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International Economics
Trade policies
Classification of Commercial Policy Instruments
Commercial Policy Instruments
Trade Contraction Trade Expansion
Tariff Export tax
Import quotaVoluntary
Export Restraint
(VER)
Import subsidyExport subsidy
Voluntary Import
Expansion (VIE)
Price Quantity Price Quantity
Defining tariffs A tariff is a tax (duty) levied on products as
they move between nations Import tariff - levied on imports Export tariff - levied on exported goods as they
leave the country Protective tariff - designed to insulate domestic
producers from competition Revenue tariff - intended to raise funds for the
government budget (no longer important in industrial countries)
Tariffs
Types of tariff Specific tariff
Fixed monetary fee per unit of the product
Ad valorem tariff Levied as a percentage of the value of the
product
Compound tariff A combination of the above, often levied on
finished goods whose components are also subject to tariff if imported separately
Tariffs
Effective rate of protection The impact of a tariff is often different from
its stated amount The effective tariff rate measures the total
increase in domestic production that the tariff makes possible, compared to free trade Domestic producers may use imported inputs
or intermediate goods subject to various tariffs, which affects the calculation
Tariffs
Effective rate of protection (cont’d)
When tariff rates are low on raw materials and components, but high on finished goods, the effective tariff rate on finished goods is actually much higher than it appears from the nominal rate
This is referred to as tariff escalation
Tariffs
Tariff welfare effects Consumer surplus
The difference between the price buyers would be willing to pay and what they actually pay
Producer surplus The revenue producers receive above the
minimum amount required to induce them to produce a good
Tariffs
Consumer and producer surplus
Tariffs
Who pays for import restrictions? Domestic consumers face increased costs
Low income consumers are especially hurt by tariffs on low-cost imports
Overall net loss for the economy (deadweight loss)
Export industries face higher costs for inputs Cost of living increases Other nations may retaliate, further restricting
trade
Tariff effects
Useful definitions: The terms of trade is the relative price of the
exportable good expressed in units of the importable good.
A small country is a country that cannot affect its terms of trade no matter how much it trades with the rest of the world.
Consumer Surplus Producer Surplus
Basic Tariff Analysis
Figure 8-5: A Tariff in a Small Country
SPrice, P
Quantity, Q
D
Price with tariff
Price withouttariff
Imports after tariff
S1 D1
Imports before tariff
D2S2
Basic Tariff Analysis-Small Country
A
B
C
FE
D
G
Tariff trade and welfare effects
Welfare effects of tariffs
Costs and Benefits of a Tariff A tariff raises the price of a good in the
importing country and lowers it in the exporting country.
As a result of these price changes: Consumers lose in the importing country Producers gain in the importing country Government imposing the tariff gains revenue
Effects of a Tariff Assume that two large countries trade with
each other. Suppose Home imposes a tax of $2 on every
bushel of wheat imported. Then shippers will be unwilling to move the wheat
unless the price difference between the two markets is at least $2.
Figure 8-4 illustrates the effects of a specific tariff of $t per unit of wheat.
Basic Tariff Analysis-Large Country
The increase in the domestic Home price is less than the tariff, because part of the tariff is reflected in a decline in Foreign’ s export price. If Home is a small country and imposes a tariff,
the foreign export prices are unaffected and the domestic price at Home (the importing country) rises by the full amount of the tariff.
Basic Tariff Analysis
In the absence of tariff, the world price of wheat (Pw) would be equalized in both countries.
With the tariff in place, the price of wheat rises to PT
at Home and falls to P*T (= PT – t) at Foreign until the price difference is $t.
• In Home: producers supply more and consumers demand less due to the higher price, so that fewer imports are demanded.
• In Foreign: producers supply less and consumers demand more due to the lower price, so that fewer exports are supplied.
• Thus, the volume of wheat traded declines due to the imposition of the tariff.
Basic Tariff Analysis
Costs and Benefits of a Tariff A tariff raises the price of a good in the
importing country and lowers it in the exporting country.
As a result of these price changes: Consumers lose in the importing country and
gain in the exporting country Producers gain in the importing country and
lose in the exporting country Government imposing the tariff gains revenue
The areas of the two triangles b and d measure the loss to the nation as a whole (efficiency loss) and the area of the rectangle e measures an offsetting gain (terms of trade gain). The efficiency loss arises because a tariff distorts
incentives to consume and produce.• Producers and consumers act as if imports were more
expensive than they actually are.• Triangle b is the production distortion loss and triangle
d is the consumption distortion loss. The terms of trade gain arises because a tariff lowers
foreign export prices (or Home import prices). If the terms of trade gain is greater than the efficiency loss, the
tariff increases welfare for the importing country.
Costs and Benefits of a Tariff
Large country model
Costs and Benefits of a Tariff
PT
PW
P*T
b c d
e
D
a
= consumer loss (a + b + c + d)
= producer gain (a)
= government revenue gain (c + e)
QT
D2S2
S
S1 D1
Price, P
Quantity, Q
Figure 8-10: Net Welfare Effects of a Tariff
PT
PW
P*T
b d
e
D
= efficiency loss (b + d)
= terms of trade gain (e)
Imports
SPrice, P
Quantity, Q
Costs and Benefits of a Tariff
Optimal Tariff Small Country: Optimal tariff t=0 Large Country: Optimal tariff (to) maximizes the
gain from tariff
Maximize [e- (b + d)]
t
e-(b+d)
to
Export Subsidies: Theory Export subsidy
A payment by the government to a firm or individual that ships a good abroad
• When the government offers an export subsidy, shippers will export the good up to the point where the domestic price exceeds the foreign price by the amount of the subsidy.
It can be either specific or ad valorem.
Other Instruments of Trade Policy
ba
Figure 8-11: Effects of an Export Subsidy
Other Instruments of Trade Policy
PS
PW
P*S
Price, P
Quantity, QExports
gfe
Subsidy dc = producer gain (a + b + c)= consumer loss (a + b)
= cost of government subsidy (b + c + d + e + f + g)
D
S
An export subsidy raises prices in the exporting country while lowering them in the importing country.
In addition, and in contrast to a tariff, the export subsidy worsens the terms of trade.
An export subsidy unambiguously leads to costs that exceed its benefits.
Other Instruments of Trade Policy
Figure: Europe’s Common Agricultural Program
Other Instruments of Trade Policy
Price, P
Quantity, Q
S
D
EU price without imports
World price
= cost of government subsidy
Support price
Exports
Import Quotas: Theory An import quota is a direct restriction on the
quantity of a good that is imported. Example: The United States has a quota on imports
of foreign cheese. The restriction is usually enforced by issuing
licenses to some group of individuals or firms. Example: The only firms allowed to import cheese
are certain trading companies. In some cases (e.g. sugar and apparel), the
right to sell in the United States is given directly to the governments of exporting countries.
Other Instruments of Trade Policy
An import quota always raises the domestic price of the imported good.
License holders are able to buy imports and resell them at a higher price in the domestic market. The profits received by the holders of import
licenses are known as quota rents. They accrue to licenses holders
Welfare analysis of import quotas versus that of tariffs The difference between a quota and a tariff is that
with a quota the government receives no revenue. In assessing the costs and benefits of an import
quota, it is crucial to determine who gets the rents.
Other Instruments of Trade Policy
Price in U.S. Market 466
World Price 280b c d
Demand
a
8.456.32
Supply
5.14 9.26
Price, $/ton
Quantity of sugar,million tons
Figure 8-13: Effects of the U.S. Import Quota on Sugar
Import Quota
Import quota:2.13 million tons
= consumer loss (a + b + c + d)
= producer gain (a)
= quota rents (c)
Imposing a tariff
of 186
Equivalence between tariff and quota
Both are equivalent Except that tariff rents accrue to govt. and
Quota rents to license holders If
P.C in domestic market Competitive foreign supply Quota allocated to ensure P.C among quota holders
Voluntary Export Restraints A voluntary export restraint (VER) is an
export quota administered by the exporting country. It is also known as a voluntary restraint agreement
(VRA).
VERs are imposed at the request of the importer and are agreed to by the exporter to forestall other trade restrictions.
Other Instruments of Trade Policy
A VER is exactly like an import quota where the licenses are assigned to foreign governments and is therefore very costly to the importing country.
A VER is always more costly to the importing country than a tariff that limits imports by the same amount. The tariff equivalent revenue becomes rents earned by
foreigners under the VER.• Example: About 2/3 of the cost to consumers of the three major
U.S. voluntary restraints in textiles and apparel, steel, and automobiles is accounted for by the rents earned by foreigners.
A VER produces a loss for the importing country.
Other Instruments of Trade Policy
Arguments for trade restrictions Job protection Protect against cheap foreign labor Fairness in trade - level playing field Protect domestic standard of living Equalization of production costs Infant-industry protection Political and social reasons
Reasons for tariffs
Politics of protectionism “Supply” of protectionism (trade policy)
depends on: the cost to society of restricting trade the political importance of the import-competing
industries Magnitude of the adjustment costs from free
trade Public sympathy for those sectors hurt by free
trade
Reasons for tariffs
Politics of protectionism “Demand” for protectionism depends on:
The amount of the import-competing industry’s comparative disadvantage
The level of import penetration The level of concentration in the affected sector The degree of export dependence in the sector
Reasons for tariffs