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Tariff Instruments. Eco 3024F Krugman & Obstfeld Ch 8. Outline. Introduction: Relevance of tariffs Types of tariffs Partial equilibrium analysis of tariffs Costs and benefits of tariffs LATER: Analysis of Tariffs (GE framework) Trade policy in presence of monopolies. 8- 2.

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tariff instruments

Tariff Instruments

Eco 3024F

Krugman & Obstfeld

Ch 8

outline
Outline
  • Introduction: Relevance of tariffs
  • Types of tariffs
  • Partial equilibrium analysis of tariffs
  • Costs and benefits of tariffs
  • LATER:
    • Analysis of Tariffs (GE framework)
    • Trade policy in presence of monopolies

8-2

slide3
“Trade theory is about identifying whose hand is in whose pocket. Trade policy is about who should take it out” (Finger, 1981).

“Tariff -- A scale of taxes on imports, designed to protect the domestic producer against the greed of his consumer”.

From Ambrose Bierce, The Devil's Dictionary:

why do we need to worry about tariffs and tariff policy
Why do we need to worry about tariffs and tariff policy?
  • Tariffs a key policy instrument used for industrial development
    • Department of trade and industry’s “National Industrial Policy Framework”
  • Trade negotiations
    • WTO negotiations
    • African countries negotiating new “economic partnership agreements” (EPAs) with EU
    • Regional integration schemes (SADC Customs union by 2010)
  • 3. Business operations: imported goods used in production and consumption
tariffs other charges
Tariffs & other charges
  • Goods imported into most countries are subject to different charges
    • Customs duties
    • Excise duties
    • Levies
      • Flue cured tobacco: 3.3c/kg + 75.9c/kg (special levy)
      • Lentils: 9.60 R/T + 2.5 R/T (special levy)
    • VAT or sales tax
types of import tariffs customs duties
Types of import tariffs (Customs duties)
  • Ad valorem tariff : PD = PW (1 + t)
    • Levied as a constant percentage of the monetary value of 1 unit of the imported good.
      • Oranges: 5%
    • But because it is based on the value of the good, an importer may understate the value while customs may overvalue as a counter measure.
  • Specific tariff: PD = PW + t
    • Import duty that assigns a fixed monetary (Rand) tax per physical unit of the good imported.
      • Blue veined cheese: 500c/kg
    • It may be collected with ease because only physical quantity of imports needs to be known and not their monetary value
    • However, protection varies with value of imported good. So inflation lessens strength of tariff
types of import tariffs customs duties1
Types of import tariffs (Customs duties)

Compound tariffs

    • Ad valorem PLUS specific tariff
    • E.g. wheat flour :10% plus 29.4c/kg
  • Mixed tariff
    • Either ad valorem OR specific (normally the one which yields higher protection)
    • E.g. Fish, fresh or chilled: 25% or 70c/kg
supply demand trade in a single industry
Supply, Demand & Trade in a Single Industry
  • Assume
    • Perfect competition in mkt for laptops.
    • Two countries in world producing laptops – SA & US
    • Initially No trade
    • Price of laptops in US lower than in SA
      • With trade SA will import laptops
        • Import demand curve for laptops from SA
      • With trade, US will export laptops
        • Export supply curve for laptops from US

8-9

import demand curve
Import demand curve

Import demand curve (MD):

SA demand –SA supply= Import demand by SA (from US)

Import demand curve is downward sloping....why?

What happens if P is above A?

8-10

export supply curve
Export supply curve

B

  • Export supply curve (XS):
    • US supply – US demand = Exports supplied to SA (by US)

Export supply curve is upward sloping....why?

What is happening at point B?

8-11

world equilibrium
World Equilibrium

At Pw , XS=MD in SA

Will Pw be the mkt clearing price in US as well?

8-12

the effects of a tariff
The Effects of a Tariff
  • Suppose SA imposes tariff on computer imports
    • This is like a tax on the price of good imported or like the effect of transport costs (Imported price=foreign price + tariff)
    • Will introduce price wedge between domestic price (PT) and foreign price (P*T)
      • PT – P*T = t
  • What price adjusts, (PT) or (P*T)?
    • As domestic price increases, quantity demanded falls in SA
    • As quantity demanded falls, so quantity supplied by US falls leading to possible foreign price decrease

8-14

the effects of a tariff cont
The Effects of a Tariff (cont.)
  • Price of the good in foreign (US) markets should fall if there is a significant drop in the quantity demanded of the good caused by the domestic (SA) tariff.
  • Extent of decline in foreign price depends on elasticity of foreign export supply and elasticity of import demand

8-15

the effects of a tariff cont1
The Effects of a Tariff (cont.)

Domestic price rises and quantity of imports demanded falls

Foreign price falls and quantity of exports supplied falls

Gap between domestic and international price equals tariff wedge

8-16

cost and benefit using a small country model
Cost and Benefit using a small country model
  • Assumptions
    • Small country is unable to influence world price Pworld through changes in production and/or consumption
    • Implies: small countries face horizontal (infinitely elastic) Export supply curves
small country supply and demand

Consumer surplus, with tariffs

Consumer surplus, no tariffs

Consumer surplus loss

PW (1+t)

A

B

C

D

PW

Q1

Q2

Q3

Q4

Imports at PW

Small country supply and demand

Price

D

S

Quantity

small country supply and demand1

Producer surplus gain

Government revenue gain

PW +t

A

B

C

D

PW

Dead weight loss

Q1

Q2

Q3

Q4

Small country supply and demand

Price

D

S

Quantity

Consumer loss-producer gain - government revenue

= dead weight loss (B+D)

small country conclusion
Small country: conclusion
  • Tariffs raise domestic production by raising the price received
  • Consumers pay for this through higher prices
  • Governments gain from tariff revenue, which they can transfer back to consumers
  • But price distortions lead to inefficient allocation of resources for consumers and producers
  • Whose hand is in whose pocket?
    • Tariffs lead to a transfer of surplus from consumers to producers

8-23

tariffs in large countries

Consumer surplus loss

PW* +t

A

C

B

D

t

PW

PW*

Q1

Q2

Q3

Q4

Tariffs in large countries

Price

D

S

E

Quantity

tariffs in large countries1

Producer surplus gain

Government revenue gain

PW* +t

t

PW

PW*

Q1

Q2

Q3

Q4

Tariffs in large countries

Price

D

S

A

C

B

D

E

Quantity

Consumer loss - producer gain - government revenue

= B+D-E

large country conclusion
Large country: conclusion
  • Tariffs lower the world price
  • Foreign producers bear some of cost of tariff through lower world prices
    • Terms of trade improvement for Home
  • Tariffs still cause production and consumption efficiency losses
  • BUT, if terms of trade improvement are large enough (area E), then the economy can gain
  • Would you advise such a strategy? Why not?