Tariffs

INTERNATIONAL ECONOMICS, 1/e

By W. Charles Sawyer
and Richard L.Sprinkle
Tariffs: Preliminary Details
 A Tariff is a tax on imported goods

 Tariffs will
 Affect domestic consumption of a good
 Affect domestic production of competing goods
 Affect foreign production of the good
 Affect the structure of the domestic economy
Tariffs: Preliminary Details
 A revenue tariff is an import tax
levied on a good that is not produced
domestically.

 A protective tariff is a tariff designed

to protect a domestic industry from
foreign competition
Types of Tariffs
 A specific tariff is a per unit tax on
imported goods.
 Expressed as a certain amount per unit:
$6 per imported ton.
 Easy to administer
 Not uniform across high and low priced
goods
 Regressive in nature
Types of Tariffs
 An ad valorem tariff is expressed as a
percentage of the value of the imported
good.
 Required valuation of the good to
determine amount of tariff
 Not regressive in nature
 Incentives to under-invoice the price
Types of Tariffs
 A compound tariff is comprised of both
a specific tariff and an ad velorem tariff.
 $6 per imported ton plus 4% of the value
of the imported good.
 Common on products whose prices
fluctuate such as agricultural products.
Methods of Valuing Imports
 Free Alongside (F.A.S.) – foreign market price
before loading for shipment
 Free on Board (F.O.B) - foreign market price
plus costs of loading
 Cost, Insurance, and Freight (C.I.F.) - foreign
market price plus costs of loading plus inter-
country transportation costs up to port of
entry.
Consumer Surplus – A Review
 Consumer Surplus is the difference
between what consumers are willing to
pay and what they actually pay for a
good.
 Represented graphically as the area
under the demand curve to the price
paid
 Consumer Surplus – A Review
Price of Cloth

P1

Pc E

D
Qc Quantity of Cloth
 Consumer Surplus – A Review
Price of Cloth

P1

Pc E

D
Qc Quantity of Cloth
Producer Surplus – A Review
 Producer surplus is the difference
between what a producer is willing to
accept and the price received.
 Represented graphically as the area
above the supply curve to the price
received.
 Producer Surplus – A Review
Price of Cloth

E
Pc

P2

Qc Quantity of Cloth
 Producer Surplus – A Review
Price of Cloth

E
Pc

P2

Qc Quantity of Cloth
Market in Autarky
 Equilibrium occurs at E, equilibrium
price and quantity without any trade.
 Producer and consumer surplus are
shown in market by corresponding
areas as before.
 U.S. Cloth Market
Price of Cloth
P1
CS S

E
Pc

P2 PS
D

Qc Quantity of Cloth
Imports and Free Trade
 India has a comparative advantage in
cloth production so U.S. decides to
import cloth.
 Assume U.S. is a small country so
quantity purchased will not affect the
world free-trade price.
Imports and Free Trade
 Import at price, Pw, lower than
domestic price, Pc.
 Quantity demanded increase from Qc to
Qd
 Quantity supplied decreases from Qc to
Qs
 Free Trade Cloth Market
Price of Cloth
P1
S

E
Pc

Pw

P2 D

Qs Qc Qd Quantity of Cloth
Imports and Free Trade
 Producer surplus falls with decrease in
price and quantity supplied
 Consumer surplus expands with
decrease in price and increase in
quantity demanded
 Total country welfare increases with
free trade equal to triangle GEF
 Decrease in Producer Surplus
Price of Cloth
P1
S

E
Pc

Pw

P2 D

Qs Qc Qd Quantity of Cloth
 Increase in Consumer Surplus
Price of Cloth
P1
S

E
Pc

Pw

P2 D

Qs Qc Qd Quantity of Cloth
 Net Gain in Surplus
Price of Cloth
P1
S

E
Pc

Pw G F

Imports
P2 D

Qs Qc Qd Quantity of Cloth
Free Trade Effects
 Consumption Effect
 Consumers can buy more cloth at a lower
price
 Production Effect
 Decline in domestic production from
production cuts and/or business failure
Tariff in Small Country
 Domestic government imposes tariff on
cloth production in the amount of $T.
 Remember U.S. is small country and
cannot affect world price – world price
stays constant at Pw.
 Price of cloth in U.S. rises by the full
amount of the tariff to Pt = Pw + T
Tariff in a Small Country
 Quantity demanded falls with the new,
higher price of cloth – Qd to Qd’.
 Quantity supplied increases with the
new, higher price of cloth – Qs to Qs’.
 Imports decrease
 Government collects tariff revenue
 Tariff in Cloth Market
Price of Cloth
P1
S

E
Pc
Pt
Tariff
Pw
P2 Imports D

Qs Qs’ Qc Qd’ Qd Quantity of Cloth

Tariff in Small Country
 Consumer surplus falls with the increase
in price and decrease in quantity
demanded.
 Producer surplus increase with the
increase in price and quantity supplied.
 Government revenue increases with
implementation of tariff
 Tariff Effects on CS
Price of Cloth
CS with
P1 Tariff
CS with Free S
Trade

E
Pc Loss in CS
with Tariff
Pt
Tariff
Pw
P2 Imports D

Qs Qs’ Qc Qd’ Qd Quantity of Cloth

 Tariff Effects on PS and Govt.
Price of Cloth
P1
Gain in PS S
with Tariff

E Gain in Govt.
Pc Revenue
Pt
Tariff
Pw
P2 Imports D

PS with Qs Qs’ Qc Qd’ Qd Quantity of Cloth

Free
Trade
 Net Effects of Tariff
•a is loss in CS but gain
Price of Cloth
in PS so net is 0
P1
S •c is loss in CS but gain
in Govt. Rev. so net is 0
•b and d are net losses
from CS – dead weight
E
loss (DWL)
Pc
Pt
Tariff a b c d
Pw
P2 Imports D

Qs Qs’ Qc Qd’ Qd Quantity of Cloth

Tariff in Large Country
 Country is large enough so that
changes in consumption affect the
world price of the good
 The supply curve will shift to the right
with implementation of free trade
 The supply curve will shift partially back
left with implementation of the tariff
 Tariff in Cloth Market
Price of Cloth
S

S+M+T
E
Pc
G S+M
Pt
F
Pw
P’
Imports D

Qs Qs’ Qd’ Qd Quantity of Cloth

Tariff in Large Country
 Consumer Surplus will fall due to higher
price and lower quantity demanded
 Producer Surplus will increase due to
higher price and quantity supplied
 Government will gain revenue equal to
tariff*imports.
 Tariff in Cloth Market
Price of Cloth
S

Gain in
Govt. S+M+T
Loss in E Rev.
CSin Pc
Gain G
Pt S+M
PS
F
Pw
P’
D

Qs Qs’ Qd’ Qd Quantity of Cloth

Tariff in Large Country
 Transfer of CS to PS
 Transfer of CS to Government Revenue
 Dead weight losses as before from loss
in CS (area b and d)
 Additional gains to government revenue
from change in price – terms of trade
effect (area e)
 Tariff in Cloth Market
Price of Cloth
S

Dead Weight
Loss
S+M+T
E
Pc
G S+M
Pt
b d F
Pw e
P’
D Net Gain from
Govt. Rev.
Qs Qs’ Qd’ Qd Quantity of Cloth
Tariff on Large Country
 Net Welfare Effects
 Loss of consumer surplus (b+d)
 Gain from terms of trade effect (e)
 Net effect depends on the magnitude of
losses and gains
 If e > b+d, could increase welfare from
implementation of a tariff
 Optimum tariff – maximize country’s own
welfare at expense of foreign country
Effective Rate of Protection
 Rate of protection depends on
 Tariff on final good
 Tariffs on intermediate inputs for that good
 Must consider tariffs on the value of
product produced domestically
 The effective rate of protection is a
measure that accounts for these items
Effective Rate of Protection
 Example 1
 DVD player sells for $200 under free trade
 $100 worth are imported components
 $100 worth is value added
 Suppose a 20% tariff on player so P=$240
 The effective rate of protection to the
domestic producer is equal to the percentage
increase in domestic value-added from tariff
Effective Rate of Protection
 Need domestic value-added after tariff
 New price – price of imported components
 $240 - $100 = $140
 Tariff + domestic value-added before tariff
 $40 + $100 = $140
 Percentage change in domestic value
 $40/$100 = 40%
 20% tariff lead to 40% effective rate of
protection
Effective Rate of Protection
 Relationship between tariff rate and effective
rate of protection depends on percentage of
and tariffs on imported components used in
production
ERP  (T f  aTc ) /(1  a )
T f  tariff rate on imported final product
a  percentage of imported components
Tc  tariff rate on imported components
ERP Example
ERP  (T f  aTc ) /(1  a)
a  100 / 200  0.5
T f  20%, Tc  10%
0.20  0.5(0.1)
ERP   .30  30%
(1  0.5)
The effective tariff depends on the tariffs on imported final
goods and components
ERP Effects
 Tariff Escalation - A small nominal tariff
with a large percentage of inputs
imported yielding a large effective rate
of protection for a good
 Common in developed countries
 Discourages final good production in
country exporting intermediate product
 Can discriminate against foreign producers
 1. Product “A” has an import value of
$100. If a tariff of 10 percent of the
product’s value plus $10 per unit were
imposed on “A”, the result would be a(n)
____ of _____ .
 a. ad valorem; $15
 b. combined; $15
 c. compound; $15
 d. compound; $20
 2. The Free alongside (FAS) method of valuing imports:
 a. defines the price of the imported good as the
foreign market price before it
 is loaded into the ship, train, or plane for shipment to the
importing country.
 b. defines the imported price as the price in the foreign
market including the cost of loading it onto the ship, train,
or plane for shipment to the importing country.
 c. defines the imported price as the price including all
inter-country charges up to the importing country’s port of
entry.
 d. none of the above
 3. The difference between the price
consumers are willing to pay and the
price that they actually pay is known
as:
 a. producer surplus.
 b.consumer surplus.
 c. price discrimination.
 d. government surplus.
 4. When a tariff is imposed on imported
goods and services, the _____ in
consumer surplus is _____ the ______ in
producer surplus.
 a. increase; less than, increase
 b. increase; less than, decrease
 c. decrease; greater than,
increase
 d. decrease; less than, increase
 5. Assume that U.S.-assembled computers
are made with $1,000 of imported components
and sell for $2,000 in the U.S. Now, a $200
tariff is imposed on foreign computers priced
at 2000.The nominal tariff is ______ and the
effective rate of protection is ________ .
 a. 10%; 10%
 b. 5%; 20%
 c. 20%; 50%
 d. 10%; 20%
 6. Consider three goods: raw leather, leather wallets,
and tanned leather. Assume that an industrial country
employs a tariff structure using these ad valorem tariff
rates on imports of 0%, 4.5%, and 7.9%. If this
hypothetical industrial country uses a tariff structure
similar to most other industrial countries, these rates will
be placed on _____, _____, and ____, respectively.
 a. raw leather, leather wallets, tanned leather
 b. leather wallets, raw leather, tanned leather
 c. raw leather, tanned leather, leather wallets
 d. tanned leather, leather wallets, raw leather
 7. A domestically produced DVD player
sells for $500, including $250 of imported
components. A tariff of 20% is imposed
on the imported DVD player. What is the
effective rate of protection?
 a. 20%
 b. 30%
 c. 40%
 d. 60%
Dumping
 Administered protection – justifications
to increase tariffs on imported goods
consistent with WTO rules
 Antidumping law – does not allow an
international firm to sell its product in
an export market for less than it is sold
in domestic market
What is Dumping?
 Cost based dumping – firm sells at price
below cost of production in foreign
market
 Price based dumping – firm sells at a
price lower than price in home market
Types of Dumping
 Sporadic dumping – excessive
inventories leads to a “sale” in the
foreign market.
 Recession in domestic market but boom in
foreign market
 Often seen as part of doing business
 Can draw legal action from industry in
importing country
Types of Dumping
 Persistent Dumping – Sale of products
in foreign market at a price lower than
domestic market over an extended
period of time
 Markets have different elasticities of
demand leading to price discrimination
 Could cause lasting damage to importing
industry
Types of Dumping
 Predatory Dumping – price product with
the goal of driving domestic firms out of
business
 If successful, foreign firm ends up with
monopoly power
 Can then increase price and decrease
quantity to maximize long run profits
History of Antidumping - US
 1916 Law prohibited only predatory dumping
 Antidumping Act of 1921
 Incorporated into 1930 Tariff Act amended in
1979, 1984, 1988
 GATT Antidumping Code
 WTO fighting US Antidumping codes
 Most antidumping codes set up to allow for
easy domestic protection against foreign
competition
Antidumping Process
 Case is filed with government
 International Trade Administration (ITA)
investigates
 US-ITC investigates to determine harm
to domestic industry
 If favorable decision, tariff is
implemented to counter price difference
(Dumping Margin)
Other Administered Protection
 Countervailing Duty - A tariff designed
to increase the price of the imported
goods by a certain amount
 Often used in export subsidy and dumping
cases
 Can be petitioned for my domestic industry
to offset foreign government subsidies on
exports
Other Administered Protection
 The Escape Clause – petitioning for
temporary protection to allow for adjustment
to compete with more intense import
competition
 Caused from shifts in a country’s comparative
advantage
 US-ITC investigates to determine harm with final
decision from the President
 Important in period of floating exchange rates