CHAPTER E I G H T

8 International Economics
Tenth Edition

Trade Restrictions: Tariffs

Dominick Salvatore
John Wiley & Sons, Inc.

Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
 Learning Goals:
 Describe the effects of a tariff on consumers
and producers
 Identify the costs and benefits of a tariff on a
small and a large nation
 Describe an optimum tariff and retaliation
 Understand the meaning and importance of
tariff structure

Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
 Introduction

 While it is generally accepted that free trade

maximizes world output and benefits all
nations, most nations impose some
restrictions on the free flow of international
trade.
 Trade policies are advocated by special
groups that stand to benefit from trade
restrictions.

Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
 Introduction

 Import vs. export tariffs

 An import tariff is a tax or duty levied on
imported commodities.
 This is the most common form of tariff.

 An export tariff is a tax on exported

commodities.
 Prohibited by the U.S. Constitution, but
occasionally practiced in developing countries
to generate government revenue.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
 Introduction

 Import vs. export tariffs

 Ad valorem tariff
 A fixed percentage on the value of the
traded commodity.

Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
 Introduction

 Import vs. export tariffs

 Ad valorem tariff
 Specific tariff
 A fixed sum per physical unit of a traded
commodity.

Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
 Introduction

 Import vs. export tariffs

 Ad valorem tariff
 Specific tariff
 A compound tariff
 A combination of an ad valorem and
specific tariff.

Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
 Introduction

 Tariffs have been sharply reduced since

World War II.

 Tariffs average 5 percent or less on industrial

products in developed nations, but are much
higher in developing nations.

Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
 Partial Equilibrium Analysis of a Tariff

 Resulting Effects of Tariff

 Consumption effect
Reduction in domestic consumption
 Production effect
Expansion of domestic production
 Trade effect
Decline in imports
 Revenue effect
Revenue collected by the government

Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
 Partial Equilibrium Analysis of a Tariff

 Resulting Effects of Tariff

 The more elastic the demand curve, the
greater the consumption effect.
 The more elastic the domestic supply curve,
the greater the production effect.
 The more elastic the demand and domestic
supply curves, the greater the trade effect, and
the smaller the revenue effect.

Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
 Partial Equilibrium Analysis of a Tariff

 Resulting Effects of Tariff

 Consumer surplus is the difference between
what consumers would be willing to pay and
what they actually pay.
 Imposition of a tariff reduces consumer surplus.
 Increase in producer surplus, or rent, is the
payment that need not be made in the long run to
induce domestic producers to supply additional
goods with the tariff.
 Also called subsidy effect of tariff.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
 Partial Equilibrium Analysis of a Tariff

 Resulting Effects of Tariff

 Tariff redistributes income -
 From domestic consumers (who pay higher
price for the commodity) to domestic producers
(who receive the higher price)
 From nation’s abundant factor (producing
exports) to the scarce factor (producing imports).
 This leads to inefficiencies, or protection
costs (deadweight losses).

Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
 FIGURE 8-1 Partial Equilibrium Effects of a Tariff.

Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
 FIGURE 8-2 Effect of Tariff on Consumer and Producer Surplus.

Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
 FIGURE 8-3 Partial Equilibrium Costs and Benefits of a Tariff.

Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
 The Theory of Tariff Structure

 The Rate of Effective Protection

 Indicates how much protection is actually
provided to domestic producer of import-
competing commodity.
 When a nation imposes a lower tariff on
imported inputs than on the final commodity
produced with the inputs, the rate of effective
protection exceeds the nominal tariff rate.

Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
 The Theory of Tariff Structure

 The Rate of Effective Protection

t - a it i
 Calculated as follows:

g=
1 - ai
g = rate of effective protection
t = nominal tariff rate on final commodity
ai = ratio of cost of imported input to price of final
commodity with no tariff
ti = nominal tariff rate on imported input
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
 The Theory of Tariff Structure

 The Rate of Effective Protection

t - a i ti
 Calculated as follows:

g=
1 - ai
Conclusions
 If ai = 0, g = t
 For given values of ai and ti, g is larger the greater is t
 For given values of t and ti, g is larger the greater is ai
 The value of g is >, = or < t, as ti <, = or > t
 When aiti > t, the rate of effective protection is negative
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
 General Equilibrium Analysis of a Tariff in a
Small Country (skip)

 A small nation will not affect prices on the world

market when imposing a tariff.
 Domestic price of importable commodity will rise
by the full amount of the tariff for individual
producers and consumers in the small nation.
 Price remains constant for nation as a whole because
the nation collects the tariff.
 Volume of trade for small nation declines, but terms
of trade do not change, so welfare always falls.

Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
 FIGURE 8-5 General Equilibrium Effects of a Tariff
in a Small Country.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
 General Equilibrium Analysis of a Tariff in a
Small Country

 Stolper-Samuelson Theorem
 An increase in the relative price of a
commodity (for example, as the result of a
tariff) raises the return of the factor used
intensively in production of the commodity.
 Thus, the real return to the nation’s scarce
factor of production will rise with the
imposition of a tariff.

Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
 General Equilibrium Analysis of a Tariff in a
Large Country

 A tariff causes the imposing nation’s offer curve to

shift or rotate toward the axis measuring the
importable commodity by the amount of the tariff.
 Under these circumstances, for a large nation:
 A reduction in trade volume will reduce welfare
 An improvement in terms of trade will increase
welfare
 Whether welfare actually rises or falls depends on
net effect.

Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
 FIGURE 8-6 General Equilibrium Effects of a Tariff
in a Large Country.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
 The Optimum Tariff

 An optimum tariff maximizes the net benefit resulting

from the improvement in the nation’s terms of trade
against the negative effect from declining trade volume.
 As the terms of trade improve for the imposing nation,
those of the trade partner deteriorate, reducing welfare
for the trade partner.
 Trade partner will likely retaliate and impose its own
optimum tariffs.
 World as a whole is made worse off as gains from
optimum tariff are less than losses of trade partner.

Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
 FIGURE 8-7 The Optimum Tariff and Retaliation.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
 Case Study 8-1 Average Tariff on
Nonagricultural Products in Major Developed
Countries

Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
 Case Study 8-2 Average Tariffs on
Nonagricultural Products in Some Major
Developing Countries

Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
 Case Study 8-3 The Welfare Effect of
Liberalizing Trade on Some U.S. Products

Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
 Case Study 8-4 The Welfare Effect of
Liberalizing Trade on Some EU Products

Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
 Case Study 8-5 Rising Tariff Rates with
Degree of Domestic Processing

FIGURE 8-4 Pre- and Post-Uruguay Round Cascading Tariff

Structure in Industrial Countries.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
 Case Study 8-6 Structure of Tariffs on
Industrial Products in the United States, the
European Union, Japan, and Canada

Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
 Appendix to Chapter 8

 Partial Equilibrium Effects of a Tariff in a

Large Nation
 The Stolper-Samuelson Theorem Graphically
 The Metzler Paradox
 Short-Run Effect of Tariff on Factors’ Income
 Measurement of the Optimum Tariff

Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
 (Figure continues on next slide)

FIGURE 8-8 Partial Equilibrium Effects of a Tariff

in a Large Nation.

Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
 FIGURE 8-8 (continued)
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
 FIGURE 8-9 The Stolper-Samuelson Theorem Graphically.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
 FIGURE 8-10 The Metzler Paradox.

Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
 FIGURE 8-11 Short-Run Effect of Tariff on Factors’ Income.

Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
 FIGURE 8-12 Measurement of the Optimum Tariff.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
  Copyright 2013 John Wiley & Sons, Inc.

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Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.