Chapter Six Tariffs. 2 Chapter Six Outline 1.Introduction 2.Why Would a Country Impose a Tariff? 3.Types of tariffs and Ways to Measure Them 4.What Happens.

Chapter Six

Tariffs

© 2003 South-Western/Thomson Learning

2

Chapter Six Outline

1. Introduction

2. Why Would a Country Impose a Tariff?

3. Types of tariffs and Ways to Measure Them

4. What Happens when a Small Country Imposes an Import Tariff?

5. What Happens when a Large Country Imposes an Import Tariff?

3

Chapter Six Outline

6. How Does a Tariff Affect Factor Prices? Specific Factors and Stolper-Samuelson

7. Tariffs and Economies of Scale

8. The Effective Rate of Protection

9. Off-Shore Assembly Provisions

10. Taxing Exports

4

Introduction

• The policies countries use to restrict trade are called Barriers to Trade.– Tariff is the most common.

• Tax imposed on a good as it crosses a national boundary.

• Use of tariffs has been declining recently due to international negotiations conducted under the WTO (successor to GATT).

5

Why Would a Country Impose a Tariff?

• Countries impose tariffs for any of four reasons:1. Tariff can discourage consumption of a particular

good (oil).2. Generate revenue for government of tariff-

imposing country.– Fig. 6.1 shows decline of U.S. tariff revenues.

3. Discourage imports in order to lower balance of trade deficit.

4. Carry out a protectionist policy – a way to insulate domestic industries from foreign competition.

See Figure 6.1

6

Figure 6.1: Tariff Revenue as a Share of Total U.S. Federal Government Receipts, 1830–1990

80183040 50 60 70 80 90 190010 20 30 40 50 60 70Year

90

100Percent

80

70

60

50

40

30

20

10

01990

7

Types of Tariffs

1. Specific Tariffs– Charge a specified amount for each unit of the

tariffed good imported.• Example: $1.09 per live goat.

2. Ad Valorem Tariffs1. Charge a specified percentage of the value of the

tariffed good.1. Example: 2.4% of a dog leash’s value.

8

Measurement of Tariffs

• U.S. tariff code contains 8,753 categories, on which tariffs range from 0% to 458%.– Tariff rates vary across goods.

• Example: 200+ different rates apply to watches and clocks.

• How do you measure a country’s level of tariff protection?– One technique: simple unweighted average of

industry tariff rates.• Country A imports two goods, X (25% tariff rate) and Y

(50% tariff rate) – average equals 37.5%.

9

Measurement of Tariffs

– Most common way to measure tariffs is using a weighted-average.

• It involves weighting the tariff rate for each industry by that industry’s share of total imports.

• Example: If Country A imported $50 of X and $50 of Y, then A’s weighted-average tariff rate would equal ($50/$100)(0.25) + ($50/$100)(0.50) = 37.5%.

• Main problem with both types of average tariffs is that they ignore trade foreclosed by the tariff.– An extreme case: a prohibitive tariff is one high enough to

halt trade in a product.

– In general, non-WTO members and developing countries impose higher tariffs.

10

Tariffs in various countries

• Tariff rates have fallen in most countries over the past few decades

• Tariff rates are highest in South Asia and lowest in industrial countries.– South Asia has rates close to 30% on average– Industrialized countries average closer to 5%

See Figure 6.2

11

Figure 6.2: Average Unweighted Tariff Rates by Region

12

What Happens when a Small Country Imposes an Import Tariff?

• In analyzing the effects of a tariff, the size of the country imposing it matters.– First, look at case of small country.

• “Small” refers to economic size in world markets.

• Small country’s terms of trade are determined exogenously and the country makes its production and consumption decisions based on those terms of trade.

See Figure 6.3

13

Figure 6.3: What Happens When a Small Country Imposes an Import Tariff?

0

PY

PY0

+ t

PY1

PY1

E

G

F

YY2 Y4 Y0 Y3 Y1

Sw

Sw+ t

Sd

Dd

14

What Happens when a Small Country Imposes an Import Tariff?

• Effects on production, consumption, and price.– Figure 6.3 clearly shows that the tariff increases

the price of the good by the amount of the tariff, reduces domestic consumption, increases domestic production, and decreases imports.

• Effects on welfare– Useful to separate effects on consumers from those

on producers.• Need to analyze consumer surplus and producer

surplus.

15

Consumer and Producer Surplus

• Consumer surplus measures the satisfaction consumers receive from a good beyond what they pay to obtain it.

• Producer surplus measures the revenue producers receive beyond the minimum required to induce them to supply the good.

• Figure 6.3 illustrates both of these measures.

See Figure 6.4

16

Figure 6.4: Consumer and Producer Surplus

0

PY

E

PY

Expenditureon Y

ConsumerSurplus C

D

YY0

0

0

P0Y

PY

G

F

ProducerSurplus

Costs

YY0

SY

(a) Consumer Surplus (b) Producer Surplus

17

Tariff’s Effect on Consumer and Producer Surplus

• Figure 6.5 shows the welfare effects of a tariff on imports by a small country as changes in consumer and producer surplus.– Rectangle n is tariff’s revenue effect.

• Transfer from consumer surplus to the government that collects the tariff revenue.

– Area j is the tariff’s redistribution effect.• Consumer surplus transferred to domestic producers.

18

Figure 6.5: How Does an Import Tariff by a Small Country Affect the Country’s Welfare?

PY

j

H

PY

+ t

PY

0

0

1

PY1

m n r

F

G

E

V

Z

Y2 Y4 Y0 Y3 Y1 Y

Sw+ t

Sw

Sd

Dd

19


– Triangle m is the tariff’s production effect.• Units Y2 through Y4 are now (with the tariff) produced

domestically rather than imported.

– Area m is a deadweight loss.• Loss to the small country of consumer surplus not

transferred to another group in the country, but lost through inefficient domestic production.

– Triangle r represents another deadweight loss.• This consumption effect is the loss of consumer surplus

that occurs because consumers can no longer obtain Y3 through Y1 at the pre-tariff price.

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• Net welfare loss to the small country as a whole from the import tariff equals the sums of areas m and r in Figure 6.5.– The tariff taxes trade, encourages domestic

production, and discourages domestic consumption and imports.

• Volume of trade falls under the tariff.

21

What Happens when a Large Country Imposes an Import Tariff?

• Large country constitutes a share of the world market sufficient to enable it to affect its terms of trade.– Tariff may be used to improve its terms of trade.

• Effects on production, consumption, and price.– Figure 6.5 illustrates the upward sloping total supply

curve for a large country.• Slopes upward because the large country, as it buys more of good

Y, pushes up the world price.

22

Figure 6.6: Total Supply Equals Domestic Supply Plus Supply by the Rest of the World

0

PY

(a) Domestic Supply

PY PYSdSw

Sd + w

0 0Y Y Y

(b) Supply by Rest of World

(c) Total Supply

+ =

23

Figure 6.7: How Does an Import Tariff by a Large Country Affect the Country’s Welfare?

0

PY

E

PY

PY

PY

G

2

0

1 I H

F

mj n rs C

t

Sd

Sd + w+ t

Sd + w

YY0Y2

Y3

Y1

Dd

24


• As shown in Figure 6.7, the tariff reduces consumption from Y0 to Y2, increases domestic production from Y1 to Y3, and decreases imports.– The price domestic consumers pay rises, and the price

foreign producers receive falls.• Area j is a transfer from domestic consumers to domestic

producers.• Areas m and r are deadweight losses reflecting inefficient

production and consumption, respectively.• Area n is a transfer from domestic consumers to the

government.• Area s is a transfer from foreign producers to the domestic

government.

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• When foreign producers face a substantially lower quantity demanded for their product, their opportunity costs of production fall, and so does price.– This effect of the tariff is called the Terms-of-Trade

Effect.• Tariff has redistributive effect among countries.

– All of large-country gains comes at expense of trading partner, which must accept lower prices for its exports.

• Tariff has negative effect on world welfare regardless of the size of the countries involved.

26

Optimal Tariffs and Threat of Retaliation

• Imposition of tariff by a large country has 2 effects:1. Volume-of-trade effect occurs when tariff lowers

welfare by discouraging trade.2. By lowering the price foreign producers receive,

the tariff enhances welfare in tariff-imposing country.

– Optimal tariff is rate that maximizes net benefits to tariff-imposing country.– Policies such as optimal tariffs that try to improve

the welfare of the domestic country at the expense of others are called beggar-thy-neighbor polices.

27

How Does a Tariff Affect Factor Prices?

• In the long run, when all factors are mobile among industries, the tariff has the effects predicted by the Stolper-Samuelson theorem.– A tariff, by raising the domestic price of the import

good, tends to raise the real reward to the scarce factor and lower the real reward to the abundant factor.

28

Tariffs and Economies of Scale

• Tariffs can interfere with economies of scale.– With widespread tariffs, each country must

produce small quantities of all the goods domestic consumers want to consume, instead of specializing in the export good and producing a large quantity of it, thereby achieving economies of scale.

• This implies that the costs of tariffs can be even higher in industries characterized by economies of scale.

29

Effective Rate of Protection

• Relationship among tariffs in related markets and industries is called Tariff Structure.

• Cascading tariffs: raw materials tend to have lower tariff rates that the finished products ultimately produced with them.– Figure 6.8 points this out -- in most countries, finished

products face higher tariffs than do raw materials.

See Figure 6.8

30

Figure 6.8: Tariffs Increase with the Level of Processing

0

Product category

Raw materials

2.1

0.8

2

4

6

8

10

Pre-Uruguay RoundPost-Uruguay Round

Percent

Semi-manufactures

5.4

2.8

Finishedproducts

9.1

6.2

31


• By ignoring the effect of tariff structure, the tariff rate on a final good may provide an inaccurate measure of the effective protection provided to domestic production.– Effective Rate of Protection: alternative measure

that accounts for the role of tariff structure.• Takes Domestic Value-Added into account: difference

between the world price of the finished good and the cost of the imported raw materials.

32


• Effective rates of protection differ greatly from actual or nominal tariff rates for many industries.– Actual tariff rates significantly underestimate the

effective protection received by many industries.

• Trade barriers on inputs always lower the effective protection given to finished-goods producers.

33

Off-Shore Assembly Provisions

• Many countries have special tariff provisions that make tariff rates more complicated.– Most common are off-shore assembly provisions.

• Allow reduced tariffs on goods assembled abroad from domestically produced components.

34

Taxing Exports

• Sometimes a country places taxes on its own exports.– In the U.S., export taxes are unconstitutional.

• Two basic reasons for these taxes:– Response to pressure by domestic consumer

groups to keep domestic price of a good low.– Second reason applies only to large countries: may

endeavor to exploit their own market power by using export taxes to raise the prices foreign buyers must pay.

35

Export Tax Imposed by a Small Country

• Figure 6.9 shows that the export tax encourages domestic consumption and discourages domestic production and exports.– Consumers gain at the expense of domestic producers.

See

Figure 6.9

36

Figure 6.8: What Happens When a Small Country Imposes an Export Tax?

PX

0

P1X

– t

P0X

Ejhgf t

Dw

Dw– t

Sd

Dd

XX1

X3

X4

X2

P1X

37

Export Tax Imposed by a Large Country

• Figure 6.10 graphically depicts that the tax-imposing country suffers deadweight losses equal to area h+j and enjoys a gain in revenue from foreign consumers equal to are k.– If (h+j) > k, the country suffers a net welfare loss from

the tax.

– If (h+j) < k, the country enjoys a net welfare gain.

See Figure 6.10

38

Figure 6.10: What Happens When a Large Country Imposes an Export Tax?

0 X1

P2X

P0X

P1X

PX

X3 X2 X0

gj f

k

h

Dd

Dd + w – t

Dd + w

t

Sd

X

39

Note for Case Three: China, Tariffs and the WTO

• Figure 6.11 indicates the regional sources of Chinese imports in 1996.– Most Chinese imports come from Asia, including Hong

Kong.

40

Figure 6.11: Regional Sources of Chinese Imports, 2000 (Billions $)

Asia(including

Hong Kong)

$3.94

$18.66

$4.72

$29.04

$9.14

$7.68

$107.72

41

Appendix A: Offer Curves and Tariffs

• Effects of an import tariff by Country A– Figure 6A.1 shows that an import tariff of t%

imposed by A reduces the volume of trade in which A wants to engage and shifts A’s offer curve inward to At.

• In exchange for Y0 units of imports, A reduces the amount of good X it is willing to export from X0 to X1.

– The difference goes to the government as tariff revenue.

See

Figure 6A.1

42

Figure 6A.1a: Effect of an Import Tariff by Country A

0

Y0

Imports ofY by A

X0X1 Exports ofX by A

C

t

At A

(a) Tariff Shifts CountryA’s Offer Curve

43

Figure 6A.1b: Effect of an Import Tariff by Country A

0

Y2

Exports of Y by B,Imports of Y by A

X2X3 Exports of X by A,Imports of X by B

BAt

A

Y3(b) Effect of Tariff by

a Small Country

44


• In panel (b) of Figure 6A.1, Country A’s smallness is represented by the straight-line shape of trading partner B’s offer curve.– The slope of B’s offer curve determines the

equilibrium terms of trade regardless of A’s action.

• The tariff imposed by A reduces the volume of trade from X2 and Y2 to X3 and Y3, but has no effect on the equilibrium terms of trade.

45


• Effects of an import tariff by large country.– Figure 6A.2 shows that A’s large size is

represented by curved shape of trading partner B’s offer curve.

• In panel (a), imposition of tariff by A raises the relative price of X, A’s export good, as shown by the increased slope of straight line from origin through intersection of the two countries’ offer curves.

See Figure 6A.2

46

Figure 6A.2a: Effect of an Import Tariff by a Large Country


Exports of X by A,Imports of X by B0

(PX/PY)tt1

(PX/PY)tt0

B

A

At

(a) Tariff By Country A

47


• Retaliation by country B– B may choose to impose an import tariff, shifting

its offer curve to Bt, in panel (b).• Retaliation further reduces the volume of trade.

• Net effect on terms of trade depends on relative sizes of the two countries’ tariffs and on the shapes of their offer curves.

– As drawn, B’s retaliatory tariff is too low to restore the terms of trade to their original, pre-tariff level.

48

Figure 6A.2b: Effect of an Import Tariff by a Large Country


Exports of X by A,Imports of X by B0

(PX/PY)ttpre-retaliation

B

AAt

Bt

(PX/PY)ttpost-retaliation

(b) Retaliation By Country B

49

Appendix B: General-Equilibrium Tariff Effects in a Small Country

• As shown in Figure 6B.1, an import tariff imposed by a small country causes a loss of efficiency and a decrease in welfare.– Consumption is inefficient, causing a further

reduction in welfare.

See Figure 6.B.1

50

Figure 6B.1: General-Equilibrium Effects of an Import Tariff by a Small Country

0

Y

Slope = – [PwX

c0

c1

c2

p1

p0

U0

U1U2

/(PwY + t)]

– (PX/PY)wSlope =

X

51

Key Terms in Chapter 6

• Barriers to trade

• Tariff

• Protectionist policy

• Specific tariff

• Ad valorem tariff

• Prohibitive tariff

• Consumer surplus

52


• Producer surplus

• Revenue effect

• Redistribution effect

• Production effect

• Deadweight loss

• Consumption effect

• Terms-of-trade effect

53


• Volume-of-trade effect

• Optimal tariff

• Beggar-thy-neighbor policy

• Tariff structure

• Cascading tariff

• Effective rate of protection (ERP)

• Domestic value-added (V)

• Off-shore assembly provision (OAP)

Chapter Six Tariffs. 2 Chapter Six Outline 1.Introduction 2.Why Would a Country Impose a Tariff? 3.Types of tariffs and Ways to Measure Them 4.What Happens.

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