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Trade Policy:
Instruments and Impacts
Appleyard & Field (& Cobbs): Chapters 13–14
Krugman & Obstfeld: Chapter 8
1
Today’s Lecture
1.
Instruments of trade policy
1.
2.
3.
2.
Tariffs
Quotas
Other Non-tariff Barriers to Trade
Impact of trade policies
1.
2.
3.
4.
Partial Equilibrium: Small Country
Partial Equilibrium: Large Country
General Equilibrium: Small Country
General Equilibrium: Large Country
2
Tariffs
• Imports tariffs
o specific tariff:
(a monetary sum that must be paid to import 1
physical unit of a product)
 Advantage: easy to collect
 Disadvantage: doesn’t take price changes into account
o
ad valorem tariff: (a percentage of the monetary value of 1 unit of import)


Advantage: takes price changes into account
Disadvantage: Need to know the monetary value of the good and
seller is tempted to undervalue the price
• Other instruments
o Import subsidy  negative import tariff
o Export tariff/subsidy (levied/paid on home-produced
goods that are destined for export)
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Features of Tariff Schedules
• Preferential duties
o products form certain countries are subject to lower
tariffs than the normal tariff rate
o Generalized System of Preferences (GSP) for
developing countries
• Most-favoured-nation (MFN) treatment = normal
trade relations (NTR)
o
“if country A grants country B the status of mostfavoured nation, it means that B’s exports will face tariff
that are no higher (nor lower) than those applied to any
other country that A calls a MFN” (Economics A-Z in The
Economist website)
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Non-tariff Barriers to Trade (1)
• Import Quotas
o a government agency allocates the rights to import
o limits the number of goods (not the price) for a given time period
• “Voluntary” export restraints (VER)
o foreign suppliers agree to “voluntary” refrain from sending some
exports
• Government procurement provisions
o restriction on purchasing foreign products by the domestic
government agencies
• Domestic content provisions
o a given percentage of the value of a good must consist of domestic
components or labour
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Non-tariff Barriers to Trade (2)
• Administrative classification
o
different tariffs to different product categories + leeway
for customs officials to decide on classification
• Restrictions on services trade
• Trade-related investment measures
• Domestic policies affecting trade
o
etc.
health, environment and safety standards; packaging and
labeling requirements; inconsistent treatment of
intellectual property rights; subsidies to domestic
firms...
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Impact of Trade Policy: Levels of Study
Partial Equilibrium analysis
•
o
analysing one market and ignoring the
subsequent or secondary effects
General equilibrium analysis
•
o
analysing all markets simultaneously (but still holding
technology, endowments etc. constant)
•
Note that here “market” means a market for one good (which can be
sold in many countries). We will use both approaches to study onecountry and two-country cases. The difference is that in general
equilibrium analysis we take also into account what happens in the
markets of goods not subject to trade policy.
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Consumer and Producer Surplus
Price (P)
•
•
•
•
In a partial equilibrium approach
we can use the concepts of
consumer and producer surplus
Both reflect the fact that there is
only one market price
Hence, there are consumers who
would have been willing to pay
more for the product
Similarly, all but the “last” unit is
produced with lesser marginal cost
than the market price received
S=
marginal cost
of production
P
consumer
surplus
producer
surplus
D
Quantity (Q)
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The Impact of Import Tariff:
The Small-Country* Case
* Small country = cannot affect world prices
Increase of producer surplus and
government income
Loss of consumer surplus
SD
P
SD
P
increase of
producer
surplus
Loss of consumer surplus
Pint
tariff to the
government
(1+τ)Pint
(1+τ)Pint
Pint
DD
imports after tariff
Q
DD
imports after tariff
Q
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imports in free trade
imports in free trade
The Impact of Import Tariff:
The Small-Country Case
• Introducing a tariff
→ Domestic price increases
→ Domestic quantity supplied increases
→ Domestic quantity demanded falls
→ Increase of government revenues
• Distributional effect
o surplus is transferred from the consumers to the
producers and the government
• Consumers lose more than producers and government
win: deadweight loss
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The Impact of Import Quota:
The Small-Country Case
• For every quota there is an
equivalent tariff (and for every
tariff there is an equivalent quota)
SD
P
• The changes in consumer
and produce surplus are
equivalent to that of a tariff
• However, the increase of
government revenue may be
lost (depending on how the
quotas are allocated)
PQ
Pint
DD
quota
imports in free trade
Q
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The Impact of Subsidy to ImportCompeting Industry (Small Country Case)
SD
P
P
Cost to the
government
P
P
SD
increase of
producer
surplus
DD
DD
imports after the subsidy
imports in free trade
Q
imports after the subsidy
Q
imports in free trade
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The Impact of Subsidy to ImportCompeting Industry (Small Country Case)
• Equivalent subsidy = producers are subsidised to produce the
same amount as they would under a tariff
→ Equal increase in the producer surplus as under tariffs
→ Large cost to the government
→ No impact on price  no impact on consumer surplus
• Cost to the government is larger than the increase of producer
surplus, i.e. there is a loss of efficiency
• However, this cost is less than the loss of consumer surplus in
the tariff/quota case → subsidies are more efficient than
tariffs/quotas
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Large country, partial equilibrium
Single Market, Two Countries
P
Country A
Country B
P
SA
SB
DB
DA
Q
Q
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Single Market, Two Countries
P
Country A
Country B
P
SA
SB
DB
DA
Q
Q
Countries A and B have different supply curves (cost of production) and demand curves
15 the
(preferences). In free trade equilibrium the world price is such that country B is willing to export
same quantity as country A is willing to import.
Single Market, Two Countries, Tariff
P
Country A
Country B
P
SA
SB
DB
tariff
DA
Q
Q
Price in Country A = Price in country B + tariff. If the price in country B would remain constant
after a tariff is set, country B would be willing to export more that country A would be willing 16to
import → price in country B must decrease (next slide)
Effect of a Tariff in a Single Market
and Two-Countries
Country A
P
DA
Country B
P
SA
DB
SB
PA
PFT
e
a
D
b
tariff
C
price decrease
in country B
PB
Q
Q
Country A:
Loss of consumer surplus = e+a+D+b; increase of producer surplus = e; Increase of government
revenue = C+D. Gain for Country A = gains–losses = (e+C+D)-(e+a+D+b) = C – a – b. That is, if
C > a + b country A has gained from the imposition of the tariff (due to lower prices of imports
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before tariff).
Impact of Elasticises
Country A
P
DA
P
SA
PA
PFT
Country B
SB
DB
e
tariff
a D b
PB
C
Q
The more elastic in the exporting market and the more inelastic in the
importing market supply and demand are, the less chances the importing
country has on gaining from tariff
price decrease
in country B
Q
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The Impact of Import Quota
• Graphically identical to the case of tariff
• The difference is in, who gets areas D (country A’s
government revenue from the tariff) and C (loss of country B’s producer
surplus that is transferred to country A in the tariff setting)
• Voluntary export restraints (VER) can be seen as a way
for the exporting country to capture areas C and D
o
Then, if this gain is greater than the deadweight loss of
the exporter (triangles around C), the exporting country
will gain from the quota
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General Equilibrium Analysis
Partial Equilibrium analysis
•
o
analysing one market and ignoring the subsequent or
secondary effects
General equilibrium analysis
•
o
analysing all markets simultaneously (but still holding
technology, endowments etc. constant)
•
Note that here “market” means a market for one good (which can be
sold in many countries). We will use both approaches to study onecountry and two-country cases. The difference is that in general
equilibrium analysis we take also into account what happens in the
markets of goods not subject to trade policy.
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General Equilibrium Effects of a
Tariff for a Small Country
•
•
•
•
•
Import tariff on good Y
changes the price ratio
Producers adjust from
point PFT to Pt
Since the tariff doesn’t
change world prices,
country’s real income
changes to (PX/PY)t
Consumers maximize
given domestic prices
and real income and
move to a lower utility
level
Note that real income is
determined by the world
prices
Good Y
CFT
Ct
Pt
PX/(1+τ)PY
PFT
(PX/PY)FT
Ct Pt CFT
PFT
Good X
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General Equilibrium Effects of a
Subsidy for a Small Country
•
•
•
Assume the government
subsidizes producer of
good Y to impose the
same production pattern
as with the tariff
The real income of the
country remains the same
Consumers face world
prices and are able to
consume at a higher
utility level
Good Y
CFT
CS
PS
PX/(1+τ)PY
PFT
(PX/PY)FT
CS
PS CFT
PFT
Good X
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Terms of Trade Effect of a Tariff
• Imposing a tariff shifts
offer curve inwards (the
(PX/PY)E’
= TOTE’
Imports to country 1
exports from country 2
→ The tariff imposing
country’s terms of
trade improve (the price
of exports decrease), which
may offset the, at least
in part, the decrease of
welfare due to
efficiency loss
Good Y:
country is now willing to trade
less for all terms of trade)
(PX/PY)E
= TOTE
Country 2’s offer curve
Country 1’s offer curve
Good X:
Exports from country 1
Imports to country 2
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Terms of Trade Effect of a Quota
• Country 1 sets a
Imports to country 1
exports from country 2
Good Y:
quota for imports
of good Y
→ country 1’s offer
curve becomes
horizontal at the
quota level
→ Country 1’s terms
of trade improve
(PX/PY)E’
= TOTE’
(PX/PY)E
= TOTE
Country 2’s offer curve
Country 1’s offer curve
Good X:
Exports from country 1
Imports to country 2
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Terms of Trade Effect of a Voluntary
Export Restraints
• Country 2 uses
Imports to country 1
exports from country 2
Good Y:
voluntary export
restraints (VER) to
limit exports of
good Y
→ country 2’s offer
curve becomes
horizontal
→ country 2’s terms
of trade improve
(PX/PY)E
Country 2’s offer curve
(PX/PY)E’
Country 1’s offer curve
Good X:
Exports from country 1
Imports to country 2
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Other Effects of Protection
• Restricting imports is likely to result decrease of
exports as well
o
o
Reallocation of domestic resources
Retaliation by the trading partners
• Distributional Effects
o
o
Transfer from the consumers to the import-competing
producers
HO-model: transfer from the abundant factor to the
scarce factor
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