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CHAPTER 8
ANALYSIS OF A TARIFF
Objectives of the Chapter
This
chapter
analyzes
the
advantages
and
disadvantages
of
tariffs.
Except
for
some
recognized
exceptional
cases, there is a rare consensus among economists
that freer trade is better than protectionism.
As illustrated in this chapter,
economic analysis has consistently
demonstrated
that
there
are
usually
net
gains from freer trade
for the nation as well as for the world. A tariff
helps import-substituting producers,
and
the
government
collects
some
tariff
revenue
(import
taxes);
however,
consumers
of
the
good
are
unambiguously harmed.
Whether or not a tariff will result in
a net gain for the importing
country
will
depend
on
the
size
of
that
country. If the country
levying the tariff is small (meaning that its
actions cannot affect the world price of
the
good
on
which
the
tariff
is
levied),
then
the
loss
to
consumers
is
larger
than
the
sum
of
gains
to
producers
and
to
the
government.
On
the
other
hand,
if
the
country
is
large
(meaning
that,
by
limiting
imports, it can force down the world
price of the good), then levying a tariff may
result in a net gain for the
country.
This will depend upon the portion of
the government’s
revenues
that
are,
in
essence,
extracted
from foreign producers versus the size
of
the country’s deadweight losses from
the tariff.
In any case, the
world as a whole always loses from the
imposition of a tariff.
After studying Chapter 8 you should be
able to identify
1. the advantages
and disadvantages of a tariff.
2.
how a tariff lowers the welfare of the world as a
whole.
3.
ad valorem
tariffs versus
specific
tariffs.
4. the effective
rate of protection.
5. how demand-
supply analysis can be used to assess the gains
and losses of a tariff, using both
graphical and tabular expositions.
Important Concepts
Ad valorem tariff:
Consumption effect:
A tariff
that is set as a percentage of a value of a good
when it reaches
the importing country.
The welfare loss to consumers in the
importing nation that corresponds
to
their being forced to cut their total purchases of
a good as a result of
the tariff.
Consumer loss from a tariff that
accrues to neither the government nor
producers.
The
percentage
by
which
the
entire
set
of
a
nation’s
trade
barriers
raises
the
indu
stry’s
value
added
per
unit
of
output.
(
This
term
is
abbreviated as e.r.p.)
Deadweight loss:
Effective
rate of protection:
35
Nationally optimal tariff:
A
tariff set at the rate that maximizes the gains
for a large country (at
the
expense
of
foreign
countries).
Technically,
the
optimal
rate,
as
a
fraction
of
the
price
paid
to
foreigners,
equals
the
reciprocal
of
the
elasticity of supply of a country’s
imports.
“Small” countries
that cannot affect the
world
price
of
the
goods
and
services
they
trade.
In
these
countries,
the
import
supply
curve
is
infinitely elastic.
The
cost
of
shifting
to
more
expensive
domestic
production
from
an
import-
competing sector that is protected by a tariff on
foreign goods.
A tariff set so high
that it reduces imports to zero.
A
tariff
stipulated
as
a
money
amount
per
physical
unit
of
the
import.
An
international
organization
of
most
of
the
world’s
countries;
it
oversees governmental policies
regarding international trade. The chief
purposes
of
the
WTO
are
to
liberalize
trade
and
limit
unfair
export
policies such as
subsidies.
Price-taking countries:
Production effect:
Prohibitive tariff:
Specific
tariff:
World Trade Organization:
Warm-up Questions
True or
False? Explain.
1.
T / F
2.
T / F
3.
T / F
4.
T / F
5.
T / F
Free trade is always a better policy
than a tariff.
An advantage of a
specific tariff is that its protective value keeps
pace with increases in
the price of the
imported good.
While a tariff may be
nationally optimal, it is not globally optimal.
Ad valorem
is
just another way of saying
ad nauseam.
A tariff always
results
in
losses
to
a
country’s
consumers
in
excess
of
the
gains
to
its
producers.
Multiple Choice
1.
The optimal tariff for a
small (price-taking) country
A. is
zero.
B.
is a prohibitive
tariff.
C.
is
unambiguously positive.
D. increases
as t
hat country’s elasticity of demand
increases.
An
optimal tariff that yields a net national welfare
gain requires that
A. t
he
nation be a “price taker.”
B.
there be no loss of
consumer surplus.
36
2.
C.
trading
partner nations not be injured by the tariff.
D. the nation has monopsony power in
the international market.
3.
The imposition of a
tariff
A. generates revenue which is
paid entirely by foreigners.
B.
always increases the domestic price in
the exporting country.
C.
reduces the welfare of
a
“small” importing country relative to free trade.
D. is always welfare-
increasing.
The effective rate of
protection of an industry is
A. always
larger than the optimal tariff.
B.
a measure of the jobs gained by the
economy imposing a tariff.
C.
more or less than the nominal tariff
rate,
depending on the domestic
output’s share in GDP.
D.
more or less than the nominal tariff rate,
depending on the tariffs on inputs.
The
imposition of an import tariff by a large nation
A. increases the n
ation’s
welfare.
B.
r
educes the nation’s
welfare.
C.
l
eaves the nation’s welfare
unchanged.
D. allows for
any of the above possibilities.
4.
5.
Problems
1.
Consider a case in which the large
country, Leinster, imposes a tariff on Saxon
bread. This tariff
reduces the volume
of bread traded from 80 million loaves to 40
million loaves, and causes the
“world”
price to fall to 0.23 telephones per loaf of
bread.
Figure 8.1
P
r
i
c
e
o
f
b
r
e
a
d
(
t
e
l
e
p
< br>h
o
n
e
s
p
e
r
l
o
a
f
)
S
L
P
r
i
c
e
o
f
b
r
e
a
< br>d
(
t
e
l
e
p
h
o
n
e
s
p
e
r
l
o
a
f
)
Leinster
Saxony
0.44
a
0.23
b
c
d
World price
37
e
f
g
h
i
S
S
World price
h
D
L
40
80
Bread in millions of
loaves
40
D
S
60
Bread in millions of loaves
38
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