Download The Instruments of Trade Policy

ECO 609/Dr. Mitchell/February 10, 2000
Week 5
The Instruments of Trade Policy
Tariffs
Tariff = a tax on imports or exports
Reasons for an Import Tariff
Discourage domestic consumption of the good
Generate revenue
Decrease balance-of-trade deficit
Protect domestic industry
Types of Tariffs
Specific
A fixed amount per unit
Pd = Pw+T
Ad valorem
% of price
Pd = (1+t) Pw
Effects of Tariff: Small country case
Defining small v. large countries for international trade.
Small
Its sales and purchases do not affect its terms-of-trade.
Large
As it buys more, the world prices of its imports rise.
As it sells more, the world prices of its exports fall.
Partial Equilibrium Trading Equilibrium in the Small Country
Consumers’ Surplus
The value to consumers from consuming a particular quantity of a good, less the amount
consumers pay for the good.
Graphically, it’s the area under D curve, above price.
Producers’ Surplus
Revenue received from selling a particular quantity of a good less the minimum amount
required to supply that quantity.
Graphically, it’s the area above S curve, below price.
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Week 5
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LR Supply Curve
The LR supply curve represents the industry's ability to supply the good at different prices
in the LR. It incorporates changes in the number of firms and also changes in factor
prices as the industry expands. If the LR supply curve is upward sloping, it represents
increasing costs in the industry. In perfect competition, the height of the LRS curve
represents the firm's average cost of production. Producers' surplus then represents rents
accruing to factors of production because of the increased demand for this good.
P
S (dom)
A
B
SW
PW
C
D
E
D
Qs
Qd
CS = A+B
PS = C
Efficiency
A measure of the efficiency in a market is the sum of CS & PS (& gov’t revenue).
Graphically, it’s the area in between D & S.
Q
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Week 5
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How does a tariff affect the market & efficiency?
Tariff-ridden trading equilibrium
P
S (dom)
A1
B4
P’D
A2
PW
B2
B1
B3
SW
C
D
E1
E2
Q’s
E3
Q’d
D
Q
Identify:
CS
PS
Tariff revenue
Deadweight losses
Transfers from cons. to prod.
Transfers from cons. to gov’t.
NET welfare loss due to tariff
Why is there deadweight loss?
B3 = lost CS because of fewer units consumed.
B1 = wasted resources because it costs dom. producers this much more to prod. these
units than it would cost to import
General Equilibrium Effects--Small Country
Domestic relative price of the imported good rises.
Produce more of the imported good, less of the exported good.
In LR, real return to the relatively abundant factor is reduced, real return to relatively
scarce factor is increased. (Apply the Stolper-Samuelson Theorem.)
Effects of Tariffs--Large Country
The large country faces an upward-sloping world supply curve.
ECO 609/Dr. Mitchell/February 10, 2000
Week 5
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Sdom
P
SI
PW
PD
DI
Ddom
QC
QP
I
Sdom
P
S+t
PD’
PD
PW’
QI
Q
J
K
J
L
N
SI
M
PW
DI
Ddom
QP QP’
QC’
QC
Q
QI
Identify
CS
PS
Tariff revenue
Change in CS
Change in PS
Deadweight losses
Gain from foreign suppliers
Bottom Line for a large country:
Costs:
Deadweight loss due to producing too much, consuming too little.
This is the volume-of-trade effect.
Benefits:
Cheaper foreign goods, which shows up as tariff revenue.
This is the terms-of-trade effect.
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The Optimum Tariff
Choose the size of the tariff to maximize: CS + PS + revenue.
A large country is better off imposing the optimum tariff than pursuing free trade (if other
countries have free trade).
Retaliation
The optimal tariff hurts the trading partners. They would do better by responding with a
tariff.
Imposing a tariff may lead to a “trade war” in which countries keep increasing their
tariffs.
Ultimately all countries may be worse off than with free trade (although some could be
better off).
Quota
A legal limit on imports of a good, expressed in units
Sdom
P
Sdom + Q
Q
P dom’
Rent
Sw
Pw
D dom
Q
Quota Rents
The premium earned by selling a good at quota-inflated prices.
Disposition of quota rents depends on the method of allocating the right to
import
First-come, first served
Rents go to importer.
Auctions
Rents are bid away in auction, collected by the gov’t in the form of payment for import
licenses.
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Week 5
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Given away to domestic importers
Rents nominally go to importer. However, the importer may have expended resources to
persuade the government to give the import licenses to that firm. The expenditure of real
resources to influence the decision is called "rent-seeking". The importer may not truly
get the rents, they may really go to the gov't official or they may be used up.
Given away to foreign gov’ts or foreign importers
Rents go to the foreign gov’t or importer.
Similarities between quotas & tariffs
In a perf. comp. market, it is always possible to choose a quota (to replace a tariff) which
yields the same prices and quantities.
Differences between quotas & tariffs
Disposition of tariff revenue/quota rents
With tariffs, it goes to the gov’t. With quota may go many different places, depending on
how the right to import is allocated. There is the possibility that rents go abroad.
Results of changing D & S curves
Ex: Growing demand over time
With a tariff, the domestic price needn’t change (small co. case). But with a quota, the
domestic price will automatically rise over time.
In imperfectly competitive markets, a quota is conducive to higher prices
With a tariff, a domestic monopolist faces unlimited imports at an artificially high price.
With a quota, he faces a limited Q of imports, enabling him to profit maximize subject to
a lower demand for his output.
Voluntary Export Restraints (VERs)
An agreement between countries to limit exports of a particular good to a certain level.
A voluntary quota in which quota rents usually go to foreign producers.
It’s used because quotas violate our obligations under the WTO.
The exporting country agrees to the VER under duress (threats of worse measures).
Example: Japanese auto imports.
Regulations as Non-tariff Barriers (NTBs)
Domestic Content Requirements
A law that says a particular % of input cost must be paid to domestic suppliers.
It effectively limits imports of raw materials and intermediate goods.
ECO 609/Dr. Mitchell/February 10, 2000
Week 5
Government Procurement Policies
Requirements on government contracts that the supplier is domestic or that give a
preference to domestic suppliers.
US-Domestic suppliers are given a 6% margin over foreign suppliers, except in defense,
where it is a 50% margin.
Product Standards
Laws controlling the type of product that may be sold.
Health regulations
Safety regulations
Labeling laws
Example:
US-EC dispute over hormones in beef exported to the EC.
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