Download Tariffs

Chapter 6
The Theory
of Tariffs
and Quotas
Chapter Objectives
• Introduce the theory of tariffs
• Discuss the welfare and efficiency
effects of tariffs
• Analyze the distinction between
tariffs and quotas
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Introduction
• Chapters 6 and 7 provide an introduction to the
theory and policy of tariffs and quotas
• In general, tariffs have been negotiated down to very
low levels by the GATT/WTO members
• However, tariffs on agriculture, textiles, and apparel
continue to have relatively high barriers
– Many developing countries have a comparative advantage in
these areas and would benefit from tariff reductions
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Analysis of a Tariff
• There are numerous barriers to trade
– Transparent barriers and
non-transparent ones
– Quotas: direct limit on imports: regulate
the quantity of imports
– Tariffs: indirect limit on imports: impose a
tax on imports
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Analysis of a Tariff (cont.)
• Tariffs and quotas encourage
– Consumers to switch to relatively cheaper
domestic goods or to drop out of the market
– Producers to increase their output as demand
switches from foreign to domestic goods
• Chapter 6 is a partial equilibrium analysis of
the effects of tariffs and quotas: considers
only their impact on the industry on which
they are imposed, rather than their economywide effects
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Analysis of a Tariff (cont.)
• Two key concepts in the analysis of the
impact of tariffs
– Consumer surplus: value received by consumers
in excess of the price they pay (can be measured
only if the demand curve is known)
– Producer surplus: value received by producers in
excess of the minimum price at which they are
willing to produce (can be measured only if the
supply curve is known)
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FIGURE 6.1
Consumer and Producer Surplus
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The Effect of a Tariff
on Price, Output, and Consumption
• Assume
1. There is only one price for a good
(world price Pw)
2. Foreign producers are willing to supply
us with all of the units of the good we
want at that price
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FIGURE 6.2 Domestic Supply
and Demand for an Imported Good
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The Effect of a Tariff on Price,
Output, and Consumption (cont.)
• Now assume: Government imposes a tariff of
amount “t.” Importers will still be able to buy the
good from foreign producers for Pw, but they will
have to pay the import tax of “t.”
– The tax is subsequently tacked onto the price to
domestic consumers: price to them is Pw + t=Pt
– The consumption of the imported good
subsequently decreases
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The Effect of a Tariff on Price,
Output, and Consumption (cont.)
• Furthermore,
– The domestic production of the good
increases as domestic firms are able to
charge a higher price while remaining
competitive vis-à-vis foreign firms
– Finally, imports of the good decrease
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Tariff’s Effect on Resource
Allocation and Income Distribution
• Besides the rise in prices and fall in
imports, tariffs influence
– Inputs in domestic production: the increase
in domestic production requires additional
resources of land, labor, and capital to be
reallocated from their prior uses
– Consumer surplus
– Producer surplus
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FIGURE 6.3 The Effects of a Tariff
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The Effects of a Tariff
on National Welfare in Sum
• The net effect of the tariff on national welfare = gains
to producers + gains to government - losses to
consumers = (a + b + c + d - a - c) = b + d
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Other Potential Costs of a Tariff
• A tariff may have effects that are less
predictable and harder to quantify
– Retaliation by other countries: adds to the
net loss of a tariff by hurting export markets
of other industries; can escalate rapidly
– Innovation: tariffs reduce competitive
pressures on domestic firms and thus their
incentives to innovate and improve the
quality of existing products
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Other Potential Costs
of a Tariff (cont.)
– Rent seeking: any activity that uses
resources in order to capture more income
without actually producing a good or
survive (e.g., firms hire lobbyists to
maintain tariff protection)
• Political systems that do not easily provide
tariffs are more likely to avoid rent seeking
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The Large Country Case
• Economists distinguish between small and
large countries in analyzing tariffs
– Large country: one that imports enough of a
particular product so that if it imposes a tariff, the
exporting country will reduce its price of the good
in order to keep its share of the large
country´s market
• In theory, large countries can improve their
national welfare by imposing a tariff as long
as their trading partners do not retaliate
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FIGURE 6.4
Tariffs in the Large Country Case
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A Comparison of Tariff Rates
• Since the mid-90s tariff rates in most
countries have fallen
• Generally, tariff rates in developing nations
are higher than developed nations
• However, developed nations often have
highest tariffs in agriculture, textiles, and
other labor-intensive products – the very
products developing nations would like
to export
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FIGURE 6.5 Average Tariff Rates for
Low-,Middle-, and High-Income Countries
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Effective versus
Nominal Rates of Protection
• The amount of protection given to any one product
depends not only on the tariff rate but also on tariffs
on the inputs used to produce the good
– Nominal rate of protection: tariff rate levied on a
given product
– Effective rate of protection: nominal rate + tariffs on
intermediate inputs
– Value added: price of a good minus the costs of
intermediate goods used to produce it (the contributions of
labor and capital at a given stage of production)
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Effective versus
Nominal Rates of Protection (cont.)
• In sum, effective rate of protection =
(VA* - VA) / VA
– VA = amount of domestic value added
under free trade; VA* = domestic value
added after taking into account all tariffs
(on both final goods and
intermediate inputs)
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Effective versus
Nominal Rates of Protection (cont.)
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Analysis of a Quota
• Quota: a quantitative restriction that specifies
a limit on the quantity of imports
• Differences between quotas and tariffs
– Tariff limits imports by imposing a tax on them
– Unlike tariffs, quotas do not generate tariff revenue
for the government
• Similarities between quotas and tariffs
– Both lead to a reduction in imports, a fall in total
domestic consumption, and an increase in
domestic production
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Analysis of a Quota (cont.)
• Both quotas and tariffs limit imports
• However, the net loss from quotas can
exceed that from tariffs
– This occurs when the lost tariff revenue
resulting from quotas ends up in the hands
of foreign producers as they raise their
prices to match supply to demand
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Types of Quotas
• Limitation on the quantity of imports: e.g., a limit on
the quantity of imports from country x, or a limit on
the quantity of imports from the rest of the world
as a whole
• Import licensing requirement: forcing importers to
obtain government licences for their imports;
government regulates the number of
licences available
• Voluntary export restraint (VER) (or voluntary
restraint agreement, VRA): the exporting country
“voluntarily” agrees to limit its exports for a period
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Types of Quotas: VERs
• VERs have similar effects as quotas
– However, VERs are more popular, as they (1) do
not require domestic legislative action; and (2)
allow politicians to provide protection for domestic
industry and to appear as proponents of free trade
• The use of VERs increased with the decline
in tariffs that results from the global trade
rounds; however, recent international
negotiations have restricted the use of VERs
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FIGURE 6.6 Analysis of Quota: 1
• Quota rents: increased profits accruing to
foreign producers from the use of quotas; take
the place of tariff revenue
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FIGURE 6.7 Analysis of a Quota: 2
• In the case of a tariff, the government earned
revenue from imports; in the case of a quota, foreign
producers receive extra profits (c)
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The Effect on the Profits
of Foreign Producers (cont.)
• Domestic firms prefer quotas over
tariffs: post-quota increase in consumer
demand increases the price paid by
consumers and thus the quantity of
producer surplus
– In contrast, increase in demand for a good
with an import tariff increase the quantity of
imports and leaves the price of the
good intact
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The Effect on the Profits
of Foreign Producers (cont.)
• Two circumstances that can limit
quota rents
– If there is a large number of foreign
producers, competition may limit their
ability to increase prices
– The government can extract the extra
profits from foreign producers through an
auction for import licences
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Hidden Forms of Protection
• Any trade barrier that reduces imports without
imposing a tax has effects similar to those of
a quota
– Tariffs: impose a tax
– Non-tariff barriers: quotas and non-tariff measures
• Non-tariff measures: hidden, non-transparent forms of
protection (e.g., discriminatory government procurement;
unclear safety standards; excessive bureaucratic
regulations; local content requirements)
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