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1
International EconomicsInternational Trade(Trade Policy I)
Piero EspositoUniversity of Cassino
University of Cassino
Economics and Business
Academic Year 2021/2022
2
Commercial Policy
◼ Policy of tariffs and quotas is called commercial
policy.
◼ There are numerous barriers to trade, some are
obvious (transparent), others are not (non-
transparent).
◼ Two common barriers are Tariffs and Quotas.
Tariffs: indirect limit on imports: impose a tax
on imports.
Quotas: direct limit on imports: regulate the
quantity of imports
3
Analysis of a Tariffs and Quotas
◼ Tariffs and quotas encourageConsumers to switch to relatively cheaper
domestic goods.
Domestic producers to increase their output as demand switches from foreign to domestic goods.
◼ We will present a partial equilibrium analysis of the effects of tariffs and quotas: it considers only their impact on the industry on which they are imposed, rather than their economy-wide effects.
4
Consumer and Producer Surplus
There are 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)
5
Diagram of Consumer and
Producer Surplus
Demand
Supply
Price
Quantity
CS
PS
P*
Q*0
6
Introducing International Trade
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
7
Bigger surplus with International
Trade
Demand
Supply
Price
Quantity
CS
PSPw
Q10
Q2
Imports
Domestic
production
P*
8
Introducing a Tariff
◼ 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 a mark-up onto the price to
domestic consumers. The price to them is
Pw+ t=Pt
The consumption of the imported good
subsequently decreases
9
Smaller surplus with the Tariff
Demand
SupplyPrice
Quantity
CS
PSPw
Q*10Q2
ImportsDomestic
production
Pw+t
Revenues
Q*2
Domestic consumption
Protection
lossesshrunk
CS
10
◼ In summary, with respect to free trade:
tariffs cause the domestic price to rise by the
amount of the tariff (consumer cost),
domestic consumption falls (consumer cost),
consumer surplus shrinks,
domestic production rises (producer benefit),
imports fall (government benefit),
public revenue increase (government benefit)
→ But total surplus falls.
Results of Tariff Policy
11
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.
12
When the Large Country imposes a tariff
Demand
Price
Quantity
CS
PSPw*
Q*10Q2
ImportsDomestic
production
Pw*+t
Revenues
Q*2
Domestic consumption
shrunk
CS
Pw
Pw=world pre-tariff price
Pw*+t=post-tariff price
t=tariff
→ Consumer Surplus falls less, Producer Surplus increases less
with respect to the small country case. Import fall less but
revenues increase more
13
Effective vs Nominal Rate 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)
14
Formula of the Effective Rate
of Protection
◼ 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)
15
Example of Nominal and Effective
Rates of Protection
(600-400)/400=50%(300-400)/400=-25%
16
Uruguay Round (1986-1995)→WTO
17
Less but cascading tariff structure
→The Uruguay Round reduced nominal tariffs, but reduced less
the ‘effective tariffs’ when there is domestic processing.
18
The problem of Tariffs
◼ Developed countries often impose tariffs (and
other barriers) that discourage exports of many
developing countries (mainly products of
agriculture, clothing, and textile industries).
◼ The Doha Development Agenda of the World
Trade Organization (WTO) is focused on the
trade problems of developing countries.
◼ Nevertheless, developing countries have higher
tariffs than developed countries.
19
Average Tariff Rates, 1986-2010
20
Low tariffs in High Income Countries
21
Higher tariffs in Less Developed
Countries
22
Economic effects of US tariffs
Consumer cost=shrinkage of consumer surplus (CS)
Producer gain=extension of producer surplus (PS)
Deadweight cost=Protection losses
jobs
‘saved’
23
US-China bilateral applied tariffs
Source: Brown (2019) The US-China trade conflict. PIIE working paper
24
US imports from China covered by
‘special’ protection
Source: Brown (2019) The US-China trade conflict. PIIE working paper
US-China Trade War I
25
US-China Trade War
26
◼ US tariffs grew
from 3.1% to
19.3% (>6 times!)
◼ Chinese tariffs
increase from 8%
to 20%. (1.5
times)
◼ Higher fall of US
imports
◼ Trade balance vs
China improved
(changed in 2021)
US imports from China
China imports from the US
27
Why tariffs?
◼ The higher a country’s income, the lower its tariffs are likely to be. This confirms that trade is beneficial for growth.
◼ But why do developing countries tend to have higher tariff rates?
◼ Because: - tariffs are a relatively easy tax to administer,- instead, on income, sales, and property require more
complex accounting systems,- the informal economy is larger in developing countries,- taxes often form an important part of government revenue.
28
Other Potential Costs
◼ 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
29
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
(e.g., firms hire lobbyists to maintain tariff
protection)
- Political systems that do not easily provide tariffs
are more likely to avoid rent seeking
Exercise
30
The figure below represents the case of an open economy with
demand and supply of a tradable good x with world price
pw=7.5, and with a tariff imposed on imports t=2.5.
Calculate:
1) Pre and post-tariff
imports/consumption
2) Pre- and post-tariff
producer surplus
3) Pre- and post-tariff
consumer surplus
4) Government revenue
The End
31