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  1. Class Outline • Introduction to Tariffs • Effect of a Tariff on Producers • Effects of a Tariff on Consumers • Tariff as Government Revenue • Economic Result from a Tariff • Nationally Optimal Tariff • Effective Rate of Protection Reading: Chapter 8

  2. Effect of a Tariff on Producers • Tariffs benefit producers that compete with the imported good • Assumptions of our analysis • Small country • Start with free trade

  3. Effect of a Tariff on Producers Price F Sd (Domestic Supply) 540 E C World Price 300 B 210 A Sd (Domestic Demand) S0=0.6 D0=1.6 Quantity

  4. Effect of a Tariff on Producers Price F Sd(Domestic Supply) 540 Domestic Price with Tariff 330 a Tariff World Price 300 B g M1 210 A M0 Sd(Domestic Demand) D0=1.6 S0=0.6 S1=0.8 D1=1.4 Quantity

  5. Effect of Tariff on Consumers Price F Sd (Domestic Supply) 540 H G Domestic Price with Tariff 330 a c Tariff b d E World Price 300 C B 210 A Sd (Domestic Demand) S0 S1=0.8 D1=1.4 D0 Quantity

  6. Tariff as Government Revenue Price F Sd (Domestic Supply) 540 H G Domestic Price with Tariff 330 c Tariff E World Price 300 C B 210 A Sd (Domestic Demand) S0 S1=0.8 D1=1.4 D0 Quantity

  7. Net National Loss F Sd (Domestic Supply) 540 H G Domestic Price with Tariff 330 Tariff b d E World Price 300 C B 210 A Sd (Domestic Demand) S0 S1=0.8 D1=1.4 D0 Quantity

  8. Effects of a Tariff Price Price Supply d b+d Demand for Imports b 330 330 a c c 300 300 Demand 0.6 0.8 1.4 1.6 0.6 1.0 Quantity Quantity Imports0 Imports1

  9. Terms of Trade and Nationally Optimal Tariff • Let us relax the assumption of a small country • Sometimes a nation can have a monopsony power • Example: The U.S. in the world auto market • In this case the tariff has a term of trade effect

  10. Effect of a Tariff in Prices • The U.S. has market power in the market for bikes • (As before) The U.S. government increases tariffs • At the international price plus the tariff, U.S. consumers demand less bikes • Because the lower demand depress the market for bikes, now foreign producers will prefer to decrease prices in order to improve sells • They will decrease price as long as the price is higher than the marginal cost • However, there is still a loss on economic efficiency for both, the U.S. and the rest of the World.

  11. Effects of a Tariff Price Price b+d d b 303 303 a c 300 c 300 e 297 297 e 0.6 0.62 1.58 1.6 0.96 1.0 Quantity Quantity Imports0 Imports1

  12. Types of Tariffs • Ad-valorem tariff • Is a tax on imports that is specified as a percentage of the value of the product being taxed • Specific tariff • A specific amount is that is levied per unit of imports • Advantages and disadvantages: • Ad valorem tariffs are easier to set that specific tariffs. • Ad-valorem tariffs are immune to inflation • Ad-valorem tariffs reward low-cost foreign suppliers by charging a lower absolute tax in their products • Specific tariffs are less prone to misinvoicing

  13. The Effective Rate of Protection The Effective rate of protection of an individual industry is defined as the percentage by which the entire set of a nation’s trade barriers raises the industry’s value added per unit of output. The effective rate of protection can be quite different from the percent tariff paid by consumers on its output What are the effects of a 10% tariff on bicycle imports and 5% tariff on imports of steel, rubber and all other material inputs? 10% tariff raises prices by 10% to $330 5% tariff increases costs by $11 per bike The total increase in value added for the industry would be $19 This protection of value added represents 23.8 percent of value added, not just 10%

  14. The Effective Rate of Protection 10% Tariff on Bikes 5% tariff on inputs Free Trade Unit Value Added=$99 Unit Value Added=$80 Unit Price=$330 Unit Price=$300 Unit Cost=$220 Unit Cost=$231 10% Tariff 5% Tariff $220 to $231

  15. The Effective Rate of Protection • Main points • A given industry’s incomes, or value added, will be affected by trade barriers on its inputs as well as trade barriers on its output • The effective rate of protection will be greater than the nominal rate when the industry’s output is protected by a higher duty than the tariff duty on its inputs • If the tariff rates on inputs and output are the same, then the output rate is also the effective rate • The effective rate of protection can be negative • Export producers are penalized with something like negative effective protection if their costs are increased by tariffs on the inputs they use in production