E&S notes 6

⚠️⚠️⚠️⚠️⚠️ MUST RMB

Autarky
→ an economic system of self-sufficiency & limited trade
→ complete state of autarky: closed economy/ country does not engage in
international trade with any other country

E&S notes 6 1
 → no fully-autarkic nations in the modern world but North Korea & Nazi Germany
are two examples of nations that have pursued a policy of autarky

Free Trade
→ policies that allow permit inexpensive imports and exports, without tariffs or
other trade barriers
→ in a free trade agreement a group of countries agrees to lower their tariffs
(taxes) or other barriers to facilitate more exchanges with their trading partners
→ pros & cons:

Trade Tariff
→ tax imposed by one country on the goods & services imported from another
country to influence it, raise revenues or protect competitive advantages

→ economists generally oppose trade restrictions because

1. from a global perspective free trade increases total output (total amount of
goods & services produced in an economy)

2. international trade provides competition for domestic companies

E&S notes 6 2
 3. restrictions (based on national security) are often abused or evaded

4. trade restrictions are addictive (may be a tendency to continue or even

escalate them, creating a cycle that is difficult to break) → rely on them
repeatedly / trade tensions

Reasons for Tariff imposed on goods

1. Protection of domestic industries from foreign competition → encourage
consumers to buy domestically produced goods since now it is cheaper →
aims to support local industries, preserve jobs & maintain economic stability

2. Revenue Generation → serve as a source of revenue for governments →

contributes to government funds → finance public services, infrastructure
projects & other government initiatives

3. Correction of Trade Imbalances → restrict imports & promote exports to

reduce trade deficit (more imports than exports) to protect country's
economic interests

Free Trade Association

→ “allow free trade among its members” but have common barriers against all
other countries' goods eg.

1. the European Union (EU)

2. the North American Free Trade Association (NAFTA)

Trade Deficit
→ the country is importing more goods & services than it is exporting

→ US rising overall trade deficit with China (goods vs services)

1. the value of goods imported from China exceeds the value of goods exported
to China.

2. China has been a major exporter of manufactured goods to the U.S., including
electronics, textiles, machinery, and consumer goods.

E&S notes 6 3
 3. US has been financing its trade deficit by selling off financial assets/ issuing
government bonds: borrowing from rest of the world

4. US has become a large debtor nation

Countries can finance its trade deficit by

1. living off past savings (government budget)

2. taking foreign aids / loans

3. depleting foreign reserves

4. selling off financial assets owned by government/ private entities

Tariff Trade & Welfare Effects

→ A tariff means that the price of imported good will rise and local consumers will
have to pay MORE for these imports
→ For small importing country (eg. Bahamas, Guatemala)

The importing country incurs a deadweight loss, DWL

→ For large importing country (eg. U.S.)

It depends

1. The importing country can gain from tariff if gain in terms of trade > DWL

2. The importing country can lose from tariff if gain in terms of trade < DWL

Small Nation
“Small country cannot influence the price because foreign export supply is
perfectly elastic relative to its demand”

→ small country is a price taker

→ small country: negligible share of global market for a certain good

E&S notes 6 4
 → small country must accept the prevailing market price determined by the
interaction of foreign supply & global demand & its own actions do not affect this
price

→ when the world price of product is fixed & country imposes tariff, the entire
extra cost caused by the tariff is usually passed on to the consumers within that
country because the mixed word price prevents foreign sellers from lowering their
prices to offset the tax

Oligopsony
→ a state of the market in which only a small number of buyers exists for a
product

Analyse Tariffs Using SD curve

E&S notes 6 5
 1. Identify equilibrium point at autarky, NO TRADE

2. Identify equilibrium points at FREE trade

3. Identify equilibrium points with TARIFF trade

4. Compare consumers' and producers' welfare (at NO trade vs FREE trade vs

Tariff trade)

Effects of Tariff (tax on imported goods) on Producers

→ Country producers can raise their selling price per unit of goods

→ An increase in production of chicken

Eventually:

E&S notes 6 6
 → an increase in employment and

→ an increase in profit

Tariff imposed on imported goods are meant to protect domestic producers,

domestic production will increase in amount

Effects of Tariff (tax on imported goods) on Consumers

→ With tariffs: domestic consumption decreases (movement up along the demand
curve which shows lower demand)

→ tariff forces consumers to pay a higher price and consume less product
→ worse-off , decrease in well-being, decrease in consumer surplus

Tariff Welfare Effects

No effect in welfare loss for the economy

1. The revenue effect: Yellow box

→ portion of the loss in consumer surplus “transferred to the government”

→ therefore this effect does not result in welfare loss for the economy

E&S notes 6 7
 2. The redistribution effect 'a' is the transfer of the consumer surplus to the
domestic producers of the import-competing product of the import-competing
product (transfer of income from consumers to producers)

Have effect in welfare loss for the economy

3. The protective effect 'b' is a “loss to the domestic economy” from wasted
resources used to produce additional goods (20 to 40 units) at increasing unit
costs

→ more efficient foreign production is replaced by less efficient domestic

production

4. The Consumption Effect 'd' is a “loss to the domestic economy” due to

consumers lowering consumption of foreign imported good, because of
higher imported price (due to tariff)

Tariff as government revenue

Revenue = (unit amount of the tariff) x (the volume of imports with the tariff)

This revenue could be used to pay for extra government spending, matched
by an equal cut in some other tax, or serve as extra income

Tax Wedge
represents the portion of labor costs that is absorbed by taxes

high tax wedge = high portion of total labor costs is allocated to taxes and
social security contributions rather than being available as take-home pay for
employees or as net income for employers

understanding tax wedge is essential for designing effective tax policies that
balance the need for government revenue with considerations for economic
growth, employment and worker well-being

E&S notes 6 8
 Summary

1. area a: redistributive effect: producer surplus increase

2. area c+e: government collects tax revenue

partly by US consumers = c

partly by foreign producers = e

3. if area e > b+d → importing nation gains

4. if area e < b+d → importing nation loses

5. to determine who bears the burden of the tariff, we consider the slope of the
world SS curve

if slope of ss curve is ELASTIC: local consumers bear a larger burden of the

tariff

if slope of ss curve is INELASTIC: foreign exporters bear a larger burden of the

tariff

6. autarky point is always interception point of ss curve

7. export = Qs-Qd

8. import = Qd-Qs

E&S notes 6 9
 Quizzes
Q1. When a tariff is imposed on an imported product, domestic consumers of that
product
✅ pay a higher price for the imported product or buy less of the imported product
⚠️ MISCONCEPTION: DECREASE their consumption of BOTH imported & domestic
versions of the product
→ this is wrong because tariff has made imported goods more expensive so
consumers are forced to INCREASE their consumption of the local good
→ corrected statement: consumers decrease their consumption of the imported
good, and increase their consumption of the domestic good

Q2. Refer to the graph shown for a small country that is a price taker
internationally. Assume the foreign supply of this product is perfectly elastic at a
price of $4 per unit. If there are no trade restrictions, this country will produce:

Ans: 2400 units domestically & import 5000 units

→ Autarky: equilibrium price = $8

E&S notes 6 10
 → Free trade: free trade price = $4
The quantity demanded at the world price of $4 is

7400 but

domestic producers are willing and able to supply only 2400 units at that price

the difference is met with imports provided that there are no trade restrictions
(5000 units)

Q3. Assume the foreign supply of this product is perfectly elastic at a price of $4
per unit. If government imposes tariff in the amount of $2 per unit, it will collect
revenue in the amount of:

Yellow area = $5000

Q4: what is condition for the world (china) ss curve of washing machine to be
inelastic (steep)

when china relies heavily on a large market (like US) for its exports of washing
machine, its SS of washing machine will be inelastic

Q5: how will china respond?

china will attempt to diversify its export markets and hence, rely less on US
market (SS curve will be more elastic) even though exports to US fall because
of US washing machine tariff, China continue to export to other markets

E&S notes 6 11
 Q6: deadweight loss = PROTECTIVE EFFECT + CONSUMPTION EFFECT

→ tariff revenue borne by consumers (YELLOW) → burden or cost of tariff is

primarily passed on to consumers of the goods which the tariff is imposed
→ tariff revenue borne by foreign exporters (RED)
Q7: For a large nation, a tariff revenue on an imported product maybe partially
borne by the domestic consumer via a higher product price and partially borne
by foreign exporter via a lower export price
Q8. Welfare Effects:

Tariff can be good for government to the extent that it produced tariff revenue
but bad because it can strain relations and cause a trade war

Producers would gain because goods imported would rise in price and be less
competitive goods could raise their prices and earn more revenue hence they
are better off

E&S notes 6 12