Download Chapter 6

Chapter 6
The Theory
of Tariffs
and Quotas
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
Chapter Objectives
• Introduce the theory of tariffs
• Discuss the welfare and efficiency effects of
tariffs
• Analyze the distinction between tariffs and
quotas
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
6-2
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
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
6-3
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
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
6-4
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
economy-wide effects
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
6-5
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)
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
6-6
FIGURE 6.1 Consumer and
Producer Surplus
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
6-7
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
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
6-8
FIGURE 6.2 Domestic Supply
and Demand for an Imported Good
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
6-9
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
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
6-10
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
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
6-11
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
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
6-12
FIGURE 6.3 The Effects of a Tariff
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
6-13
TABLE 6.1 Economic Effects of
the Tariff in Figure 6.3
• 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
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
6-14
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
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
6-15
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
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
6-16
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
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
6-17
FIGURE 6.4 Tariffs in the Large
Country Case
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
6-18
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 laborintensive products – the very products
developing nations would like to export
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
6-19
FIGURE 6.5 Average Tariff Rates,
1986-2003
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
6-20
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)
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
6-21
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)
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
6-22
TABLE 6.2 Nominal and Effective
Rates of Protection
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
6-23
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
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
6-24
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
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
6-25
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
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
6-26
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
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
6-27
FIGURE 6.6 Analysis of a
Quota: 1
• Quota rents: increased profits accruing to foreign
producers from the use of quotas; take the place of tariff
revenue
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
6-28
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)
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
6-29
The Effect on the Profits
of Foreign Producers (cont.)
• Domestic firms prefer quotas over tariffs: postquota 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
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
6-30
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
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
6-31
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)
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
6-32