Transcript tariff

Costs and benefits of
tariffs
Preview
• Types of tariffs
• Effects of tariffs when domestic consumers fully pay
• Effects of tariffs when foreign producers partially pay
• Optimal tariff
• Effective rate of protection
8-2
Types of tariffs
• A tariff is a tax on goods and services produced abroad
and sold domestically.
 It is also sometimes called a duty.
 Products that do not have tariffs/taxes are called duty free.
 Tariffs or duties are usually collected by customs officials at
the port of entry.
 See http://www.customs.go.kr/
8-3
Types of tariffs
• A specific tariff is an amount of money per unit of the
imported product.
 for example, 3,000원 per kg of rice
• An ad valorem tariff is a percentage of the estimated
value of the imported product.
 for example, 5% of the value of rice
• Tariffs generally raise the domestic price of imported
products above the price in international markets,
 and generally domestic consumers pay all or part of the tariff.
8-4
Types of tariffs
• Most favored nation (MFN) tariffs are tariffs that each
member of the World Trade Organization (WTO)
promises to apply to all other members,
 as it applies to the country to which it gives its lowest or most
favorable rate.
 But exceptions include tariff rates used in a preferential trade
agreement and for very poor countries.
 Some countries impose higher tariffs on products from
countries that are not part of the WTO.
8-5
Types of tariffs
• Preferential tariffs are exceptions to the MFN tariffs
and are lower than MFN tariffs.
• They allowed by the WTO for
 members of a preferential trading agreement:
 customs union (with a common external tariff policy) or
 a free trade area (with no common external tariff policy).
 very poor countries.
 The largest of set of unilateral preferential tariffs for poor
countries is the Generalized System of Preferences (GSP),
o which lists the countries and the types of goods on which preferential
tariffs may be applied.
8-6
Types of tariffs
• A bound tariff is the maximum (potential) tariff that a
country promises to charge WTO members now or in
the future.
 WTO members are allowed to raise or to lower their tariff
rates over time, but they promise to raise them only up to the
bound tariff rate.
 Bound tariffs are not necessarily actual tariffs; they are the
maximum potential tariffs for WTO members.
 In other words, the actual tariff rate is less than or equal to the
bound tariff rate for WTO members.
8-7
Types of tariffs
percent
bound tariff rate
Tariff rate for
non-WTO
members
Preferential
tariff rate
Most favored
nation tariff
rate
8-8
Types of tariffs
• If the domestic government imposes or raises a tariff, in
response
 foreign governments might not impose their own tariffs, or
they might impose them as “retaliation”.
 foreign producers might keep the price of their product the
same,
 or not, if they want to accommodate domestic consumers in order
to maintain their shares in the domestic market.
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Tariffs when domestic consumers fully pay
• First, let’s assume that foreign producers do not change
the price of their product, so that domestic consumers
must pay all of the tariff.
 Foreign suppliers might not change the price of their product
because events in the domestic market (like the imposition of
a tariff) have no significant influence on the price that foreign
suppliers want to charge.
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Tariffs when domestic consumers fully pay
• Because tariffs generally raise the domestic price of
imported products,
 the quantity of imported products should fall, and
 domestic consumers will be worse off because
 some can no longer afford to buy imported or domestic products.
 those who continue to buy imported products need to pay more.
 some will switch to less desirable and more expensive substitutes
that were produced domestically.
 some will need to pay more for domestic substitutes due to
scarcity or lack of competition in the domestic market.
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Tariffs when domestic consumers fully pay
• Because tariffs generally raise the domestic price of
imported products, domestic import-competing firms
can respond by
 raising the prices of their own products,
 producing and selling more of their own products,
 doing both.
 By making imported products less “competitive” in the
domestic market, a tariff should make domestic importcompeting firms better off.
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Tariffs when domestic consumers fully pay
• Because tariffs allow the government (customs officials)
to collect money/revenue,
 it should be better off.
 It can use this money/revenue to pay for various projects or
simply to pay customs officials higher salaries.
 Because administering and enforcing the tariff uses real resources
(ex., people), the government can self-finance the administration
and enforcement with tariff revenue.
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Tariffs when domestic consumers fully pay
• We can represent these ideas through a simple supplydemand diagram:
8-14
Tariffs when domestic consumers fully pay
Price of
citrus fruit
In this case, we
assume that
domestic consumers
pay all of the tariff,
so the price in the
domestic market
rises by the full
amount of the tariff.
Domestic
supply
Price with
tariff
Tariff
Price without
tariff
0
Imports
with tariff
S
Q
S
Domestic
demand
D
Q
Q
Imports
without tariff
D
Q
World
price
Quantity of
citrus fruit
Tariffs when domestic consumers fully pay
Price of
citrus fruit
Consumer surplus
before tariff
Domestic
supply
Producer
surplus
before tariff
Price without
tariff
Domestic
demand
0
S
D
Q
Q
Imports
without tariff
World
price
Quantity of
citrus fruit
Tariffs when domestic consumers fully pay
Price of
citrus fruit
Consumer surplus
after tariff
Domestic
supply
A surplus
Producer
after tariff
B
Price with
tariff
Price without
tariff
0
Tariff
C
G
Imports
with tariff
S
Q
S
Domestic
demand
D
Q
Q
Imports
without tariff
D
Q
World
price
Quantity of
citrus fruit
Tariffs when domestic consumers fully pay
Price of
citrus fruit
Domestic
supply
Tariff revenue
Price with
tariff
Tariff
E
Price without
tariff
0
Imports
with tariff
S
Q
S
Domestic
demand
D
Q
Q
Imports
without tariff
D
Q
World
price
Quantity of
citrus fruit
Tariffs when domestic consumers fully pay
Price of
citrus fruit
Losses from some consumers
who are forced to buy more
expensive domestic citrus fruit.
Domestic
supply
Losses from consumers
who are no longer able
to afford citrus fruit.
A
B
Price with
tariff
Price without
tariff
0
Tariff
C
D
E
G
F
Imports
with tariff
S
Q
S
Domestic
demand
D
Q
Q
Imports
without tariff
D
Q
World
price
Quantity of
citrus fruit
Tariffs when domestic consumers fully pay
• Consumers lose because
 some consumers can no longer afford to buy the product.
 The loss for these consumers is represented by area F.
 some consumers buy a product that was produced less
efficiently and more expensively by domestic producers.
 The loss from less efficient production and more expensive
products is represented by areas C + D, which is called the
efficiency loss of the tariff.
 some consumers must pay a higher price for imported products
with the tariff instead of buying from foreign firms duty free.
 The loss for these consumers is represented by area E and is
called the import markup loss.
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Tariffs when domestic consumers fully pay
• The full loss for consumers is C + D + E + F and is
called the consumption loss of the tariff.
 Losses C and E for consumers are offset by gains from
producers and from tariff revenue.
 But losses D and F are not offset: they are called deadweight
losses.
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Tariffs when domestic consumers fully pay
• Tariffs benefit some groups, which is principally why
they are used, even though they create deadweight
losses for the economy.
 The government collects tariff revenue, which is represented
by area E.
 Area E is directly above Q2D – Q2S , the distance representing the
smaller amount of imports.
 Import-competing producers are able to increase their prices
and sell more, the benefit of which is represented by area C.
 The distance Q2S – Q1S represents increased domestic
production and sales, and part of the reduction of imports.
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Tariffs when domestic consumers fully pay
• This analysis assumes that each group’s welfare is
equally weighted.
 We view and measure the (monetary) value of benefits and
losses of consumers, producers and the government equally
and objectively.
 One group’s or person’s loss is not weighted more than one
group’s or person’s benefit.
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Tariffs when domestic consumers fully pay
• But in practice some people favor one group more
than the other.
 Since the government sets policy, it might favor its own
interests over the interests of consumers and increase a tariff
for its benefit.
 If import-competing firms are politically influential, they can
lobby the government to increase a tariff for their benefit at
the expense of consumers.
 Millions of consumers, however, have difficulty organizing and
lobbying for lower tariffs.
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Tariffs when foreign producers partially pay
• When a country is large and important in a market, its
actions can affect the market price.
 In particular, if it sets a tariff on a product, the price in
international markets can fall because (quantity) demand(ed)
of the product falls significantly due to the more expensive
price that domestic consumers must pay.
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Tariffs when foreign producers partially pay
• Foreign firms might respond to a tariff by reducing
their prices for domestic consumers,
 because they believe this is necessary to maintain the market
share in the domestic market.
 or because the demand of their products has significantly
decreased.
 For example, if the US place a tariff on the cars from Korea,
Korean producers/sellers might have to lower their prices due
to the loss in the (quantity) demand(ed) in the US market,
which is large and important for the Korean producers/sellers.
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Tariffs when foreign producers partially pay
• Formally, economists say that a buyer with power to
influence the market price has monopsony power.
 A single buyer in a market, which would have the maximum
amount of power, is called a monopsony.
• A large and important country, one with monopsony
power, can cause foreign sellers to lower their prices
and earn tariff revenue at the same time.
• Even in competitive markets, a large reduction in
demand can force sellers to lower their prices.
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Tariffs when foreign producers partially pay
• On the other hand, foreign firms might respond to a
tariff simply by selling fewer exports (domestic imports)
instead of reducing prices.
 When foreign firms do not change their prices at all, then
domestic consumers fully pay for the tariff.
 In this case, buyers in the domestic market (and the
government that represents them) have no monopsony power.
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Tariffs when foreign producers partially pay
• But tariffs set by a large and important country still
have costs.
 As long as the prices with the tariffs increase in the domestic
market, domestic consumers will lose.
 In particular, there are still losses from less efficient/more
expensive production and from the fact that some consumers can
no longer afford to buy the more expensive products.
 However, if price increases are smaller relative to a case where
foreign sellers do not lower their prices, then the losses for
consumers are smaller.
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Tariffs when foreign producers partially pay
Price of
citrus fruit
Consumer surplus
after tariff
Domestic
supply
A
Tariff burden for
domestic consumers
Producer surplus
after tariff
Tariff burden for
foreign sellers
B
Price paid by
domestic consumers
Price without tariff
Price accepted by
foreign firms
0
E1
C
Tariff
E2
G
Domestic
demand
Imports with tariff
S
Q
S
D
Q QD
Q
Imports
without tariff
Higher price paid by
domestic consumers
Lower price received
by foreign sellers
Quantity of
citrus fruit
Tariffs when foreign producers partially pay
Price of
citrus fruit
Losses from some consumers
who are forced to buy more
expensive domestic citrus fruit.
Domestic
supply
A
Losses from consumers
who are no longer able
to afford citrus fruit.
B
Price paid by
domestic consumers
Price without tariff
Price accepted by
foreign firms
0
C
E1
D
F
E2
G
Domestic
demand
Imports with tariff
S
Q
S
D
Q QD
Q
Imports
without tariff
Tariff
Higher price paid by
domestic consumers
Lower price received
by foreign sellers
Quantity of
citrus fruit
Tariffs when foreign producers partially pay
• As before, losses for domestic consumers result from
1. being no longer able to afford more expensive domestic or
foreign products (area F).
2. being forced to buy a less efficiently and more expensively
produced domestic product instead of a similar foreign
product, and being forced to buy a more expensive domestic
product due to scarcity or lack of competition, even if they
bought the domestic product previously (areas C + D).
3. being forced to pay more for the imported product (area E1).
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Tariffs when foreign producers partially pay
• As before, some of these losses are offset by gains for
others, but some are not.
1. Domestic producers/sellers gain because domestic
consumers are forced to buy a more expensive product.
 They can sell more and charge a more expensive price, a gain
represented by area C.
2. The domestic government earns tariff revenue, represented
by area E1 + E2.
 But because foreign producers/sellers are willing to lower their
prices, they effectively absorb some of the cost of the tariff and
allow domestic consumers to save: E1 < E.
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Tariffs when foreign producers partially pay
• Losses for foreign producers/sellers result from
1. a decrease in the price (profit) of their exports (domestic
imports), which makes them share the burden of the tariff
with domestic consumers.
2. a decrease the quantity of their exports (domestic imports),
which also results in a loss in profit.
 We can measure this loss in profit by the loss in revenue (the full
price x quantity that could have been sold) minus the (marginal)
cost of production for the units not sold.
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Tariffs when foreign producers partially pay
• We can represent the losses for foreign producers/
sellers and for domestic consumers that are not offset
by representing
1. the (marginal) cost of production for foreign producers/
sellers, represented by an export supply function.
2. the (marginal) willingness to buy/pay by domestic consumers,
represented by an import demand function.
8-35
Tariffs when foreign producers partially pay
Price of
citrus fruit
Tariff burden for domestic
consumers: cost due to
higher prices paid
Price paid by
domestic consumers
represents the marginal
cost of production
(lower than for domestic
firms)
E1
Price without tariff
Price in accepted by
foreign firms
E2
Domestic demand
of imports
Tariff burden for foreign
producers/sellers: cost due to
lower prices (profit) received
0
Foreign supply of
exports
Quantity Quantity of
of imports imports
with tariff without tariff
represents the
(marginal) willingness
to pay/buy
Quantity of
citrus fruit
Tariffs when foreign producers partially pay
Price of
citrus fruit
Losses for domestic consumers
who no longer buy imports that
are not offset by domestic firm
Foreign supply of
gains or tariff revenue
exports
Price paid by
domestic consumers
E1
D+F
E2
H
Price without tariff
Price in accepted by
foreign firms
Domestic demand
of imports
Losses for foreign producers/
sellers: decrease in profit from
a decreased quantity of exports
0
represents the marginal
cost of production
(lower than for domestic
firms)
Quantity Quantity of
of imports imports
with tariff without tariff
represents the
(marginal) willingness
to pay/buy
Quantity of
citrus fruit
Optimal tariff
• The smaller deadweight losses for domestic consumers
could be completely offset by tariff revenue:
 The tariff revenue earned by the government that is effectively
paid by foreign producers/sellers when they lower their prices
(area E2) can be larger than consumer losses that are not offset
by gains of others (areas D + F).
• So the domestic country as a whole can benefit from
the tariff,
 at the expense of foreign firms who suffer from their own
deadweight losses (area H) and losses from being forced to
lower their prices (area E2).
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Optimal tariff
• When the domestic government can take advantage of
the willingness of foreign producers/sellers to lower
their prices in response to a tariff, it can calculate the
optimal tariff:
 the tariff that forces foreign firms to lower their prices the
most so that losses for domestic consumers are the smallest
relative to tariff revenue earned by the domestic government.
 However, this analysis assumes that foreign governments will
not respond likewise.
 Such “retaliation” would hurt domestic firms, possibly erasing any
gains from a tariff imposed by the domestic government.
8-39
Optimal tariff
• To calculate the optimal tariff, we consider a change in
the current tariff (possibly at zero) and
 the marginal (extra) gains from having foreign firms lower their
prices relative to
 the marginal losses for consumers from a more expensive
product.
• A rule from calculus says that when we have achieved
the optimal tariff, then
marginal gains – marginal losses = 0
8-40
Optimal tariff
• Let
 the current tariff be t0 and dt be a change in the tariff.
 M be the current quantity of imports and dM be the change
in imports from a change in the tariff.
 P be the current price charged by (and received by) foreign
firms and dP be the change in this price from a change in the
tariff.
 P* be the price paid by consumers and received by foreign
firms without a tariff (with free trade).
8-41
Optimal tariff
• then
 marginal gains from a change in the tariff, caused by foreign
firms lowering the prices of their products, is represented by
M ×dP/dt.
 total marginal losses from a change in the tariff, for domestic
consumers buying less and foreign firms selling less, is
represented by t0P ×dM/dt.
 domestic marginal losses from a change in the tariff, caused by
domestic consumers buying less, is represented by
((P + t0P)–P*)×dM/dt.
8-42
Optimal tariff
• Setting the marginal gains equal to the total marginal
losses and solving for t0 shows that
t0 = (M ×dP/dt)/(P ×dM/dt)
t0 = (M/P) ×(dP/dt)/(dM/dt)
• Setting the marginal gains equal to only domestic
marginal losses and solving for t0 shows that:
((P + t0P)–P*)×dM/dt = M ×dP/dt
(P + t0P)–P* = M ×(dP/dt)/(dM/dt)
t0 = (M/P) ×(dP/dt)/(dM/dt) + P*/P – 1
8-43
Optimal tariff
Price of
citrus fruit
Domestic marginal losses Total marginal losses of a
of a higher tariff from
higher tariff for domestic
domestic consumers
consumers and foreign firms
buying fewer imports
Foreign supply of
exports
((P + t0P) – P*)
represents the marginal
cost of production
(lower than for domestic
firms)
t0P
dP/dt
dM/dt
0
M
P
Marginal gains
Domestic demand
of higher tariff
of imports
from foreign
firms lowering
represents the
the prices of
(marginal) willingness
to pay/buy
their products.
Quantity of
citrus fruit
Effective rate of protection
• Tariffs can be applied to products that compete with
those which a firm sells, as well as to inputs to
production—materials and components—that a firm
buys to make its products.
 The tariffs on competing products allow a firm to increase its
price and its income/revenue.
 The tariffs on the inputs increase the costs of the producer.
• The effective rate of protection compares the tariffs on
products that compete with those which a firm sells
with the tariffs on inputs to production that a firm buys.
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Effective rate of protection
• To calculate the effective rate of protection for a firm,
we calculate the change in the price earned and the cost
paid from a change in tariffs:
Psell  C buy
 where
Psell_0  C buy_0
 ∆Psell = change in price earned as a seller
 ∆Cbuy = change in cost paid as a buyer
 Psell_0 = original price earned as a seller
 Cbuy_0 = original cost paid as a buyer
8-46
Effective rate of protection
• The difference between the price that a producer sells
a product for and the cost that it pays for its inputs to
production is called value added.
 It represents the additional value created in a good or service
from the production process.
 It also represents the value of the income/revenue earned by
the firm for producing and selling the product.
 The original value added equals Psell_0 – Cbuy_0
 The new value added equals Psell_1 – Cbuy_1
 where ∆Psell = Psell_1 - Psell_0
 where ∆Cbuy = Cbuy_1 - Cbuy_0
8-47
Effective rate of protection
with tariffs
without tariffs
value added
per unit sold:
income earned
by producers
costs of inputs
to production
value added
per unit sold:
income earned
by producers
costs of inputs
to production
8-48
Effective rate of protection
• The effective rate of protection can also be calculated
with value added:
v1  v0
v0
 where
 v 1 = Psell_1 - Cbuy_1
 v 0 = Psell_0 - Cbuy_0
8-49
Effective rate of protection
• The effective rate of protection can be negative,
 implying that the prices on the inputs to production increase
more than the prices on the products that the firm sells.
 or implying that the prices on the products that the firm sells
decrease more than the prices on the inputs to production.
8-50
Summary
1. Tariffs are taxes/duties on imported products that
raise their prices for domestic consumers.
2. Tariffs also raise the prices of domestic substitutes and
allow importing-competing firms to produce more
with less competition.
3. Tariffs allow the government to raise revenue, which it
can use to finance the administration/enforcement of
the tariff or to finance other projects.
8-51
Summary
4. Tariffs create various kinds of losses for domestic
consumers:
 some can no longer afford to buy imported products or
domestic substitutes because the prices of both increase.
 some must pay more for imported products.
 some must buy less efficiently and more expensively produced
domestic products instead of imported products.
 some continue to buy domestic products, but must pay more
due to scarcity or lack of competition in the domestic market.
8-52
Summary
5. The efficiency loss of the tariff represents the fact that
some domestic consumers
 must buy less efficiently and more expensively produced
domestic products instead of imported products.
 continue to buy domestic products, but must pay more due to
scarcity or lack of competition in the domestic market.
6. The import markup loss of the tariff represents the
fact that some domestic consumers
 must pay more for imported products.
8-53
Summary
7. The deadweight loss of the tariff represents the fact that
 some domestic consumers can no longer afford to buy
imported products or domestic substitutes because the prices
of both increase.
 some domestic consumers must buy less efficiently and more
expensively produced domestic products instead of imported
products.
 some losses for domestic consumers are not offset by gains for
domestic firms and the government.
 foreign firms are no longer able to profitably produce and sell
as much with the tariff.
8-54
Summary
8. If a country has monopsony power, its tariffs will force
foreign firms to lower their prices,
 which will reduce losses for domestic consumers,
 while still allowing the domestic government to earn tariff
revenue.
9. A country can have so much monopsony power that
its tariff revenue can be larger than deadweight losses
for domestic consumers, and the country as a whole
can gain at the expense of foreign firms.
8-55
Summary
10. An optimal tariff is one that forces foreign firms to
lower their prices so that losses for domestic
consumers are the smallest relative to tariff revenue
earned by the domestic government.
 At the optimal tariff, gains in tariff revenue from marginal
changes in the tariff = domestic consumer losses from
marginal changes in the tariff.
 However, when trying to use an optimal tariff, the domestic
government needs to be careful about retaliation from foreign
governments.
8-56
Summary
11. The effective rate of protection compares the tariffs
on the products that a firm sells with the tariffs on the
inputs to production that a firm buys.
12. The difference between the price that a producer sells
a product for and the cost that it pays for its inputs to
production is called value added.
8-57