7 Trade Barriers Analysis Trade Barriers Analysis 1 Tariffs a Definition b Small Country Case c Large Country Case d Special Tariff Concepts e Tariff Escalation 2 Quotas a Definition b Small Country Case c Large Country Case 3 Other Barriers a VERs b Product Standards c Domestic Content Laws Tariffs Tax on imports Types of Tariffs 1 Unit or Specific Tariff unit more impt for problem sets 2 Ad Valorem Tariff Tax Country Sizes Small country Price taker in the global market Large country Price setter in the global market o Changes in import quantities affect the global price 7 Trade Barriers Analysis Small Country Case If a tariff is imposed o If price remains unchanged Imports will disappear because they are losing potential money by buying cell phones abroad and selling it in the small country o Price will rise since a shortage results o If the price can change Price will increase because of the shortage until the new price PFT Tariff Imports desired imports will decrease Overall o Producers gain Production effect of the tariff Area of the left triangle Unnecessary extra cost resources to our own economy of producing cell phones instead of importing it o Government gains o Consumers lose o Overall loss Consumption effect of the tariff Area of the right triangle Deadweight loss Tariff Amount of Imports 7 Trade Barriers Analysis Large Country Case After Tariff o Price in the US increases o Price in the ROW decreases Equilibrium post tariff o US imports ROW exports o PUS PROW Tariff Special Tariff Concepts 1 Prohibitive Tariff Reduces imports to zero Moves both countries back to autarky price Tariff Difference in both countries autarky prices 2 Optimal Tariff If a tariff exists for which the deadweight loss 0 it maximizes the benefit the country can get out of the tariff E B D Such a tariff is more likely to exist when the exports for the ROW are more price inelastic Extreme case Suppose price elasticity of exports 0 in ROW completely price inelastic exports Countries do not try to set optimal tariffs a Only applies to large countries b Large countries in most markets are also rich countries c Most countries with rather inelastic exports are poor countries exporting natural resources Inelastic creates large area E Sells at any price d Invites retaliation Rich countries maintain that their Average Tariff Rate is 2 3 Problems 1 Tariffs are not the only trade barriers 2 Average Tariff Rate is biased downward o Average Tariff Rate Tariff Revenue Total Value of Imports t1P1Q1 t2P2Q2 P1Q1 P1Q1 ti Tariff rate for good i Qi Quantity imported of good i Pi Price per unit of good i o But as t1 increases Q1 falls Overall effect on tariff revenue is dependent on elasticity As tariff becomes a prohibitive tariff It drops out of consideration because post tariff imports 0 3 Tariffs are highest on imports from poor countries 4 Tariff escalation 7 Trade Barriers Analysis Rich Country Average Tariff Rates 1 Raw materials eg Iron ore 2 Semi manufacturers eg Steel rods 3 Final goods eg Car 1 3 6 When gains are concentrated and the losses are dispersed as a result of a policy change Suppose that there is a policy change 1 000 000 in gains 1 200 000 in losses Suppose that there are 4 gainers and 1 000 000 losers Each gainer gains 250 000 Each loser loses 1 20 Intense lobbying for the change the change o If gains are dispersed and losses are concentrated Lobbying against Assume Total gains and total losers from a policy change are given Greater concentration of losses Increased lobbying against Greater dispersion of losses Decreased lobbying against Greater concentration of gains Increased lobbying in support Intense lobbying on both sides Unknown outcome Intense lobbying for less lobbying against Change is more likely Greater dispersion of gains Decreased lobbying in support Intense lobbying against less lobbying for Change is less likely Little lobbying Change might be decided based on the merits True regardless of whether the change is a PPI 7 Trade Barriers Analysis Tariff Escalation The closer the good to being the final good in the production stage the higher the tariff US Product Tariff is on imports only Raw materials are usually produced by many companies Semi manufacturers are usually from a few large corporations due to large internal economies of scale Alumnium is used by hundreds of businesses in the production of each of the hundreds of different types of products Gainers from Tariff Losers from Tariff Bauxite Raw Material Few hundred US Bauxite mines Aluminium Semi Manufacturers 2 US Aluminium corporations 2 US Aluminium corporations Specific Final Good A few manufacturers of a specific final good Millions of consumers Retailers Hundreds of US consumer good manufacturers Hundreds of consumer goods that use alumnium X Hundreds of producers producing each of these goods Concentrated gains dispersed losses Higher tariff on Aluminium Concentrated gains and very dispersed losses Even higher tariff a 1975 Trade Promotion Authority or Fast Track Authority b You either take all the benefits and all the losses Or no benefits and no Summary Likely Result Dispersed gains concentrated losses Little or no tariff on Bauxite 2 Antidotes to Tariff Escalation 1 Walmart 2 All or nothing Trade Agreements losses c Balanced lobbying Quotas 1 Quotas 2 2 Part Tariff a Enforced via a license allocation mechanism a b Imports up to a certain quantity Low tariff rate Imports beyond a certain quantity Much higher tariff rate 7 Trade Barriers Analysis License Allocation Mechanisms Illegal to bring goods into the country unless you have a license to bring a certain quantity of the good Summary of License Allocation Mechanism Types Description Type of License Allocation Mechanism Government Auction Fixed Formula Corrupt Auctions Resource Using Procedure Quota Rent Gained By Government Domestic Import Companies Corrupt Officials No one gains the quota rent Line waiters and Lawyers are not gaining quota rent because there is a large opportunity cost to their participation Mere shifting of resources in the economy no welfare gain Importers bid up the price of each license up to the point where price of each license is the price increase required to lower imports to quota level Max value of license Licenses given without charge to domestic import companies based on a formula that these companies cannot influence eg According to each company s share of imports in the past Import companies buy each unit of the imports at the