 TARIFF; .

 A tariff is a tax or duty levied on the traded commodity as it crosses a

national boundary.
1) An import tariff is a duty on the imported commodity, 2) while an export
tariff is a duty on the exported commodity. Import tariffs are more
important than export tariffs. Developing nations rely heavily on export
tariffs to raise revenues because of their ease of collection. Conversely,
industrial countries invariably impose tariffs or other trade restrictions to
protect some (usually labor-intensive) industry, while using mostly
income taxes to raise revenues.
 Types;three types;
 1) The ad valorem tariff; is expressed as a fixed percentage of the value of
the traded commodity.2) The specific tariff; is expressed as a fixed sum
per physical unit of the traded commodity. Finally,3) a compound tariff; is
a combination of an ad valorem and a specific tariff. For example, a 10
percent ad valorem tariff on bicycles would result in the payment to
customs officials of the sum of $10 on each $100 imported bicycle and the
sum of $20 on each $200 imported bicycle. On the other hand, a specific
tariff of $10 on imported bicycles means that customs officials collect the
fixed sum of $10 on each imported bicycle regardless of its price. Finally, a
compound duty of 5 percent ad valorem and a specific duty of $10 on
imported bicycles would result in the collection by customs officials of the
sum of $15 on each $100 bicycle and $20 on each $200 imported bicycle.
 Analysis of tariffs;

when a small nation imposes a tariff on imports,the tariff will affect

neither world prices (because the nation is small) nor the rest of
the economy (because the industry is small).

 Partial Equilibrium Effects of a Tariff;

Nation 2 is now assumed to be small and so is industry X. In the absence of trade,
the intersection of DX and SX defines equilibrium point E, at which 30X is
demanded and supplied at PX = $3 in Nation 2. With free trade at the world price
of PX = $1, Nation 2 will consume 70X (AB), of which 10X (AC) is produced
 domestically and the remainder of 60X (CB) is imported (as in the right panel of
Figure 3.4). The horizontal dashed line SF represents the infinitely elastic free trade
foreign supply curve of commodity X to Nation 2. If Nation 2 now imposes a 100
percent ad valorem tariff on the imports of commodity X, PX in Nation 2 will rise to
$2. At PX = $2, Nation 2 will consume 50X (GH), of which 20X (GJ) is produced
domestically and the remainder of 30X (JH) is imported. The horizontal dashed line
SF + T represents the new tariff-inclusive foreign supply curve of commodity X to
Nation 2. Thus, the consumption effect of a tariff (i.e., the reduction in domestic
consumption) equals 20X (BN); the production effect (i.e., the expansion of
domestic production resulting from the tariff) equals 10X (CM); the trade effect
(i.e., the decline in imports) equals 30X (BN + CM); and the revenue effect (i.e., the
revenue collected by the government) equals $30 ($1 on each of the 30X imported,
or MJHN). Note that for the same $1 increase in PX in Nation 2 as a result of the
tariff, the more elastic and flatter DX is, the greater is the consumption effect (see
the figure). Similarly, the more elastic SX is, the greater is the production effect.
Thus, the more elastic DX and SX are in Nation 2, the greater is the trade effect of
the tariff (i.e., the greater is the reduction in Nation 2’s imports of commodity X)
and the smaller is the revenue effect of the tariff.

 Effect of a Tariff on Consumer and Producer Surplus;

1)Consumer surplus; consumer surplus is the difference between what consumers
would be willing to pay for each unit of the commodity and what they actually
 pay. Graphically, consumer surplus is measured by the area under the demand
curve above the going price.

The left panel shows that a tariff that increases the price of commodity X from PX=$1 to PX
=$2 results ina reduction in consumer surplus from ARB = $122.50 to GRH = $62.50, or by
shaded area AGHB = $60.The right panel shows that the tariff increases producer surplus by
shaded area AGJC =$15.The consumer surplus thus shrinks from ARB = $122.50 (with PX = $1
before the tariff) to GRH = $62.50 (when PX = $2 with the tariff), or by AGHB = $60. With the
tariff and PX = $2, they produce 20X and receive OGJU = $40. Of the $30 increase (AGJC +
VCJU) in the revenue of producers, VCJU = $15 (the unshaded area under the SX curve
between 10X and 20X) represents the increase in their costs of production, while the
remainder (shaded area AGJC = $15) represents the increase in rent or producer surplus.

 rent or producer surplus; This is defined as a payment that need not be made in
the long run in order to induce domestic producers to supply the additional 10X
with the tariff. The increase in rent or producer surplus resulting from the tariff is
sometimes referred to as the subsidy effect of the tariff.
 Costs and Benefits of a TariffS;The concept and measure of consumer and
producer surplus can now be used to measure the costs and benefits of the tariff.

The figure shows that with a 100 percent import tariff on commodity X,
PX rises from $1 to $2 in Nation 2.
This reduces the consumer surplus by
AGHB=a+b+c+d=$15+$5+$30+$10=$60.Of this MJHN=c=$30
is collected by the government as tariff revenue,AGJC=a= $15 is redistributed to
domestic producers of commodity X in the form of increased rent or producer
surplus, while the remaining $15 (the sum of the areas of triangles CJM = b = $5
and BHN = d = $10) represents the protection cost, ordeadweight loss, to the
economy.
The production component (CJM = b = $5) of the protection cost, or
deadweightloss , arises because, with the tariff, some domestic resources are
transferred from the more efficient production of exportable commodity Y to the
less efficient production of importable commodity X in Nation 2. The consumption
component (BHN =d =$10) of the protection cost, or deadweight loss, arises
because the tariff artificially increases PX in relation to PY and distorts the pattern
of consumption in Nation 2. Thus, the tariff redistributes income from domestic
consumers (who pay a higher price for the commodity) to domestic producers of
the commodity (who receive the higher price) and from the nation’s abundant
 factor (producing exportables) to the nation’s scarce factor (producing
importables). This leads to inefficiencies, referred to as the protection cost, or
deadweight loss, of the tariff. By dividing the loss of consumer surplus by the
number of jobs “saved” in the industry because of the tariff (or equivalent rate of
protection),
 Other non-tariff trade barriers;
 1) Import Quotas; ‘limitations on the quantity of imports by govt.” A quota is
the most important nontariff trade barrier. It is a direct quantitative restriction on
the amount of a commodity allowed to be imported or exported.
 Effects of an Import Quota;

Import quotas can be used to protect a domestic industry, to protect domestic

agriculture, and/or for balance-of-payments reasons. Import quotas were very
common in Western Europe immediately after World War II.

DX is the demand curve and SX is the supply curve of commodity X for the nation.
With free trade at the world price of PX = $1, the nation consumes 70X (AB), of which
10X (AC) is produced domestically and the remainder of 60X (CB) is imported. An
 import quota of 30X (JH) would raise the domestic price of X to PX =$2, exactly as with
a 100 percent ad valorem import tariff on commodity X (see Figure 8.1). The reason is
that only at PX = $2 does the quantity demanded of 50X (GH) equal the 20X (GJ)
produced domestically plus the 30X (JH) allowed by the import quota. Thus,
consumption is reduced by 20X (BN) and domestic production is increased by 10X
(CM) with an import quota of 30X (JH), exactly as with the 100 percent import tariff
(see Case Study 9-1). If the government also auctioned off import licenses to the
highest bidder in a competitive market, the revenue effect would be $30 ($1 on each
of the 30X of the import quota), given by area JHNM. Then the import quota of 30X
would be equivalent in every respect to an “implicit” 100 percent import tariff. With
an upward shift of DX to DX, thegiven import quota of 30X (JH) would result in the
domestic price of X rising to PX = $2.50, domestic production rising to 25X (GJ), and
domestic consumption rising from 50X to 55X (GH). On the other hand, with the given
100 percent import tariff (in the face of the shift from DX to DX), the price of X would
remain unchanged at PX = $2 and so would domestic production at 20X (GJ), but
domestic consumption would rise to 65X (GK) and imports to 45X (JK).

2)EXPORT RESTRAINT; “limitation on the quantity of exports which usually is imposed

by the expoting country and by the request of importing country.”

 Comparison of an Import Quota to an Import Tariff;

1)with a given import quota, an increase in demand will result in a higher domestic price and greater
domestic production than with an equivalent import tariff. On the other hand, with a given import tariff,
an increase in demand will leave the domestic price and domestic production unchanged but will result
in higher consumption and imports than with an equivalent import quota . 2) A second important
difference between an import quota and an import tariff is that the quota involves the distribution of
import licenses. If the government does not auction off these licenses in a competitive market, firms
that receive them will reap monopoly profits. In that case, the government must decide the basis for
distributing licenses among potential importers of the commodity.3) Finally, an import quota limits
imports to the specified level with certainty, while the trade effect of an import tariff may be uncertain.
It is for this reason, and also because an import quota is less “visible,” that domestic producers strongly
prefer import quotas to import tariffs. However, since import quotas are more restrictive than
equivalent import tariffs, society should generally resist these efforts.
 Other Nontariff Barriers;

1) Voluntary Export Restraints; “It is also known as the voluntary agreemennts,it is imposed from
exporting countryside instead of the importers” It is always more costly to the importing country
than the tariff that limits imports by the same amount. Exporter’s limitation on importer… These
refer to the case where an importing country induces another nation to reduce its exports of a
commodity “voluntarily,” under the threat of higher all-around trade restrictions, when these
exports threaten an entire domestic industry.
2) International Cartels; “An international cartel is an organization of suppliers of a commodity
located in different nations (or a group of governments) that agrees to restrict output and
exports of the commodity with the aim of maximizing or increasing the total profits of the
organization.” E.g present-day international cartels is OPEC (Organization of Petroleum
Exporting Countries), which, by restricting production and exports, succeeded in quadrupling
the price of crude oil between 1973 and 1974. cartels are inherently unstable and often collapse
or fail. If successful, however, a cartel could behave exactly as a monopolist (a centralized cartel)
in maximizing its total profits.

3) Dumping; “Dumping is the export of a commodity at below cost or at least the sale of a
commodity at a lower price abroad than domestically.” Over the past four decades, Japan was
accused of dumping steel and television sets in the United States, and European nations of
dumping cars, steel, and other products. When dumping is proved, the violating nation or firm
usually chooses to raise its prices.

4) EXPORT SUBSDY; “Export subsidies are direct payments (or the granting of tax relief and
subsidized loans) to the nation’s exporters or potential exporters and/or low-interest loans to
foreign buyers to stimulate the nation’s exports.” As such, export subsidies can be regarded as
a form of dumping. Although export subsidies are illegal by international agreement, many
nations provide them in disguised and not-so-disguised forms.

Analysis of Export Subsidies;Graph

At the free trade price of PX=$3.50,smallNation2produces35X( A’C’),consumes20X( A’B’),and exports
15X ( B’C’). With a subsidy of $0.50 on each unit of commodity X exported,PX rises to $4.00 for domestic
producers and consumers. At PX= $4, Nation 2 produces 40X ( G’J’), consumes 10X ( G’H’), and exports
30X ( H’J’). Domestic consumers lose $7.50 (area a’ +b’), domestic producers gain $18.75 (area a’+b’ +c’),
and the government subsidy is $15 ( b’ +c’ +d’). The protection cost or deadweight loss of Nation 2 is
$3.75 (the sum of triangles B’H’N’ =b ‘=$2.50 andC’J’M’ =d’=$1.25).

 EFFECTS OF TRADE POLICY;

Strategic trade policy is a relatively recent development advanced in favor of an activist trade policy and
protectionism. According to this argument, a nation can create a comparative advantage (through
temporary trade protection, subsidies, tax benefits, and cooperative government–industry programs) in
such fields as semi-conductors, computers, telecommunications, and other industries that are deemed
crucial to future growth in the nation. These high-technology industries are subject to high risks, require
large-scale production to achieve economies of scale, and give rise to extensive external economies
when successful. Strategic trade policy suggests that by encouraging such industries, the nation can reap
the large external economies that result from them and enhance its future growth prospects. This is
similar to the infant-industry argument in developing nations, except that it is advanced for industrial
nations to acquire a comparative advantage in crucial high-technology industries. Most nations do some
of this. Indeed, some economists would go so far as to say that a great deal of the postwar industrial and
technological success of Japan was due to its strategic industrial and trade policies.
Examples of strategic trade and industrial policy are found in the steel industry in the 1950s, in
semiconductors in the 1970s and 1980s in Japan, in the development of the Concorde (the supersonic
aircraft) in the 1970s, and the Airbus from the 1970s in Europe. Semiconductors in Japan are usually
given as the textbook case of successful strategic trade and industrial policy. The market for
semiconductors (such as computer chips, which are used in many new products) was dominated by the
United States in the 1970s. While strategic trade policy can theoretically improve the market outcome in
oligopolistic markets subject to extensive external economies and increase the nation’s growth and
welfare, even the originators and popularizers of this theory recognize the serious difficulties in carrying
it out. First, it is extremely difficult to pick winners (i.e., choose the industries that will provide large
external economies in the future) and devise appropriate policies to successfully nurture them. Second,
since most leading nations undertake strategic trade policies at the same time, their efforts are largely
neutralized, so that the potential benefits to each may be small. Third, when a country does achieve
substantial success with strategic trade policy, this comes at the expense of other countries (i.e., it is a
beggar-thy-neighbor policy) and so other countries are likely to retaliate. Faced with all these practical
difficulties, even supporters of strategic trade policy grudgingly acknowledge that free trade is still the
best policy, after all. That is, free trade may be suboptimal in theory, but it is optimal in practice.
Strategic trade and industrial policy is another qualified argument for protection. It suggests that by
encouraging high-tech industries, a nation can reap the large external economies that result from them
and enhance its future growth prospects. Strategic trade and industrial policy does face, however, many
practical difficulties because it is difficult for nations to pick winners and because it invites retaliation.
Thus, free trade may still be the best policy after all.