1 the instruments of trade policy: part i, tariffs international economics, eco 486 harmonized...

1The Instruments of Trade Policy:

Part I, Tariffs• INTERNATIONAL

ECONOMICS,ECO 486

• Harmonized tariff schedule (HTS) of the United States:http://www.usitc.gov/taffairs.htm#HTS

2Learning Objectives

• Reprise the gains from trade

• Analyze the welfare cost of tariffs

• Determine the optimal tariff

• Analyze export subsidies

• Explain the effective rate of protection

4Gains from Trade

• Static Gains (PPF doesn’t shift)– Consumption gains– Production gains

• Dynamic Gains (PPF does shift)– Trade expands resources– Trade may raise productivity

• Political Gains

5

SOYBEANS, S (bushels per year)

0

A

TE

XT

ILE

S, T

(yar

ds

per

yea

r)

CIC0

Consumption & Production Gains

CIC1

CIC2

F

B

C

X

6

SOYBEANS, S (bushels per year)

0

A

TE

XT

ILE

S, T

(yar

ds

per

yea

r)

CIC0

Consumption & Production Gains

CIC1

CIC2

F

B

C

X

PS/PT = S=|slope of terms of trade line|

A to B shows consumption gainsB to C shows production gains

7Dynamic Gains from Trade

• Trade may speed economic growth

8Dynamic Gains from Trade

• Trade may speed economic growth– When more K goods are imported than produced in

autarky, PPF shifts out.– Trade diffuses new technology.– Trade raises real income. Savings rise.– Free trade an effective anti-trust policy– Trade expands the market, allowing firms to exploit

IRS.– When trade spurs development, decreasing-costs

may occur.

10Commercial Policy

• Governments action that may change the composition and volume of trade flows

– Tariffs

– Quotas

– Subsidies

– Other non-tariff barriers

• We’ll analyze the cost & benefits of these

11Tariffs

• Taxes on– Imports– Exports– Subsidies

• Components -- See HTS– Ad valorem-- % of value– Specific -- flat fee per unit– Compound -- both

12Positive Effects of Tariffs

• Revenue Effect -- provide tax revenue

• Protective Effect -- shelter domestic producers from foreign competition

13Tariff Terminology

• A pure-revenue tariff is one imposed on a good not produced domestically– A tariff on bananas imported to Iceland

• A prohibitive tariff is one that is so high that none of the good is imported– no revenue is collected

14Uses of Tariffs

• Developing countries may rely on tariffs to provide tax revenue

• Developed countries impose tariffs for their protective effect

15Tariffs as tools of int’l policy

• Most Favored Nation status, MFN– granted as a reward, withheld as a punishment

• Generalized System of Preferences, GSP– Most developed countries have GSP as means

of helping developing countries• access to markets of developed countries

16Welfare Cost Analysis

• Use (National) Supply and Demand– Partial equilibrium– One import or export good

• Measure Changes in Consumer Surplus and Producer Surplus

• Start with a small country– Its trade is too small to affect terms of trade

17Gains from free trade -- imports

3

6

10

0 1 4 10Quantity (millions bushels of grapes per year)

Pri

ce ($

per

bu

shel

of

gra

pes

)

7

2

18Gains from free trade -- imports

3

6

10

0 1 4 10

b

Domestic demand for grapes

Domestic Supplyof grapes

ac

Quantity (millions bushels of grapes per year)

Pri

ce ($

per

bu

shel

of

gra

pes

)

World price of grapes

7

2

19Welfare of a Move to Free Trade

A Small Country’s Imports

Change in Consumer Surplus

Change in Producer Surplus

Net Welfare Change


A Small Country’s Imports

Change in Consumer Surplus +a +b +c

Change in Producer Surplus -a

Net Welfare Change +b +c

21Gains from free trade -- exports

9

6

10

0 1 4 10Quantity (millions jars of honey per year)

Pri

ce ($

per

jar

of

hon

ey)

7

2

22Gains from free trade -- exports

9

6

10

0 1 4 10

f

Domestic demand for honey

Domestic Supplyof honey

g

Quantity (millions jars of honey per year)

Pri

ce ($

per

jar

of

hon

ey)

World price of honey

7

e

2


A Small Country’s Exports



Net Welfare Change


A Small Country’s Exports

Change in Consumer Surplus -e -f

Change in Producer Surplus +e +f +g

Net Welfare Change +g

25Welfare Cost of a Tariffon Imports -- Small Country

3

5

10

0 1 10Quantity (millions bushels of grapes per year)

Pri

ce ($

per

bu

shel

of

gra

pes

)

7

2

3 5

26Welfare Cost of a Tariff on Imports -- Small Country

3

5

10

0 1 10

b



a c


Pri

ce ($

per

bu

shel

of

gra

pes

)


7

2

World price + tariff $2/bu

3 5

d




Change in Gov't Revenue

Net Welfare Change (a.k.a. Deadweight loss)

Loss = 0.5 x tariff x change in imports


Change in Consumer Surplus -a -b -c -d

Change in Producer Surplus +a

Change in Gov't Revenue +c

Net Welfare Change(a.k.a. Deadweight loss)

-b -d

Loss = 0.5 x tariff x change in imports

29Welfare Cost of a TariffSmall Country

3

5

10

0 1 10

b



c


Pri

ce ($

per

bu

shel

of

gra

pes

)


7

2


3 5

d


3

5

10

0 1 10

b



a1 c


Pri

ce ($

per

bu

shel

of

gra

pes

)


7

2


3 5

d

a2

31Export Tariff -- Small Country

9

6

10

0 1 4 10




Pri

ce ($

per

jar

of

hon

ey)

7

2

32Export Tariff -- Small Country

9

6

10

0 1 4 10

b



c


Pri

ce ($

per

jar

of

hon

ey)

PW

7

a

2

PW -T

d

33Welfare Cost -- Export Tariff

Small Country Case


+a

Change in Producer Surplus -a -b -c -d


Net Welfare Change in A (a.k.a. Deadweight loss)

-b -d

34Welfare Cost -- Export Tariff

Small Country Case


+a

Change in Producer Surplus -a -b -c -d



-b -d

36Int’l Free Trade Eq. Large Country

Quantity (lb. of Lobster per year)

0

Pri

ce ($

per

lb.)

PA

PB

0

37Int’l Free Trade Eq. Large Country


0

A’s demand for L

A’s Supplyof L

Pri

ce ($

per

lb.)

PA

PFT

Q1 Q2

PB

PFT

B’s demand for L

B’s Supplyof L

Q1’ Q2’0

38

0

A’s demand for Lobster

A’s Supplyof Lobster

Pri

ce ($

per

lb.)

PA

PFT

Import Demand


PB

0

Pri

ce ($

per

lb.)

PA

M = QD - QS

PB

39

0



Pri

ce ($

per

lb.)

PA

PFT

Import Demand


PB

0

A’s demand for imported lobster (excess demand); |slope| = rise/(sum of runs)

Pri

ce ($

per

lb.)

PA

M = QD - QS

PB

40Export Supply

0


Pri

ce ($

per

lb.)

PA

X = QS - QD

PB

B’s demand for L

B’s Supplyof L

QD QS

0

PB

41Export Supply

0

B’s Supply of exports, excess supply; slope = rise/(sum of runs)


Pri

ce ($

per

lb.)

PA

X = QS - QD

PB

B’s demand for L

B’s Supplyof L

QD QS

0

PB

42

0



Pri

ce ($

per

lb.)

PA

PFT

Q1 Q2

Export Supply & Import Demand


0

PB

0

Pri

ce ($

per

lb.)

PA

PFT

M = Q2 - Q1

PFT

Export Supply, X

Import Demand, M

43Export Supply & Import Demand

0

Import Demand, M

Export Supply, X


Pri

ce ($

per

lb.)

PA

PFT

0 M = Q2 - Q1

X = Q2‘ - Q1 ‘

PB

PFT

B’s demand for L

B’s Supplyof L

Q1’ Q2’0

PB

44Optimal Tariffs

• Large countries may force foreign producer to pay part of their tariff.

• Because they are important customers, they force foreign suppliers to cut price.

• The optimal tariff maximizes the net welfare change

• Retaliation is likely to offset this gain

45Equilibrium with a Tariff Large Country

0

A’s demand for L

A’s Supplyof L


Pri

ce ($

per

lb.)

PFT

Q1 Q2

PFT

B’s demand for L

B’s Supplyof L

0

P’P’

P”

Q1’Q3 Q4Q2’Q3’ Q4’

46Equilibrium with a Tariff Large Country

0

A’s demand for L

A’s Supplyof L


Pri

ce ($

per

lb.)

PFT

Q1 Q2

PFT

B’s demand for L

B’s Supplyof L

0

P’P’

P”

Q1’Q3 Q4Q2’Q3’ Q4’

a c de e

bh i j

47A’s Welfare Cost -- Import Tariff

Imposed by Large Country, AChange in Consumer Surplus

-a -b -c -d


Change in Gov't Revenue +c +e


-b -d +e

48A’s Welfare Cost -- Import Tariff

Imposed by Large Country, A


-a -b -c -d


Change in Gov't Revenue +c +e


-b -d +e

49B’s Welfare Cost from A’s Tariff

Import Tariff Imposed by AChange in Consumer Surplus

+h

Change in Producer Surplus -h -i -e -j


Net Welfare Change in B (a.k.a. Deadweight loss)

-i -e -j

50B’s Welfare Cost from A’s Tariff

Import Tariff Imposed by AChange in Consumer Surplus

+h

Change in Producer Surplus -h -i -e -j


Net Welfare Change in B (a.k.a. Deadweight loss)

-i -e -j

51World Welfare Cost of A’s Tariff

Net Welfare Change in A

-b -d +e

Net Welfare Change in B

-e -i -j

Net Welfare Change in World

-b

-d

-i

-j

52World Welfare Cost of A’s Tariff


-b -d +e


-e -i -j


-b

-d

-i

-j

53World Welfare Changes

• Tariff raises the price in A to P” = PW + T

• Tariff lowers the world price to P’ = PW

• Tariff reduces the quantity world trade from Q1 Q2 to Q3 Q4

• A’s welfare change = – b – d + e

• B’s welfare change = – e – i – j

• World welfare change = – b – d – i – j

55B Subsidizes its ExportsLarge Country Case

0

A’s Supplyof L


Pri

ce ($

per

lb.)

PFT

Q1 Q2

PFT

B’s demand for Lobster

B’s Supplyof L

0

P’P’

P”

Q1’Q3 Q4Q2’Q3’ Q4’

P”


56B Subsidizes its ExportsLarge Country Case

0

A’s Supplyof L


Pri

ce ($

per

lb.)

PFT

Q1 Q2

PFT

B’s demand for Lobster

B’s Supplyof L

0

P’P’

P”

Q1’Q3 Q4Q2’Q3’ Q4’

h j e

a

f

cP”

db

ki g


57B’s Welfare Cost from its Export Subsidy





58B’s Welfare Cost from its Export Subsidy


-a -b

Change in Producer Surplus +a +b +c

Change in Gov't Revenue -b -e

-c -f

-d -g


-b -e

-f

-d -g

59A’s Welfare Cost from B’s Export Subsidy





60A’s Welfare Cost from B’s Export Subsidy


+h +i +j +k

Change in Producer Surplus -h



+i +j +k

61World Welfare Cost

from B’s Export Subsidy




62World Welfare Cost

from B’s Export Subsidy


+i +j +k


-b -d -e -f -g


-b -d +i -e

+j -f

+k -g

63World Welfare Changes

• Export subsidy raises price in B to P” = PW + S

• Subsidy lowers the world price to P’ = PW • World trade grows from Q1 Q2 to Q3 Q4 • B’s welfare change = – b – d – e – f – g• A’s welfare gain = + i + j + k• World welfare change = – b – d – e – f – g +

i + j + k

65Nominal & Effective Rates of Protection

• t = tariff

• P = free-trade price of good

• v = domestic value added with free trade

• v’= domestic value added with tariff

67Effective Rate of Protection

gj = Effective Rate of Protection on final product j

tj = nominal tariff rate on final product j

ti = nominal tariff rate on imported input i

aij = share of i in the total value of j in the absence of tariffs

ERP gt a t

ajj ij i

ij

, 1

68Welfare Cost of Tariffs as a

Percentage of GDP• Traditional: Square the tariff rate

– Ten percent tariff reduces GDP by 1%

• Tariffs & NTBs often exclude new goods– GDP loss almost twice the tariff rate

69Welfare Cost of Tariffs as a

Percentage of GDP• Traditional: Square the tariff rate

– Ten percent tariff reduces GDP by 1%

• Tariffs & NTBs often exclude new goods– GDP loss almost twice the tariff rate– Ten percent tariff lowers GDP by 19.8%– Twenty-five percent tariff lowers GDP by 47%

70Consumers’ Surplus

• Consumers’ Surplus is the difference between consumers’ maximum willingness-to-pay and the amount they actually paid.

• The amount actually paid equals PQ.• Graphically, Consumers’ Surplus (CS) is the area

under the demand curve above P.

71Producer Surplus

• Producer surplus is the price of a good minus the opportunity cost of producing it.– Graphically, Producers’ Surplus (PS) is the area

under the Price line and above Supply.

72Export Supply + Specific Tariff, T

0

Import Demand, M

Export Supply, X


Pri

ce ($

per

lb.)

MFT

T

T


0

Import Demand, M

Export Supply, X


Pri

ce ($

per

lb.)

PA

PFT

MFT

PB

X + TARIFF, T

PW +T

PW

MT

T

T

gf

74Graphing Tariffs

• Specific tariff raises the y-intercept of the export supply curve, p = a + b q

p + T = a + b q + T

• Ad-valorem tariff raises the slope and y-intercept of the export supply curvep = a + b q

p (1 + t) = (a + b q) (1 + t) = (1 + t) a + (1 + t) b q

75Export Supply with Ad-Valorem Tariff, t

0

Import Demand, M

Export Supply, X


Pri

ce ($

per

lb.)

PA

PFT

MFT

PB

X(1+t)

PW +T

PW

MT

gf

76Price Elasticity of Demand, ed

ed and slope are inversely related.

Q

P

SlopeQ

P

QP

Q

P

P

Q

P

P

Q

Q

P

P

Q

Q

d

d

e

e

11

77The Price Elasticity of Supply, es• The formula for price elasticity of supply,

es, at a point is shown below. Note that it’s

the same as the formula for ed , but lacks

the absolute value notation

seQ

P

P

Q Slope

P

Q

1

78Import Demand Elasticity, em

• The formula for price elasticity of import demand,

em, at a point is shown below. Q is the quantity

of imports; P is the price; P is the change in

price;Q is the change quantity imported

Q

P

SlopeP

P

Q

Qme

1

79Import Demand Elasticity, em

• The formula for price elasticity of import demand,

em, at a point is shown below

Qm is the quantity of imports; Qd is the quantity

demanded; Qs is the quantity supplied

eee sm

sd

m

dm Q

Q

Q

Q

80Interpreting em

•em is directly related to A’s ed and es

•em is inversely related to the share of imports in A’s consumption and production

eee sm

sd

m

dm Q

Q

Q

Q

81Export Supply Elasticity, ex

• The formula for price elasticity of export supply,

ex, at a point is shown below. Q is the quantity

of exports; P is the price; P is the change in

price;Q is the change quantity exported

Q

P

SlopeQ

P

P

Qex

1

82Export Supply Elasticity, ex

• The formula for price elasticity of export supply, ex, at a point is shown below.

– Qx is the quantity of exports; Qd is the quantity consumed; Qs is the quantity produced

eee sx

sd

x

dx Q

Q

Q

Q

83Interpreting ex

•ex is directly related to B’s ed and es

•ex is inversely related to the share of exports in B’s consumption and production

eee sx

sd

x

dx Q

Q

Q

Q


0

Import Demand, M

Export Supply, X


PA

PFT

MFT

PB

X + TARIFF, T

PW +T

PW

MT

T

g

fA’s burden, b

85Compare em and ex

to determine A’s burden, b; 0b1• When em = ex , b = _____

• When em > ex , b _______

• When em < ex , b _______

1

1

eeb

xm

86Compare em and ex

to determine A’s burden, b; 0b1• When em = ex , b = 0.5

• When em > ex , b < 0.5

• When em < ex , b > 0.5

1

1

eeb

xm

87

B’s burden, 1- bPW

Differing em

0

Inelastic M

Export Supply, X


PA

PFT

MFT

X + TARIFF, T

PW +T

PW

MT

T

gfA’s burden, b

Elastic M

MT

PW +T

fg

88Differing ex

0

Import Demand, M

Elastic X


PA

PFT

MFT

PB

Elastic X + T

PW +T

PW

MT

T

g

fA’s burden, b

Inelastic X

T

Inelastic X + T

89SUPACHAI CITES KEY NEGOTIATING AREAS

• Trade liberalization and poverty reduction– Welfare gains from eliminating trade barriers gains of up to

US$620 billion annually• about one third to one half would go to developing countries.

• Tariff “peaks” – agricultural products, textiles, clothing and footwear

• Market access conditions key in trade in services• Regional trade agreements

– 240 currently in force, perhaps 300 by 2005• Increasing use of contingency measures

– e. g., anti-dumping



• Become familiar with tariffs




• Learn the imperfect substitutes model

91Imperfect Substitutes

• Increased trade in final products relative to raw materials and intermediate goods

• A final-good import and competing domestic products are often imperfect substitutes

• Tariff increases demand for the domestic good

• Increased price of domestic good increases demand for the import

• Welfare cost is more difficult to estimate

92Imperfect Substitutes Small Country -- Free Market

0

DM

Quantity of Imports

Pri

ce o

f Im

por

t

PM

QM QD

0

SM

Quantity of Domestic Substitute

DD

SD

PD

Pri

ce

93Imperfect Substitutes Small Country -- Tariff

0

DM

Quantity of Imports

Pri

ce o

f Im

por

t

e

QM

QD0

SM

Quantity of Domestic Substitute

DD

SD

lP

rice

f

D’DD’M

S’M

m

h

i

r g

kj

n

tariff

Q’DQ’M Q”M

94Welfare Cost of a Tariff

Imperfect Substitutes



Change in Government Revenue

Net Welfare Change (a.k.a. Deadweight loss)

95Welfare Cost of a Tariff

Imperfect Substitutes

Change in ConsumerSurplus

-areaefig

-arealmkj

Change in ProducerSurplus

+arealmkj

Change in GovernmentRevenue

+areaefir

Net Welfare Change(a.k.a. Deadweight loss)

-areargi

96Review homework

97Trade with a TariffVersus Autarky

65

10

0 1 10



e


Pri

ce ($

per

bu

shel

of

gra

pes

)


7

2


3 5

d

3

98Pure Revenue TariffVersus Free Trade

5

10

0 1 10

Iceland’s demand for bananas

Domestic Supplyof grapes lies along y-axis

a

Quantity (millions bushels of bananas per year)

Pri

ce ($

per

bu

shel

of

ban

anas

)

World price of bananas

7

2


3 5

b3

c

99

PW

Differing em

0

Inelastic M

Export Supply, X


PA

PFT

MFT

X + TARIFF, T

PW +T

PW

MT

T

g

f

Elastic M

MT

PW +T

fg

1 the instruments of trade policy: part i, tariffs international economics, eco 486 harmonized...

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