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1
Welcome to Econ 414 International Economics
Study Guide
Week Seven
Chapter 6
2
• Tax on imported goods• Why?
– Revenue for Government
– Protect domestic suppliers of similar goods from foreign completion• Protect jobs
What is a tariff?
3
What are the types of tariff?
1. Specific tariffs Tax per unit
• specific tariff is regressive. Why?– A specific tariff of $1,000 on each
imported auto• a high percentage of the value of less
expensive cars• a low percentage of the value of high-
priced cars
4
Under specific tariff, what type of cars will be imported less? Expensive cars?
Cheap cars?• Cheap cars
– A specific tariff encourages domestic producers to produce less expensive goods.
5
2. Ad valorem tariffs– Taxes = fraction of the value of the imported
goods• A 5% tariff on an international price of $10,000
means that customs officials collect the fixed sum of _________.
– Importers have an incentive to under-voice the price of the imported good.
– Ad valorem tariffs are more difficult for a country to administer than specific tariffs.
What are the types of tariff?
$500
6
3. Compound tariffs
– a combination of an ad valorem and a specific tariff
– Common on agricultural products whose prices tend to fluctuate.
What are the types of tariff?
7
1. Free alongside (FAS) price• The price of the imported good in the exporting
nation before loading the good for shipment to the importing country
2. Free on Board (FOB) price• FAS + the cost of loading the good in the
means of transportation
What are different methods of valuing imports?
8
3. Cost, Insurance, and Freight (CIF) price• FOB + all inter-country
transportation costs up to the importing country’s port of entry.
What are different methods of valuing imports?
9
What is consumer surplus (CS)?
D
P1
P
Q
Consumer Surplus
Price
Quantity
The difference between the highest price consumers would be willing to pay (Price on demand curve) and the market price.
Graphically, it is equal Graphically, it is equal to the area under the to the area under the demand curve and demand curve and above the priceabove the price
The higher the CS the ___________ the consumers
Better off
10
What is producer surplus (PS)?
E
P2
Producer Surplus
S
Quantity of Cloth
Price of Cloth
Q
P
The difference between the market price and lowest price producers will sell a good (price on the supply curve).
Graphically, it is Graphically, it is equal to the area equal to the area under the price and under the price and above the supply above the supply curvecurveThe higher the PS the ___________ the producers
Better off
11
The combined effect
S
D
E
Price
Quantity
P1
Q
P
P2
Consumer Surplus
Producer Surplus
12
How does a free trade affect consumer surplus and producer surplus?
Price
Quantity
Price
Quantity
D
Exports
Imports
D
E
US
India
a
b
c
d
SS
10
4
a’
b’
c’
d’
8
E’
8
CS ↑ by b+ d, PS ↓ by b CS↓ by b’, PS ↑ by b’ + d’
13
What are the economic effects of tariffs?
1. Case of small importing nation Note: A small nation can import as much as it
likes at the same international price.
– World Prices = €8.– Domestic government imposes a specific
tariff on imported good in the amount of €2/unit
– Domestic Price = 8 + 2 = €10
14
What are the economic effects of tariffs in a small importing
nation?
S
D
E
Price
Quantity
20
2
a b c d
35 401510
8
10
Tariff = 2
-a+b+c+d: loss in CS = €75- a: added to PS= €25- b: cost of resources transferred from their best use to the production of 5 more units of the good= €5- c: government revenue = €40-d: loss to consumers = €5- a + c: redistributed effect- b+d: dead-weight loss
15
2. Case of large importing nation• Note: A large nation can influence the international
price.
– World Prices = €8.– Domestic government imposes a specific tariff
on imported good in the amount of €2 .– World supplier reduces the price to €7– Domestic Price after tariff= 7+ 2 = €9
What are the economic effects of tariffs
16
What are the economic effects of tariffs
in a large importing nation?
S
D
E
Price
Quantity
20
2
a b c d
35 401510
8
9
Tariff = 2
-a+b+c+d: loss in CS = €37.5- a: added to PS= €12.5- b: efficiency loss= €2.5- c+ f: government revenue = €40-d: loss to consumers = €2.5- a + c: redistributed effect- b+d: dead-weight loss-f: loss in exporter’s revenue
7f
17
The Effective Rate of Protection
• Effective Rate of ProtectionERP = (Tf – aTc)/(1-a)
which,
Tf = tariff rate on imported final product
Tc = tariff rate on the imported components
18
The Effective Rate of Protection
• Example: Consider two DVD players; one produced in the U.S. and one produced in a foreign country. Both DVD players sell for $100 in the U.S. with half of that price represents the cost of components purchased from a third country. An ad valorem tariff of 20% imposed by the U.S. raises the value added from $50 to $70. Thus, the effective rate of protection is (70-50)/50 = 40%.
19
Arguments for Tariffs
• Infant Government Argument– Developing countries use tariffs as a way to generate revenue.
• National Defense Argument– Certain industries need to be protected from foreign competition
to ensure an adequate output of the industry in the case of conflict.
– Two problems arise with this argument:• It is hard to identify the industries that are essential for national
defense.
• A tariff is a costly means of protection. Instead, a domestic production subsidy should be used to encourage domestic production of the good.
– The next slide depicts the effects of a domestic production industry.
20
• Infant Industries– From World War II until the 1970s many developing countries
attempted to accelerate their development by limiting imports of manufactured goods to foster a manufacturing sector serving the domestic market.
– The most important economic argument for protecting manufacturing industries is the infant industry argument.
• Senile Industry Protection– Many developed countries protect industries that are old.
• For example, the apparel industry in most developed countries experience this type of protection.
Arguments for Tariffs
21
Arguments for Tariffs
S
D
E
Price of Cloth
Quantity of Cloth
P1
P
P2
a b c
Q
d
G
F
Q4 Q2Q3Q1
Pw
Pt
Tariff = T
Figure 6-6: The Effects of a Domestic Production Subsidy
S’
Subsidy
22
• Tariffs, Trade and Jobs– The imposition of a tariff in a particular industry produces more
jobs in that particular industry but fewer jobs in other industries.• The overall level of employment is unchanged in the short-run
whereas in the long-run it may decrease.
• An economy with a lot of tariffs will usually grow more slowly than a more open economy.
Arguments for Tariffs