the impact of trade policies copyright © 2010 by the mcgraw-hill companies, inc. all rights...

The Impact of Trade Policies

Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

Chapter 14Chapter 14

14-2

Learning Objectives Illustrate how tariffs, quotas, and

subsidies affect domestic markets. Identify the winners, losers, and net

country welfare effects of protection. Explain how the effects of protection

differ between large and small countries.

Demonstrate how protection in one market can affect other markets in the economy.

14-3

Consumer Surplus

Consumer surplus (CS) is a measure of the overall well-being of consumers.

CS is the area between the demand curve and the price.

CS varies inversely with the price.

14-4

Consumer Surplus

D

Q

P

P*

14-5

Producer Surplus

Producer surplus (PS) is a measure of the well-being of producers.

PS is the area between the supply curve and the price.

PS varies directly with price.

14-6

Producer Surplus

S

Q

P

P*

14-7

Trade Restrictions in Partial Equilibrium: The Small

Country Case What happens when a country

imposes a tariff? Its domestic price rises.

Therefore, tariffs: • benefit domestic producers• harm domestic consumers• generate tariff revenue for the

government

Tariffs: Small Country Case

D

Q

P S

$1

$1.35

1000 20001250 1750

c dba

CS falls by area a+b+c+d,

or $656.25.

PS rises by area a, or $393.75.

Revenue rises by area c, or $175.

Deadweight loss is areas b+d,

or $87.50.

14-8

14-9

Tariffs: Small Country Case

A tariff makes producers better off, but overall, the small country’s welfare falls.

14-10

Import Quotas: Small Country Case

Recall that quotas and tariffs can be designed to be equivalent.

The difference is that with quotas there is no revenue collected.

Instead rent will be captured by• holders of import licenses or • the government if it auctions the licenses, or• foreign suppliers, if they organize.

The welfare implications of the quota are otherwise the same as for tariffs.

Production Subsidies: Small Country Case

D

Q

PS

$5

$6

100 190120 160

c

ba

A $1 subsidy has the effect of

shifting the supply curve to the right.

CS doesn’t change, because consumers still pay $5.

PS rises by areas a+b

The cost of the subsidy is a+b+c

Deadweight loss is areas c.

S'

14-11

14-12

Production Subsidies: Small Country Case

Production subsidies lead to deadweight loss because of the expansion of relatively inefficient production.

However, the DWL is less than would have occurred if an equivalent tariff or quota were used.

14-13

Export Taxes: Small Country Case

Export taxes cause the price in the imposing (i.e., exporting) country to fall, since some of what had been exported is not anymore.

We’d predict an increase in CS, a decrease in PS, and a gain in revenue.

14-14

Export Taxes: Small Country Case

P

Q

S

D

PFT

PET

CS rises by area a.

PS falls by areas a+b+c+d.

Revenue rises by area c.

DWL is b+d.

ad

cb

14-15

Export Taxes: Small Country Case

An export tax tariff makes consumers better off, but overall, the small country’s welfare falls.

14-16

Export Subsidies: Small Country Case

Export subsidies cause the price in the imposing (i.e., exporting) country to rise, since more of what is produced is now exported.

We’d predict an decrease in CS, an increase in PS.

The subsidy will generate cost, not revenue.

14-17

Export Subsidies: Small Country Case

P

Q

S

D

PES

PFT

CS falls by area a+b

PS rises by areas a+b+c+d+e

Subsidy cost is b+c+d+e+f

Overall effect is a loss: b+f

a dc

be

f

14-18

Export Subsidies: Small Country Case

An export subsidy tariff makes producers better off, but overall, the small country’s welfare falls.

14-19

Voluntary Export Restraints: Small Country Case

Similar to tariffs or quotas, VERs raise the domestic price which• lowers CS• raises PS

Rent, however, is captured by the exporting country.

The imposing country will lose not only the DWL triangles, but also the rent rectangle; welfare falls.

14-20

Tariffs: Large Country Case

In the previous analysis, the tariff caused the imposing country’s price to rise by the full amount of the tariff.

This would mean that the imposing country is “small”; if it imposes a tariff, it is unable to affect the world price.

What if a country is not “small”?

Tariffs: Large Country Case

P

Q

P

Q

S

D

S

D

Importing CountryImporting Country Exporting CountryExporting Country

PFTa b dc

e

The tariff causes price

to rise in the importing

country; P falls in the

exporting country.

14-21

Tariffs: Large Country Case

P

Q

P

Q

S

D

S

D

Importing CountryImporting Country Exporting CountryExporting Country

PFTa b dc

e

Importing country CS falls by a+b+c+d

PS rises by area a.

Revenue increases by areas c+e

Overall effect: e–(b+d)

14-22

14-23

Tariffs: Large Country Case

A large country could increase its welfare by imposing a tariff if the revenue extracted from the exporting country (area e) is bigger than the deadweight loss (areas b+d).

This assumes that the exporting country does not retaliate.

14-24

Import Quotas: Large Country Case

As with the tariff, IQs cause prices in the importing country to rise, and prices in the exporting country to fall.

As with the tariff, if enough of the quota rent is transferred from the exporting country to offset the deadweight loss, a quota can increase a country’s overall welfare.

This also assumes no retaliation.

14-25

VERs: Large Country Case

As with the tariff and the quota, VERs cause prices in the importing country to rise, and prices in the exporting country to fall.

However, unlike quotas rent generated is captured by the exporting country.

VERs are welfare-diminishing even in the large country case.

14-26

Export Taxes: Large Country Case

In the previous analysis, the export tax caused the imposing country’s price to fall by the full amount of the tax.

If the exporting country is large, its price will fall somewhat but the price in the importing country will also rise.

Export Taxes: Large Country Case

P

Q

P

Q

S

D

S

D

Importing CountryImporting Country Exporting CountryExporting Country

PFT

The export tax causes the price to fall in the

exporting country and rise in the importing

country.

a b dc

e

14-27

Export Taxes: Large Country Case

P

Q

P

Q

S

D

S

D

Importing CountryImporting Country Exporting CountryExporting Country

PFT

CS rises by area a.

PS falls by areas a+b+c+d

Revenue rises by areas c+e

a b dc

e

14-28

14-29

Export Taxes: Large Country Case

A large country could increase its welfare by imposing an export tax if the revenue extracted from the importing country (area e) is bigger than the deadweight loss (areas b+d).

This assumes that the importing country does not retaliate.

14-30

Export Subsidies: Large Country Case

CS falls. PS rises. But there is no revenue; instead cost. Overall, export subsidies are welfare-

diminishing for small countries and for large countries.

14-31

Trade Restrictions in General Equilibrium: The Small Country

Case We can use general equilibrium

analysis to better understand the economy-wide effects of protection.

A tariff on imports of good Y will stimulate domestic production.

The economy winds up on a lower indifference curve.

Tariffs in General Equilibrium: Small Country Case

Y

X

B0

C0

B1

(Px/Py)0

C1

Px/Py(1+t)

In free trade, producer equilibrium is at B0, and consumer equilibrium is at C0. The tariff changes production to point B1;consumption moves to C1 (on a lower indifference curve).

14-32

14-33

Trade Restrictions in General Equilibrium: The Large

Country Case To understand the effects of

protectionism in the large country case we can use offer curve analysis.

14-34

Tariffs or Export Taxes

Y

X

(PX/PY)FT

X2

Y2

OCA

OCB

OCA' (PX/PY)t

By imposing a tariff or an export

tax, Country A decreases trade

volume, but improves its terms

of trade (note: B’s terms of trade

deteriorate).

Y1

X1

14-35

Export Subsidies

Y

X

(PX/PY)FT

X1

Y1

OCA

OCB

(PX/PY)ES

X2

Y2

Country A’s terms of trade

deteriorate; volume rises.

14-36

Import Quotas

Y

X

(PX/PY)FT

X1

Y1

OCFTA

OCFTB

OCIQA

Y2

The quota causes the imposing

country’s terms of trade to

improve, and trade volume to

fall.

(PX/PY)IQ

X2

14-37

VERs

Y

X

(PX/PY)E

X1

Y1

OCFTA

OCFTB

OCVERB

Y2

The quota decreases trade

volume, and causes A’s terms of trade to deteriorate.