1 Lecture 5 Tariffs Econ 340 Lecture 5: Tariffs 2 Outline: Tariffs • What Are They? • Who Uses Them? • Effects of Tariffs – Small Country Case • Effects on quantities and prices • Effects on economic welfare – Large Country Case • Effect on world price • Effect on welfare – Size of These Effects Lecture 5: Tariffs 3 What Are Tariffs? • Tariffs are Taxes on imports • Two main types – Ad valorem: % of value – Specific: $ per unit • How are they implemented? – At the border, by customs officers – They determine • What good it is • What price to use for ad valorem tariffs – Customs officers have power that may be abused (e.g., bribery) Lecture 5: Tariffs 4 Outline: Tariffs • What Are They? • Who Uses Them? • Effects of Tariffs – Small Country Case • Effects on quantities and prices • Effects on economic welfare – Large Country Case • Effect on world price • Effect on welfare – Size of These Effects Lecture 5: Tariffs 5 Who Uses Tariffs? • Virtually all countries • How big are tariffs? – In US, today, average only 2-3% – In developing countries, often around 20% – Both used to be much higher – Some particular tariffs are still much higher Lecture 5: Tariffs 6 Who Uses Tariffs? • Sample US tariffs – Cars: 2.5% – Trucks: 25% – Men’s cotton shirts 19.7% – Women’s blouses 26.9% – Tariffs facing exports of developing countries: • Nepal 13.2% • Bangladesh 13.6% See Schavey That’s why minivans are “trucks”2 Lecture 5: Tariffs 7 Who Uses Tariffs? • Aside: Schavey, “The Catch-22 of U.S. Trade” – US tariffs are much larger against developing countries than against developed countries – Who gains and loses? • US workers gain, but they have social policies to protect them (unemployment insurance, etc.) • Developing-country workers lose, and their governments are too poor to help – WTO Agreement on Textiles and Clothing (1995) promised to eliminate quotas on these products by 2005, but not tariffs. (It did.) – Why “Catch-22”? • Countries can only develop by exporting • But if they do, we raise tariffs! Lecture 5: Tariffs 8 Outline: Tariffs • What Are They? • Who Uses Them? • Effects of Tariffs – Small Country Case • Effects on quantities and prices • Effects on economic welfare – Large Country Case • Effect on world price • Effect on welfare – Size of These Effects Lecture 5: Tariffs 9 Effects of Tariffs • Easy to see from supply and demand • Consider a good whose price would be above the world price without trade • We will look at two cases: – Small country: Too small for its behavior to matter for the world price – Large country: Large enough (in market for this good) that its behavior may change world price Lecture 5: Tariffs 10 Effects of Tariffs: Small Country S D Free trade price = world price = PW Autarky price = Pa P Q QS0 QD0 Lecture 5: Tariffs 11 Effects of Tariffs: Small Country S D PW Pa P PW+t Tariff Q QS0 QD0 Effect on Price Lecture 5: Tariffs 12 Effects of Tariffs: Small Country S D PW P PW+t Tariff Q QS0 QS1 QD1 QD0 Pa Effects on Quantities3 Lecture 5: Tariffs 13 Effects of Tariffs: Small Country • Thus: what happens due to a tariff: – Domestic output rises (Employment also rises in this industry) – Domestic demand falls – Domestic price rises (by full amount of tariff) – Imports (=D−S) fall – Suppliers gain – Demanders lose – Gov’t gets tariff revenue – World sells us less (but it doesn’t lose, because we’re too small for it to notice) P Q D S Lecture 5: Tariffs 14 Effects of Tariffs: Small Country • How much do we gain and lose? • Use changes in “consumer surplus” and “producer surplus” from Econ 101 Lecture 5: Tariffs 15 Reminder: Change in Consumer Surplus When price changes, Consumers – Gain from price decrease – Lose from price increase • By amount equal to area to the left of the demand curve while… Q P D Gain from price decrease, or loss from price increase Lecture 5: Tariffs 16 Producers – Gain from price increase – Lose from price decrease • By amount equal to area to the left of the supply curve Q P S Gain from price increase, or loss from price decrease Reminder: Change in Producer Surplus Lecture 5: Tariffs 17 Effects of Tariffs: Small Country • Apply these to the effects we found for a tariff • Also note that the government (and thus the taxpayer) of the country gets benefit of tariff revenue Lecture 5: Tariffs 18 Effects of Tariffs: Small Country S D PW P PW+t Tariff Q QS0 QS1 QD1 QD0 a b c d Pa Effects on Welfare Suppliers gain +a4 Lecture 5: Tariffs 19 Effects of Tariffs: Small Country S D PW P PW+t Tariff Q QS0 QS1 QD1 QD0 a b c d Pa Effects on Welfare Demanders lose –(a+b+c+d) Lecture 5: Tariffs 20 Effects of Tariffs: Small Country S D PW P PW+t Tariff Q QS0 QS1 QD1 QD0 a b c d Pa Effects on Welfare Government gains +c Lecture 5: Tariffs 21 Effects of Tariffs: Small Country S D PW P PW+t Tariff Q QS0 QS1 QD1 QD0 a b c d Pa Effects on Welfare Net for country −(b+d) Country loses from tariff Lecture 5: Tariffs 22 Effects of Tariffs: Small Country • Suppliers gain +a • Demanders lose −(a+b+c+d) • Government gains +c • Net effect on country Loss = −(b+d) S D PW P PW+t Q QS0 QS1 QD1 QD0 a b c d Pa Summary: “Dead Weight Loss” = Lecture 5: Tariffs 23 Effects of Tariffs: Small Country • Dead Weight Loss • Why? • Because demanders and suppliers both are led by the tariff to behave as if the good’s value were PW+t, when in fact the country can buy or sell it for PW. S D PW P PW+t Q Lecture 5: Tariffs 24 Outline: Tariffs • What Are They? • Who Uses Them? • Effects of Tariffs – Small Country Case • Effects on quantities and prices • Effects on economic welfare – Large Country Case • Effect on world price • Effect on welfare – Size of These Effects5 Lecture 5: Tariffs 25 Effects of Tariffs: Large Country • If the country is not small, but large, then – when it reduces its imports of the
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