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Tariff Instruments

Eco 3024F

Krugman & Obstfeld

Ch 8

2

Outline

• Introduction: Relevance of tariffs

• Types of tariffs

• Partial equilibrium analysis of tariffs

• Costs and benefits of tariffs

• LATER:– Analysis of Tariffs (GE framework)

– Trade policy in presence of monopolies

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• “Trade theory is about identifying whose hand is in whose pocket. Trade policy is about who should take it out” (Finger, 1981).

“Tariff -- A scale of taxes on imports, designed to protect the domestic producer

against the greed of his consumer”. From Ambrose Bierce, The Devil's Dictionary:

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Why do we need to worry about tariffs and tariff policy?

1. Tariffs a key policy instrument used for industrial development

Department of trade and industry’s “National Industrial Policy Framework”

2. Trade negotiations WTO negotiations African countries negotiating new “economic

partnership agreements” (EPAs) with EU Regional integration schemes (SADC Customs union

by 2010)

3. 3. Business operations: imported goods used in production and consumption

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Tariffs & other charges

• Goods imported into most countries are subject to different charges– Customs duties– Excise duties– Levies

• Flue cured tobacco: 3.3c/kg + 75.9c/kg (special levy)

• Lentils: 9.60 R/T + 2.5 R/T (special levy)

– VAT or sales tax

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Types of import tariffs (Customs duties)

• Ad valorem tariff : PD = PW (1 + t)– Levied as a constant percentage of the monetary value of 1 unit of

the imported good.• Oranges: 5%

– But because it is based on the value of the good, an importer may understate the value while customs may overvalue as a counter measure.

• Specific tariff: PD = PW + t– Import duty that assigns a fixed monetary (Rand) tax per physical

unit of the good imported.• Blue veined cheese: 500c/kg

– It may be collected with ease because only physical quantity of imports needs to be known and not their monetary value

– However, protection varies with value of imported good. So inflation lessens strength of tariff

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Types of import tariffs (Customs duties)

Compound tariffs– Ad valorem PLUS specific tariff– E.g. wheat flour :10% plus 29.4c/kg

• Mixed tariff

– Either ad valorem OR specific (normally the one which yields higher protection)

– E.g. Fish, fresh or chilled: 25% or 70c/kg

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HS6 Label Tariff010310 Live swine. 0.0%020311 Meat of swine, fresh, chilled or frozen. 15%020410 Meat of sheep or goats, fresh, chilled or frozen. 40%020610 Edible offal of bovine animals, swine, sheep, goats, horses, asses, mules or hinnies,

fresh, chilled or frozen.30%

070511 Lettuce (lactuca sativa) and chicory (cichorium spp.), fresh or chilled. 0%071010 Vegetables (uncooked or cooked by steaming or boiling in water), frozen. 30%071130 Vegetables provisionally preserved (for example, by sulphur dioxide gas, in brine, in

sulphur water or in other preservative solutions), but unsuitable in that state forimmediate consumption.

20%

071310 Dried leguminous vegetables, shelled, whether or not skinned or split. 15%071410 Manioc, arrowroot, salep, jerusalem artichokes, sweet potatoes and similar roots and

tubers with high starch or inulin content, fresh or dried, whether or not sliced or in theform of pellets; sago pith.

5%

283531 Phosphinates (hypophosphites), phospho- nates (phosphites), phosphates andpolyphosphates.

10%

290322 Halogenated derivatives of hydrocarbons. 10%950510 Festive, carnival or other entertainment articles, including conjuring tricks and novelty

jokes.30%

930610 Bombs, grenades, torpedoes, mines, missiles and similar munitions of war and partsthereof; cartridges and other ammunition and projectiles and parts thereof, includingshot and cartridge wads.

20%

020810 Other meat and edible meat offal, fresh, chilled or frozen. 8c/kg030211 Fish, fresh or chilled, (excluding fish fillets of heading no. 03.04): 25% or 70c/kg070320 Onions, shallots, garlic, leeks and other alliaceous vegetables, fresh or chilled. 325c/kg with a maximum

of 39%110100 Wheat or meslin flour. 40% plus 40.3c/kg200600 Vegetables, fruit, nuts, fruit-peel and other parts of plants, preserved by sugar 20% or 215c/kg less 80%

511111 Woven fabrics of carded wool or of carded fine animal hair. 22% or 30% with amaximum of 2880c/kg

621510 Ties, bow ties and cravats. 40% or 60% with amaximum of 7500c/kg

520941 Woven fabrics of cotton, containing 85 % or more by mass of cotton, of a massexceeding 200 g/m2.

22% or 30% with amaximum of 890c/kg

521011 Woven fabrics of cotton, containing less than 85 % of cotton, mixed mainly or solelywith man-made fibres, of a mass not exceeding 200 g/my.

22% or 30% with amaximum of 1000c/kg

240110 Unmanufactured tobacco; tobacco refuse. 15% or 860c/kg less 85%

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Supply, Demand & Trade in a Single Industry

• Assume

– Perfect competition in mkt for laptops.

– Two countries in world producing laptops – SA & US

– Initially No trade

– Price of laptops in US lower than in SA

• With trade SA will import laptops

– Import demand curve for laptops from SA

• With trade, US will export laptops

– Export supply curve for laptops from US

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Import demand curve

8-10

Import demand curve is downward sloping....why?What happens if P is above A?

Import demand curve (MD): SA demand –SA supply= Import demand by SA (from US)

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B

Export supply curve

8-11

Export supply curve is upward sloping....why?What is happening at point B?

Export supply curve (XS):US supply – US demand = Exports supplied to SA (by US)

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World Equilibrium

8-12

At Pw , XS=MD in SA

Will Pw be the mkt clearing price in US as well?

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Partial equilibrium analysis of impact of tariffs

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The Effects of a Tariff

• Suppose SA imposes tariff on computer imports

– This is like a tax on the price of good imported or like the effect of transport costs (Imported price=foreign price + tariff)

– Will introduce price wedge between domestic price (PT) and foreign price (P*

T)

• PT – P*T = t

• What price adjusts, (PT) or (P*T)?

– As domestic price increases, quantity demanded falls in SA

– As quantity demanded falls, so quantity supplied by US falls leading to possible foreign price decrease

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The Effects of a Tariff (cont.)

8-15

1. Price of the good in foreign (US) markets should fall if there is a significant drop in the quantity demanded of the good caused by the domestic (SA) tariff.

2. Extent of decline in foreign price depends on elasticity of foreign export supply and elasticity of import demand

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The Effects of a Tariff (cont.)

• Domestic price rises and quantity of imports demanded falls

• Foreign price falls and quantity of exports supplied falls

• Gap between domestic and international price equals tariff wedge

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Welfare: Who wins and who loses?

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Welfare: Who wins and who loses?

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Cost and Benefit using a small country model

• Assumptions– Small country is unable to influence world

price Pworld through changes in production and/or consumption

– Implies: small countries face horizontal (infinitely elastic) Export supply curves

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Small country supply and demand

PW (1+t)

S

PW

Q4Q1

D

Q3Q2

BA DC

Imports at PW

Consumer surplus loss

Price

Quantity

Consumer surplus, no tariffsConsumer surplus, with tariffs

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Dead weight loss

Small country supply and demand

PW +t

S

PW

Q4Q1

D

Q3Q2

BA DC

Government revenue gain

Producer surplus gain

Price

Quantity

Consumer loss-producer gain - government revenue

= dead weight loss (B+D)

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Small country: conclusion

• Tariffs raise domestic production by raising the price received

• Consumers pay for this through higher prices

• Governments gain from tariff revenue, which they can transfer back to consumers

• But price distortions lead to inefficient allocation of resources for consumers and producers

• Whose hand is in whose pocket?

– Tariffs lead to a transfer of surplus from consumers to producers

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Tariffs in large countries

PW* +t

S

PW

Q4Q1

D

Q3Q2

BA DC

Price

Quantity

PW*

tE

Consumer surplus loss

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Tariffs in large countries

PW* +t

S

PW

Q4Q1

D

Q3Q2

BA DC

Government revenue gain

Producer surplus gain

Price

Quantity

Consumer loss - producer gain - government revenue

= B+D-E

PW*

tE

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Large country: conclusion

• Tariffs lower the world price

• Foreign producers bear some of cost of tariff through lower world prices

– Terms of trade improvement for Home

• Tariffs still cause production and consumption efficiency losses

• BUT, if terms of trade improvement are large enough (area E), then the economy can gain

• Would you advise such a strategy? Why not?