Download Brief answers to problems and questions for review

Brief answers to problems and questions for review
1.
A revenue tariff is just another means for a government to raise money. It functions
just like any other tax. A protective tariff is used to protect some favored domestic
industry. The difference is motive. The former is a way to raise money and the latter
is used to protect an industry from foreign competition.
2.
Revenue tariffs are used primarily by developing countries. In a poor country, raising
money through income or sales taxes may be difficult. It takes a certain level of
development in order to efficiently collect these types of taxes. Protective tariffs are
more likely to be used in a middle-income or high-income country. In the former, the
tariff may be a form of infant industry protection. In the latter, protective tariffs are
used to shield comparative disadvantage industries from import competition.
3.
A specific tariff is a tariff that is measured as a fixed amount of money per unit
imported. An ad valorem tariff is a tariff that is measured as a percentage of the value
of the imported good. A compound tariff is a tariff that includes a specific tariff and
an ad valorem tariff.
4.
A specific tariff is especially problematical if the industry exhibits vertical product
differentiation. In this case, the government would be levying the same tariff on both
low- and high-priced versions of the product. As a result, the percentage of value that
the tariff represents would be higher for cheap versions and lower for more expensive
versions.
5.
The three different methods countries use to determine the value of imports are the
free alongside price (FAS), the free on board price (FOB), and the cost, insurance and
freight price (CIF). The FAS price, defines the price of the imported good as the
foreign country’s market price before it is loaded into the ship, train, truck, or airplane
for shipment to the importing country. The FOB price defines the imported price of
the good as the foreign country’s market price plus the cost of loading the good into
the means of conveyance. The CIF price defines the price of the imported good as the
foreign country’s market price plus the cost of loading the goods into the means of
conveyance plus all intercountry transportation costs up to the importing country’s
port of entry.
6.
Consumer surplus is the difference between the price a consumer would be willing to
pay for the good and the market price. Producer surplus is the difference between the
price at which a good is sold and the minimum price that the seller would be willing
to accept for it.
7.
Referring to Figure 8.1, one can easily see what happens to consumer and producer
surplus when the price changes. If the price rises, then consumer surplus will fall and
producer surplus will rise. On the other hand, if the price falls, then consumer surplus
will rise and producer surplus will fall.
8.
The economic effects of a tariff are caused by the higher price of imports as consumer
surplus declines. Consumers lose as a result of a tariff. Those that gain include the
government as it collects tariff revenue and domestic producers as part of the
consumer surplus is transferred to domestic producers. However, as seen in Figure
© 2015 W. Charles Sawyer and Richard L. Sprinkle
8.4, the net loss to society and loss of consumer welfare is composed of area b + d.
This loss to society is referred to as the dead-weight loss of a tariff.
9.
The effects of a tariff on consumer and producer surplus can be readily seen in Figure
8.4. The imposition of a tariff reduces consumer surplus by the area a + b + c + d. The
tariff only increases producer surplus by the area a.
10.
The deadweight loss from a tariff can be seen in Figure 8.4. The tariff transfers area c
from consumers to the government. Area a is transferred from consumers to
producers. Area d is a loss to consumers as the quantity demanded falls due to the
higher price. Area b represents the waste of resources being transferred to domestic
production. These two latter areas (b + d) represent the deadweight loss from a tariff.
11.
The difference between the case of the large country and the small country is that part
of the tariff burden falls on consumers of the imported good and part falls on foreign
producers of the imported good. In this case, the total government revenue collected
from the tariff includes two components. The first component is the amount of the
tariff revenue that is shifted from domestic consumers to the government. The second
component is the amount of the tariff revenue that is shifted from foreign producers to
the government. This second component is called the terms of trade effect and
represents a redistribution of income from the foreign country to the domestic
country. The terms of this trade improves the welfare of the domestic country at the
expense of the foreign country. As seen in Figure 8.4, in the case of a large country
the welfare effects of a tariff are: (1) the loss of consumer surplus, area b + d, and (2)
the gain of welfare through the terms of trade affect, area e.
12.
a. $11,000.
b. Before the tariff, domestic value added is $7,500 and after the tariff the
domestic value added is $8,375.
c. The effective rate of protection is 11.67 percent.
13.
14.
The effective rate of protection is a measure of the amount of protection provided to
an industry by a country’s tariff schedule. It is a measure of the protection afforded to
domestic value added in an industry.
To determine the actual degree of protection an industry receives, one must not only
consider the tariff on the final good but also any tariffs on imported components that
the industry uses to produce the final good. This means that we need to consider the
impact of tariffs on the value of the product produced domestically. A measure that
accounts for the importance of these items is called the effective rate of protection.
The general formula for determining the effective rate of protection is:
ERP = (Tf – aTc )/(1 – a)
Tf is the tariff rate on the imported final product; a is the percentage of imported
components used in producing the final product; and Tc is the tariff rate on the
imported components used to produce the final product. Since the effective rate of
protection is determined by the interaction of three variables, the potential outcomes
are infinite, and the effective rate of protection can even be negative. This occurs
© 2015 W. Charles Sawyer and Richard L. Sprinkle
when the tariff on imported components multiplied by the percentage of imported
inputs into the production process is larger than the tariff on the final good. The tariffs
on final goods in the US tariff schedule are frequently small. However, a seemingly
small nominal tariff coupled with a large percentage of the product coming from
imported inputs can yield a large effective rate of protection. This phenomenon is so
common that it is referred to as tariff escalation. Any time the tariff escalates with the
stage of processing, foreign producers who wish to produce the final product with
local inputs are being discriminated against.
15.
The structure of protection in developed countries usually escalates with the level of
processing. In general, if the tariff escalates in this manner then the effective rate of
protection will be higher than the nominal tariff. This clearly tends to discourage the
processing of commodities in developing countries.
16.
Revenue tariffs tend to be used in developing countries due to the lack of alternatives.
Sales and income taxes require a certain level of sophistication for both businesses
and government bureaucracies in order to be effectively collected. Tariffs are much
easier to collect. Further, tariffs can be structured in such a way as to have some of the
characteristics of a progressive income tax. Finally, importers may be much more able
to pay the tax than the average citizen or business in a poor country.
17.
This question can be answered by referring to Figure 8.4. In order for a tariff to
increase the output of the industry, the deadweight loss from a tariff is b + d. The
same increase in output can be accomplished with a production subsidy of only b. The
same increase in output is achieved at a lower cost to the economy.
18.
A tariff is a costly means of accomplishing an increase in output of an industry as it
results in a dead-weight loss. A production subsidy can increase the output of a
domestic industry at a lower cost. The effect of a subsidy is to shift the domestic
supply downward by the amount of the subsidy and the industry would be willing to
produce the larger output. With a subsidy the consumer is still paying the world price
for the good and as such the dead-weight loss is only the production effect and does
not include the consumption effect.
19.
Infant industry protection has a number of drawbacks. First, is it reasonable to assume
that the government can pick comparative advantage industries before the fact?
Second, even if it could a production subsidy would be more efficient than a tariff. A
final problem is that an infant industry that is protected may never grow up. Shielded
from foreign competition, the industry may never become efficient enough to develop
a comparative advantage.
20.
No, tariffs increase employment in the protected industry as opposed to the overall
level of employment in the economy. A tariff will create jobs in this particular
industry but there are fewer jobs in other industries. This is because consumers spend
more to goods from the protected industry but less on other goods. The tariff has not
increased the total number of jobs, it has just rearranged them. Protected industries
have more jobs and other industries have fewer jobs. The overall level of employment
hasn’t changed. The total number of jobs in the economy is determined by
macroeconomic forces such as the rate of economic growth in the long run and the
© 2015 W. Charles Sawyer and Richard L. Sprinkle
state of fiscal and monetary policy in the long run. Tariffs don’t change the total
number of jobs, they just put jobs in places that the market would not.
© 2015 W. Charles Sawyer and Richard L. Sprinkle