Download Tariffs: Two Countries

Tariffs: Two Countries
Udayan Roy
http://myweb.liu.edu/~uroy/eco41
Tariffs: Two Countries Case
• For a country that is so large that it can by itself
affect the worldwide prices of the goods it imports,
the gains from a tariff may exceed the losses and the
country as a whole may benefit from the tariff.
• However, the imposition of the tariff will harm other
countries more than the country imposing the tariff
will gain.
• So, the world, as a whole, will be harmed by the
tariff.
Prices after the tariff
• Suppose Japan imposes a tariff on its imports
of European steel
• Then, Price in Japan = Price in Europe + Tariff
– as long as some European steel continues to be
imported into Japan even after the tariff
• Why?
Prices after the tariff
•
•
•
•
•
•
•
•
Suppose the price of European steel in Europe = 4 per ton
Suppose the tariff = 2 per ton
Then the price of European steel in Japan = 4 + 2 = 6 per ton
Therefore, Japanese steel producers can’t charge more than 6
in Japan
But can they charge less than 6? Can they charge 5.40?
No. I have assumed that some European steel continues to be
imported into Japan even after the tariff. That would not have
happened if Japanese steel was selling for less than European
steel
Therefore, the price of Japanese steel in Japan is also 6
In general, the Price (of both European steel and Japanese
steel) in Japan = Price in Europe + Tariff
Demand, Before Tariff
• Under free trade, the
price of steel in Japan is
the same as in Europe
• Demand is DemandB
• When the price in
Europe (and in Japan) is
6, the Japanese buy 10
tons of steel
Price
(in Europe or Japan)
6
DemandB
10
Quantity
in Japan
Effect of Tariff on Demand
Price
in Europe
1. Before Japan imposes a tariff, Japan’s
demand curve is DemandB. When the price
of steel in Europe is 6, so is the price in
Japan, and the Japanese buy 10 tons of
steel.
2. Then Japan imposes a tariff = 2 on
European steel
6
DemandB
4
DemandA
10
Quantity
in Japan
3. Now, the Japanese will not buy 10 tons
unless the price in Europe is 4.
4. This implies that the new demand in
Japan after the tariff is DemandA.
5. That is, Japan’s demand corresponding to
the price in Europe shifts downward by the
exact extent of the tariff.
6. Japan’s demand corresponding to the
price in Japan remains DemandB.
Effect of Tariff on Supply
• A similar logic shows
that:
– Japan’s supply
(corresponding to the
price in Europe) shifts
downward by the exact
extent of the tariff.
– Japan’s supply
(corresponding to the
price in Japan) remains
SupplyB.
Price
in Europe
SupplyB
6
SupplyA
4
10
Quantity
in Japan
Price in Europe, after Japan’s tariff
• As Japan’s demand shifts left, so does the
World’s demand
• As Japan’s supply shifts right, so does the
World’s supply
• Therefore, the free trade price of Europe’s
exports must fall
– Note that Japan is indeed a “large country” in this
example
• Japan may potentially benefit, by forcing
down the price of its imported good
Recall: The free trade worldwide price is the
price at which excess demand in one country is
equal to the excess supply in the other country.
Price
Europe
+
Japan
=
World
Quantity
1. Japan imposes a
tariff on its imports.
2. As a result, the
price in Japan
exceeds the price in
Europe by the size of
the tariff.
3. Therefore Japan’s Demand curve corresponding to the
European price (broken line) will be below its Demand
curve corresponding to the Japanese price (unbroken line)
by the size of the tariff.
Price
4. The same is true for the
Supply curve.
The price in Japan
increases, but by
less than the tariff.
The price in Europe
decreases because
of Japan’s tariff.
Europe
Japan
Quantity
1. Japan imposes a
tariff on its imports.
2. As a result, the
price in Japan must
exceed the price in
Europe by the size of
the tariff.
3. And Japan’s
imports must equal
Europe’s exports.
The price in Japan
after Japan
imposes a tariff
Tariff
Price
F
Tariff
A
B
D
Europe
C
E
G
H
I
L
The price in Europe
after Japan imposes
a tariff
J
K
M
N
Free Trade
O
Japan
Quantity
Japan imposes a
tariff on its imports.
In Europe, consumer
surplus increases from
A to AB.
In Japan, consumer
surplus decreases from
FGHIJK to FG.
Producer surplus
increases from LO to
HLO.
And tariff revenue
increases from zero to
JM.
Price
Producer surplus
decreases from BCDE
to DE.
The price in Japan
after the tariff.
F
A
B
D
Europe
H
C
Worldwide
free trade
price
G
I
L
J
K
M
N
O
E
The price in Europe
after the tariff.
Japan
Quantity
Tariffs: Two Countries Case
Europe
Before
After
Japan
Before
After
Consumer
A
AB
FGHIJK
FG
Surplus
Producer BCDE
DE
LO
HLO
Surplus
Tariff
---JM
Revenue
Total
ABCDE ABDE FGHIJKLO FGHJLOM
Surplus
Gains and Losses from Tariffs:
Importing Country
• The loss to the country that imposes the tariff
(Japan) include I and K, which represents the loss of
the gains from trade. But,
• Japan also gains M, which represents the
improvement in its terms of trade.
• Had Japan been a “small” country, it would not have
been able to force a reduction in the price of its
imported good. Therefore, tariffs would have had
only losses and no gains.
Effects of Tariff—Small Country
Price
of Steel
Domestic
supply
A
Deadweight Loss
B
Price
with tariff
Tariff
C
D
Price
without tariff G
0
E
F
Imports
after tariff
S
Q
S
Domestic
demand
D
Q
Q
Imports
without tariff
D
Q
World
price
Quantity
of Steel
Effects of Tariff—Large Country
Price
of Steel
A large country can use
tariffs to force down the
price of its imported
good. This leads to
Domestic
additional gain of E2. If
supply
E2 exceeds D+F, the
country will be better
off after imposing the
tariff.
A
B
Price
with tariff
C
D
F
World price before tariff
E2
G
0
Tariff
E1
S
Q
S
Domestic
demand
D
Q
Q
Imports
without tariff
D
Q
World price after tariff
Quantity
of Steel
Gains and Losses from Tariffs: All
Countries
• The country that imposes a tariff will gain
(lose) if M exceeds (is less than) I plus K
• The other country will lose by the amount C
• C exceeds M. Therefore, the world as a whole
loses
Retaliation
• The analysis so far has assumed that one
country can impose tariffs on its imports
without the other country retaliating with
tariffs of its own
• If retaliation occurs, even the conditional
support for tariffs outlined earlier has no basis
Textbook
• For more on this topic, see “Costs and
Benefits of a Tariff” in Chapter 9.
– See especially Figures 9-9 and 9-10.