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Theory of Protection II + Theory of Economic Co-Operation

The document discusses theories of economic cooperation and tariffs, including how tariffs can lead to deadweight loss but also potentially increase imports under certain conditions. It also covers optimal tariff theory and analyses tariff retaliation and trade agreements.

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Vishnu Venugopal
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45 views18 pages

Theory of Protection II + Theory of Economic Co-Operation

The document discusses theories of economic cooperation and tariffs, including how tariffs can lead to deadweight loss but also potentially increase imports under certain conditions. It also covers optimal tariff theory and analyses tariff retaliation and trade agreements.

Uploaded by

Vishnu Venugopal
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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Theory of Protection II

+
Theory of Economic Co-operation
Theory of Tariff
 Tariff is a combination of consumption tax and
production subsidy.

 Tariff protects the producers of the import competing


good.

 Tariff leads to dead-weight loss.

Sunandan Ghosh, CDS, 2013 2


Lerner Case
 Tariff is imposed but import demand increases –
paradox! After imposing tariff TOT deteriorates.

 Government import demand is given by (MPC for


imports) by how much Govt. demand increases.

 Private demand for imports falls given tariff – we get


that by (import demand elasticity)

 Net import demand increases if we have | |

Sunandan Ghosh, CDS, 2013 3


Lerner Case
 Necessary Conditions –
1. Govt. must spend the tariff revenue on imports
2. . | |

 Tariff imposed price increases. Now we have –


Price Effect = Income Effect + Substitution Effect

 When Govt. redistributes the tariff revenue to the public,


income rises. Price rises, I reduce my demand. Income
rises, I increase my demand. These two cancels out. Left
with substitution effect which is always negative.

Sunandan Ghosh, CDS, 2013 4


Lerner Case: OC

Sunandan Ghosh, CDS, 2013 5


Optimal Tariff
 We can show that
p* X 1 X2 p *C1 C2
p *dX 1 X 1dp * dX 2 p *dC1 C1dp * dC2 .... (1)
dy pdC1 dC2 .... (2)
p (1 t ) p * .... (3)
dy Mdp * ( p p * )dM

topt pˆ * 1
Mˆ *
1

*
where, is foreign import demand elasticity.
Sunandan Ghosh, CDS, 2013 6
Optimal Tariff
 TOT effect Mdp *
 VOT effect ( p p* )dM

*
 For small country we have
Optimal tariff = 0

*
 For large country we have | | of which we
*
neglect the zone 0 1
Optimal tariff > 0

Sunandan Ghosh, CDS, 2013 7


Optimal Tariff
 Dead-weight loss, still positive tariff – why?

 Retaliation – if H imposes tariff but F does not, then,


H gains at the cost of F – global welfare falls. Hence
best for F to retaliate.

6,6 12,5

5,12 10,10

Sunandan Ghosh, CDS, 2013 8


Tariff Retaliation
 H imposes tariff followed by F or we can consider this
game as simultaneous.

 What will be the equilibrium?

 Scitovsky’s prediction: Continuous tariff retaliation


will lead to autarky.

Sunandan Ghosh, CDS, 2013 9


Tariff Retaliation

Sunandan Ghosh, CDS, 2013 10


Quota/VER
 Administered by license issued by the Govt. with a
view to controlling the amount of foreign goods
imported.

 Import demand = excess demand function. As Govt.


restricts import using quota, prices shoot up.

 Implicit tariff under quota is given by

pd p*
p*

Sunandan Ghosh, CDS, 2013 11


Quota/VER
 Under tariff we had
pd (1 t ) p* p* tp*
pd p*
t
p*

 Bhagwati’s Price Equalization: Given universal perfect


competition we have

t
 Also known as tariff-quota equivalence.

Sunandan Ghosh, CDS, 2013 12


Quota/VER
 Difference between Quota and VER – improvement of
TOT.

 Under quota TOT always improves in favour of H


(unlike tariff, where TOT may deteriorate given Lerner
case)

 Under VER, TOT improves in favour of F

 Evident from OC approach.

Sunandan Ghosh, CDS, 2013 13


Quota/VER

Sunandan Ghosh, CDS, 2013 14


Theory of Regional Trading
 Jacob Viner (1951) – defined the following five stages of
preferential trading.
1. Preferential Trading Arrangements (low, prefixed
tariff rates, commitment)
2. Free Trade Area (zero import tariff or quota)
3. Customs Union (common external tariff obtained by
joint welfare maximization)
4. Free Market (free movement of factors across
borders)
5. Economic Union (unified and syncronised monitory
and fiscal policies)
Sunandan Ghosh, CDS, 2013 15
Theory of Regional Trading
 In total there are more than 250 bi/multilateral agreements
at present reported at WTO. ASEAN is an FTA.

 More than a dozen of CUs are in force.

 Benelux is the first Trading Bloc.

 EU is the only economic union that has gone through all


the five stages and have a common currency as well.

 NAFTA has a free market.

Sunandan Ghosh, CDS, 2013 16


Preferential Trading
 Static Gains: Trade Creation, Trade Diversion, Reduction in Illegal
Trade/Smuggling

 Dynamic Gains:
1. Relocation and Agglomeration benefits.
2. Productivity Gain from Common Market
3. Environmental Issues
4. Advantages of monitory union (exchange rate fluctuations)
5. R&D, Technology Spillover

 Types of Regionalism: Open, Unanimous.

Sunandan Ghosh, CDS, 2013 17


Address Game
 Choose addresses simultaneously

 Cases: {4}, {3,1}, {2,2}, {1,1,1,1}

 Pay-offs: {20}, {23,3}, {13,13}, {10,10,10,10}

 NE: {4} in case of simultaneous game


{3,1} in case of sequential game

 Debate over stepping stones vis-à-vis stumbling blocs

Sunandan Ghosh, CDS, 2013 18

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