO486 Notes
Export Supply
Price ($ per lb.)
B’s Supply
of L PA PB PB
B’s demand for L QD QS
X = QS - QD
Quantity (lb. of Lobster per year)
Tariffs

43. Export Supply Price ($ per lb.) Quantity (lb. of Lobster per year)
Eastwood's ECO486 Notes
Export Supply
B’s Supply of exports, excess supply; slope = rise/(sum of runs)
Price ($ per lb.)
B’s Supply
of L PA PB PB
B’s demand for L QD QS
X = QS - QD
Quantity (lb. of Lobster per year)
Tariffs

44. Export Supply & Import Demand
Eastwood's ECO486 Notes
Export Supply & Import Demand
A’s demand for Lobster
A’s Supply
of Lobster
Price ($ per lb.) PA
PFT Q1 Q2
Price ($ per lb.)
Export Supply, X PA
PFT
PFT PB
Import Demand, M
M = Q2 - Q1
Quantity (lb. of Lobster per year)
Tariffs

45. Export Supply & Import Demand
Eastwood's ECO486 Notes
Export Supply & Import Demand
Price ($ per lb.)
B’s Supply
of L
Export Supply, X PA
PFT
PFT PB PB
Import Demand, M
B’s demand for L
Q1’
Q2’
M = Q2 - Q1
X = Q2‘ - Q1 ‘
Quantity (lb. of Lobster per year)
Tariffs

46. Optimal Tariffs Retaliation is likely to offset this gain
Eastwood's ECO486 Notes
Optimal Tariffs
Large countries may “export” part of their tariff.
Because they are important customers, they force foreign supplier to cut price.
The optimal tariff maximizes the net welfare change
Retaliation is likely to offset this gain
Tariffs

47. Equilibrium with a Tariff Large Country
Eastwood's ECO486 Notes
Equilibrium with a Tariff Large Country
Price ($ per lb.)
A’s Supply
of L
B’s Supply
of L P”
PFT
PFT P’ P’
A’s demand for L
B’s demand for L
Q1’
Q3’
Q4’
Q2’ Q1 Q3 Q4 Q2
Quantity (lb. of Lobster per year)
Tariffs

48. Equilibrium with a Tariff Large Country
Eastwood's ECO486 Notes
Equilibrium with a Tariff Large Country
Price ($ per lb.)
A’s Supply
of L
B’s Supply
of L P” a c b d
PFT
PFT i j e h e P’ P’
A’s demand for L
B’s demand for L
Q1’
Q3’
Q4’
Q2’ Q1 Q3 Q4 Q2
Quantity (lb. of Lobster per year)
Tariffs

49. A’s Welfare Cost -- Import Tariff Imposed by Large Country, A
Eastwood's ECO486 Notes
A’s Welfare Cost -- Import Tariff Imposed by Large Country, A
Tariffs

50. A’s Welfare Cost -- Import Tariff Imposed by Large Country, A
Eastwood's ECO486 Notes
A’s Welfare Cost -- Import Tariff Imposed by Large Country, A
Tariffs

51. B’s Welfare Cost from A’s Tariff Import Tariff Imposed by A
Eastwood's ECO486 Notes
B’s Welfare Cost from A’s Tariff Import Tariff Imposed by A
Tariffs

52. B’s Welfare Cost from A’s Tariff Import Tariff Imposed by A
Eastwood's ECO486 Notes
B’s Welfare Cost from A’s Tariff Import Tariff Imposed by A
Tariffs

53. World Welfare Cost of A’s Tariff
Eastwood's ECO486 Notes
World Welfare Cost of A’s Tariff
Tariffs

54. World Welfare Cost of A’s Tariff
Eastwood's ECO486 Notes
World Welfare Cost of A’s Tariff
Tariffs

55. World Welfare Changes Tariff raises the price in A to PW + T
Eastwood's ECO486 Notes
World Welfare Changes
Tariff raises the price in A to PW + T
Tariff lowers the world price to PW
Tariff reduces the quantity world trade from MFT to MT
Welfare loss area, f = b+d
Welfare loss area, g = i+j
Tariffs

56. Export Supply + Specific Tariff, T
Eastwood's ECO486 Notes
Export Supply + Specific Tariff, T
Price ($ per lb.) T
Export Supply, X T
Import Demand, M
MFT
Quantity (lb. of Lobster per year)
Tariffs

57. Export Supply + Specific Tariff, T
Eastwood's ECO486 Notes
Export Supply + Specific Tariff, T
Price ($ per lb.)
X + TARIFF, T T PA
Export Supply, X
PW +T f
PFT g PW T PB
Import Demand, M MT
MFT
Quantity (lb. of Lobster per year)
Tariffs

58. Eastwood's ECO486 Notes
Graphing Tariffs
Specific tariff raises the y-intercept of the export supply curve,
p = a + b q
p + T = a + b q + T
Ad-valorem tariff raises the slope and y-intercept of the export supply curve
p (1 + t) = (a + b q) (1 + t) = (1 + t) a + (1 + t) b q
Tariffs

59. Export Supply with Ad-Valorem Tariff, t
Eastwood's ECO486 Notes
Export Supply with Ad-Valorem Tariff, t
Price ($ per lb.)
X(1+t) PA
Export Supply, X
PW +T f
PFT g PW PB
Import Demand, M MT
MFT
Quantity (lb. of Lobster per year)
Tariffs

60. Price Elasticity of Demand, ed
ed and slope are inversely related.

61. The Price Elasticity of Supply, es
Eastwood's ECO486 Notes
The Price Elasticity of Supply, es
The formula for price elasticity of supply, es, at a point is shown below. Note that it’s the same as the formula for ed , but lacks the absolute value notation
Tariffs

62. Import Demand Elasticity, em
The formula for price elasticity of import demand, em, at a point is shown below. Q is the quantity of imports; P is the price; DP is the change in price; DQ is the change quantity imported

63. Import Demand Elasticity, em
Eastwood's ECO486 Notes
Import Demand Elasticity, em
The formula for price elasticity of import demand, em, at a point is shown below
Qm is the quantity of imports; Qd is the quantity demanded; Qs is the quantity supplied
Tariffs

64. Interpreting em em is directly related to A’s ed and es
Eastwood's ECO486 Notes
Interpreting em
em is directly related to A’s ed and es
em is inversely related to the share of imports in A’s consumption and production
Tariffs

65. Export Supply Elasticity, ex
Eastwood's ECO486 Notes
Export Supply Elasticity, ex
The formula for price elasticity of export supply, ex, at a point is shown below. Q is the quantity of exports; P is the price; DP is the change in price; DQ is the change quantity exported
Tariffs

66. Export Supply Elasticity, ex
Eastwood's ECO486 Notes
Export Supply Elasticity, ex
The formula for price elasticity of export supply, ex, at a point is shown below.
Qx is the quantity of exports; Qd is the quantity consumed; Qs is the quantity produced
Tariffs

67. Interpreting ex ex is directly related to B’s ed and es
Eastwood's ECO486 Notes
Interpreting ex
ex is directly related to B’s ed and es
ex is inversely related to the share of exports in B’s consumption and production
Tariffs

68. Export Supply + Specific Tariff, T
Eastwood's ECO486 Notes
Export Supply + Specific Tariff, T PA
X + TARIFF, T
PW +T T f
A’s burden, b
PFT
Export Supply, X g PW PB
Import Demand, M MT
MFT
Quantity (lb. of Lobster per year)
Tariffs

69. Compare em and ex to determine A’s burden, b; 0£b£1
Eastwood's ECO486 Notes
Compare em and ex to determine A’s burden, b; 0£b£1
When em = ex , b = _____
When em > ex , b _______
When em < ex , b _______
Tariffs

70. Compare em and ex to determine A’s burden, b; 0£b£1
Eastwood's ECO486 Notes
Compare em and ex to determine A’s burden, b; 0£b£1
When em = ex , b = 0.5
When em > ex , b < 0.5
When em < ex , b > 0.5
Tariffs

71. Differing em Quantity (lb. of Lobster per year) PA X + TARIFF, T PW +T
Eastwood's ECO486 Notes
Differing em PA
X + TARIFF, T
PW +T T
Export Supply, X f
A’s burden, b
PFT g PW
B’s burden, 1- b
Elastic M PB
Inelastic M MT
MFT
Quantity (lb. of Lobster per year)
Tariffs

72. Differing ex Quantity (lb. of Lobster per year) PA Inelastic X + T T
Eastwood's ECO486 Notes
Differing ex PA
Inelastic X + T T
Elastic X + T
PW +T
Inelastic X f
A’s burden, b
PFT
Elastic X g PW PB T
Import Demand, M MT
MFT
Quantity (lb. of Lobster per year)
Tariffs

73. Learning Objectives Reprise the gains from trade
Eastwood's ECO486 Notes
Learning Objectives
Reprise the gains from trade
Become familiar with tariffs
Analyze the welfare cost of tariffs
Determine the optimal tariff
Explain the effective rate of protection
Learn the imperfect substitutes model
Tariffs

74. Nominal & Effective Rates of Protection
Eastwood's ECO486 Notes
Nominal & Effective Rates of Protection
t = tariff
P = price of good
v = domestic value added with free trade
v’= domestic value added with tariff
Tariffs

75. Nominal & Effective Rates of Protection
Eastwood's ECO486 Notes
Nominal & Effective Rates of Protection
t = tariff
P = price of good
v = domestic value added with free trade
v’= domestic value added with tariff
Tariffs

76. Effective Rate of Protection
Eastwood's ECO486 Notes
Effective Rate of Protection
gj = Effective Rate of Protection on final product j
tj = nominal tariff rate on final product j
ti = nominal tariff rate on imported input I
aij = share of I in the total value of J in the absence of tariffs
Tariffs

77. Welfare Cost of Tariffs as a Percentage of GDP
Eastwood's ECO486 Notes
Welfare Cost of Tariffs as a Percentage of GDP
Traditional: Square the tariff rate
Ten percent tariff reduces GDP by 1%
Tariffs & NTBs often exclude new goods
GDP loss almost twice the tariff rate
Tariffs & NTBs often exclude new goods (e.g., computers, just-in-time inventory processes)
Tariffs

78. Welfare Cost of Tariffs as a Percentage of GDP
Eastwood's ECO486 Notes
Welfare Cost of Tariffs as a Percentage of GDP
Traditional: Square the tariff rate
Ten percent tariff reduces GDP by 1%
Tariffs & NTBs often exclude new goods
GDP loss almost twice the tariff rate
Ten percent tariff lowers GDP by 19.8%
Twenty-five percent tariff lowers GDP by 47%
Tariffs & NTBs often exclude new goods (e.g., computers, just-in-time inventory processes)
Tariffs

79. Learning Objectives Reprise the gains from trade
Eastwood's ECO486 Notes
Learning Objectives
Reprise the gains from trade
Become familiar with tariffs
Analyze the welfare cost of tariffs
Determine the optimal tariff
Explain the effective rate of protection
Learn the imperfect substitutes model
Tariffs

80. Imperfect Substitutes
Eastwood's ECO486 Notes
Imperfect Substitutes
Increased trade in final products relative to raw materials and intermediate goods
A final-good import and competing domestic products are often imperfect substitutes
Tariff increases demand for the domestic good
Increased price of domestic good increases demand for the import
Welfare cost is more difficult to estimate
Tariffs

81. Imperfect Substitutes Small Country -- Free Market
Eastwood's ECO486 Notes
Imperfect Substitutes Small Country -- Free Market SD
Price
Price of Import PD PM SM DM DD QM QD
Quantity of Imports
Quantity of Domestic Substitute
Tariffs

82. Imperfect Substitutes Small Country -- Tariff
Eastwood's ECO486 Notes
Imperfect Substitutes Small Country -- Tariff SD
Price
Price of Import i m k
S’M j f n h l
tariff e SM r g
D’D
D’M DM DD QD
Q’M
Q”M QM
Q’D
Quantity of Imports
Quantity of Domestic Substitute
Tariffs

83. Welfare Cost of a Tariff Imperfect Substitutes
Eastwood's ECO486 Notes
Welfare Cost of a Tariff Imperfect Substitutes
Tariffs

84. Welfare Cost of a Tariff Imperfect Substitutes
Eastwood's ECO486 Notes
Welfare Cost of a Tariff Imperfect Substitutes
Tariffs

85. Eastwood's ECO486 Notes
Review homework
Tariffs

86. Trade with a Tariff Versus Autarky
Eastwood's ECO486 Notes
Trade with a Tariff Versus Autarky
Domestic Supply
of grapes 10
Price ($ per bushel of grapes) 6 d e 5
World price + tariff $2/bu 3
World price of grapes 2
Domestic demand for grapes 1 3 5 7 10
Quantity (millions bushels of grapes per year)
Tariffs

87. Pure Revenue Tariff Versus Free Trade
Eastwood's ECO486 Notes
Pure Revenue Tariff Versus Free Trade
Domestic Supply
of grapes lies along y-axis 10
Price ($ per bushel of bananas) a 5
World price + tariff $2/bu b c 3
World price of bananas 2
Iceland’s demand for bananas 1 3 5 7 10
Quantity (millions bushels of bananas per year)
Tariffs