Transcript Import Tariffs and Quotas Under Perfect Competition

8
IMPORT TARIFFS AND
QUOTAS UNDER
PERFECT COMPETITION
1
A Brief History of the
World Trade
Organization
2
The Gains from Trade
3
Import Tariffs for a
Small Country
4
Import Tariffs for a
Large Country
5
Import Quotas
6
Conclusions
Chapter Outline
• Introduction
• A Brief History of the World Trade Organization
• The Gains from Trade
 Consumer and Producer Surplus
 Home Welfare
 No-Trade
 Free Trade for a Small Country
 Gains from Trade
 Home Import Demand Curve
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Chapter Outline
• Import Tariffs for a Small Country
 Free Trade for a Small Country
 Effect of the Tariff






Effect of the Tariff on Consumer Surplus
Effect of the Tariff on Producer Surplus
Effect of the Tariff on Government Revenue
Overall Effect of the Tariff on Welfare
Production Loss
Consumption Loss
 Why are Tariffs Used?
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Chapter Outline
• Import Tariffs for a Large Country
 Foreign Export Supply
 Effect of the Tariff
 Terms of Trade
 Home Welfare
 Foreign and World Welfare
• Import Quotas
 Import Quota in a Small Country
 Free Trade Equilibrium
 Effect of the Quota
 Effect on Welfare
• Allocation of Quota
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Chapter Outline





Costs of Import Quotas in the U.S.
Growth in Exports from China
Welfare Cost of MFA
Import Quality
Reaction of the United States and Europe
• Conclusions
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Learning Objectives
• Understand what a trade policy is and why it is
used.
• Understand the history of the World Trade
Organization (WTO) and the General Agreement
on Tariffs and Trade (GATT).
• Understand what a tariff is and why it is used.
• Understand and be able to explain the effect of a
tariff on a small country.
• Understand and be able to explain the effect of a
tariff on a large country.
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Learning Objectives
• Understand how a large country could potentially
gain from implementing a tariff.
• Understand what a quota is and why it is used.
• Understand and be able to explain the effects of a
quota on a country.
• Understand how the quota can have costs even
greater than tariffs.
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Introduction
• During the 2000 presidential campaign, President
George W. Bush promised to consider
implementing a tariff on the imports of steel.
• This was a political move to secure votes in large
steel-producing states as the tariffs would
“protect” the domestic producers of steel.
• The steel tariff is an example of a trade policy—a
government action meant to influence the amount
of international trade.
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Introduction
• Because gains from trade are unevenly spread,
producers often feel the government should help
them limit losses due to competition from trade.
• Trade policy can include the use of import tariffs
(taxes on imports), import quotas (limits on
imports), and subsidies for exports.
• This chapter will focus on the use of tariffs and
quotas as trade policy.
• The international governing body, the World Trade
Organization (WTO), acts as a forum for trade
issues between countries.
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Introduction
• We will look at the history of the WTO, beginning
with its precursor, the General Agreement on
Tariffs and Trade (GATT).
• We will then examine in detail the most commonly
used trade policy, the tariff, looking at why they
are used and the consequences of their use.
• The chapter will also examine the use of import
quotas, showing that although their costs are
similar to tariffs, they can also be greater.
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Introduction
• Given the potentially greater costs of quotas, they
have been greatly reduced under the WTO.
• We will assume that firms are perfectly
competitive. They produce a homogeneous good
and are small compared to the market.
• Under perfect competition, each firm is a pricetaker in its market.
• Imperfect competition will be evaluated in the next
chapter.
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A Brief History of the
World Trade Organization
• When peace was reestablished following WWII,
representatives of 44 countries met in Bretton
Woods, NH, to discuss the rebuilding of Europe
and issues with high trade barriers and unstable
exchange rates.
• The outcome was an agreement outlining an
international system of free trade, convertible
currencies, and fixed exchange rates.
• As part of this Breton Woods Agreement, the
GATT was established in 1947 to reduce barriers
to trade between nations.
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A Brief History of the
World Trade Organization
• Under the GATT, countries met periodically to
negotiate for lower trade barriers between them.
• Each meeting was named for the location where it
took place and at the Uruguay Round, the WTO
was established.
• The WTO greatly expanded GATT by adding rules
that govern an expanded set of global interactions
through binding agreements.
• The most recent round of the WTO was the Doha
Round, in Doha, Qatar, which began in November
2001.
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A Brief History of the
World Trade Organization
•
Some Articles of GATT which still govern trade in
the WTO:
1. A nation must extend the same tariffs to all trading
partners that are WTO members. This is the “most
favored nation” clause
2. Tariffs may be imposed in response to unfair trade
practices such as dumping
3. Countries should not limit the quantity of goods and
services that they import. Article XI states that
countries should not maintain quotas against imports
4. Countries should declare export subsidies provided
to particular firms, sectors, or industries
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A Brief History of the
World Trade Organization
5. Countries can temporarily raise tariffs for certain
products. Article XIX is called the safeguard
provision or the escape clause and is our focus in
this chapter.
 The importing country can temporarily raise a tariff when
domestic producers are suffering due to import competition.
 European governments strenuously objected to the U.S. steel
tariffs, and filed a complaint against the U.S. with the WTO.
 A panel at the WTO ruled in favor of the European countries,
entitling them to retaliate by placing tariffs of their own on $2.2
billion worth of U.S. exports.
 This lead President Bush to remove the steel tariffs in
December 2003.
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A Brief History of the
World Trade Organization
6. Regional trade agreements are permitted under
Articles XXIV of the GATT
 Free trade areas
 Customs unions
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The Gains from Trade
• We will now demonstrate the gains from trade
using Home demand and supply curves, together
with the concepts of consumer surplus and
producer surplus.
• Consumer and Producer Surplus
 Figure 8.1 (a) shows the Home demand curve D where
consumers face a price of P1.
 A person buying unit D2 is willing to pay P2, but only
has to pay of P1.
 The individual obtains a surplus of (P2 – P1) from being
able to purchase the good for less than their willingness
to pay.
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The Gains from Trade
• Consumer and Producer Surplus
 For each unit before D1, the consumer’s value exceeds
the purchase price of P1.
 Adding up the surplus obtained on each unit
purchased, from zero to D1, gives the total surplus.
 The total satisfaction that consumers receive from the
purchased quantity D1, over and above the amount P1D1 that
they have paid.
 Consumer surplus then is the shaded region between
the demand curve and the market price, up to the total
quantity purchased, D1 in this case.
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The Gains from Trade
Figure 8.1 (a)
Price
Total Consumer
surplus, CS
Adding
up all curve
the individual
The demand
gives us the
surplus
for each
on the
consumer’s
valuepoint
for each
unit of
A consumer
who
demand
gives
us total D2
the
good.curve
Given
Ppurchases
1, consumers
has buy
a value
of P
only
has
consumer
surplus—the
area
will
a total
of2,Dbut
1.
to pay P1the
– that
gives and
surplus
between
demand
the
equalpaid—up
to (P2-P1)to the quantity
price
sold
P2
P1
Surplus for
consumer
purchasing quantity
D2
D
D2
D1
Quantity
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The Gains from Trade
• Part (b) of figure 8.1 illustrates producer surplus.
• At the price of P1, the industry will supply S1.
• Remember that the supply curve represents a
firm’s marginal cost of production.
• The firm supplying unit S0 could produce it with a
marginal cost of P0, but is able to sell it for P1.
 This gives the firm a surplus of (P1 – P0).
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The Gains from Trade
• For each unit sold before S1, the marginal cost to
the firm is less than the sale price of P1.
• If we add up all these individual surpluses
obtained for each unit sold from zero to S1, we get
the total producer surplus (PS).
• Producer surplus is the area above the supply
curve to the price received, up to the quantity
sold.
• We can also refer to PS as the return to fixed
factors of production in the industry, and can
loosely refer to it as “profit.”
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The Gains from Trade
Figure 8.1 (b)
Price
Total Producer
surplus, PS
S
The supply
curve
gives
us athe
A
producer
who
sells
S0 has
Adding
up all
the
individual
consumer’s
valuePpoint
for each
unit of
MC
of P0, but
gets
surpluses
for each
on the
1. That
the surplus
good.
producers
gives
equalPus
to
(P
1, total
supply
curveGiven
gives
1-P0)
will sell surplus—the
a total of S1. area
producer
between the supply and the price
received—up to the quantity sold.
P1
P0
Surplus for firm producing
quantity S0
S0
S1
Quantity
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The Gains from Trade
• Home Welfare
 Again we consider the world of two countries, Home
and Foreign, with producers and consumers.
 Total Home welfare can be measured by adding up
consumer and producer surplus.
 The greater the total surplus, the greater the total home
welfare—the better off the country is.
 We will compare the welfare in Home in no-trade and
free-trade situations.
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The Gains from Trade
• No-Trade
 In figure 8.2 (a), the no trade equilibrium occurs at the
autarky price of PA, where quantity demanded equals
quantity supplied at Q0.
 Consumer and producer surplus are shown as the
areas defined before. Adding these gives total surplus
for Home before trade.
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The Gains from Trade
Figure 8.2
(a) No-Trade
Price
No-trade equilibrium
S
CS
A
PA
PS
D
Q0
Quantity
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The Gains from Trade
• Free Trade for a Small Country
 Suppose Home can now engage in trade.
 The world price PW is determined by the supply and
demand in the world market (shown in in figure 8.2 (b)).
 Suppose Home is a small country.
 Price taker in the world market
 Faces a fixed price at PW
 Assume PW is below the Home no-trade price PA.
 At the lower price, Home quantity demanded will
increase to D1 and Home quantity supplied will
decrease to S1.
 Home will be an importer of the product at the world
price.
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The Gains from Trade
Figure 8.2
Price
At the free trade price of
PW, Home supply will fall to
S1 and Home demand will
rise to D1.
(b) Free Trade
S
PA
PW
D
S1
D1
Imports will make up for
the excess demand and
will equal (D1 – S1)
Quantity
Imports
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The Gains from Trade
• Consumers gain more than the producers lose
indicating total Home welfare increased.
• By looking at the changes in surplus we see:
Rise in consumer surplus
Fall in producer surplus
Net effect on Home welfare
+(b+d)
-b
d
• d is a measure of the gains from trade for the
importing country due to free trade.
• We can measure this gain directly using the
formula for the area of the triangle = ½ bh
 Welfare increase = ½ (M1)(PA-PW)
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The Gains from Trade
• Gains from Trade
 We can now measure the welfare effects for producers
and consumers under free trade.
 Since price has fallen under trade, we would expect this
to be good for consumers and therefore consumer
surplus to increase.
 Consumer surplus increases by b+d in figure 8.2 (b).
 Similarly, a lower price is worse for producers so we
would expect producer surplus to fall.
 Producer surplus falls by b in figure 8.2 (b).
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The Gains from Trade
Figure 8.2
At lower world price,
consumer surplus increases
to a+b+d  an increase of
b+d from no-trade
(b) Free Trade
Price
S
At lower world price,
producer surplus falls to c
 a decrease of b from
no-trade
a
PA
b
Gain in trade is triangle d
with area equal to
½(M1)(PA-PW)
d
PW
c
D
S1
D1
Quantity
Imports, M1
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The Gains from Trade
• Home Import Demand Curve
 We can derive the import demand curve, shown in
figure 8.3
 The relationship between the world price of a good and the
quantity of imports demanded by Home consumers.
 At the no-trade equilibrium, there are zero imports
 This is shown as point A′ in panel (b).
 At the world price of PW, the quantity demanded is
greater than quantity supplied, and we import M1.
 This is point B in panel (b).
 Joining A′ and B gives import demand curve M.
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The Gains from Trade
Figure 8.3
(b)
(a)
Price
No-trade
equilibrium
Price
S
A'
PA
Each point on the import
demand curve is a point
that corresponds to Home
imports at a given Home
price
A
B
PW
Import demand
curve, M
D
S1
Q0
D1
Quantity
M1
Imports
Imports, M1
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Import Tariffs for a Small Country
• We can now use the supply/demand framework to
show what happens when a small country
imposes a tariff.
• Remember that a small country is one where its
tariff does not have any effect on the world price.
• This means the price charged to Home
consumers will increase by the amount of the
tariff.
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Import Tariffs for a Small Country
• Free Trade for a Small Country
 We start with the free-trade-equilibrium for the Home
country (in figure 8.4).
 The Foreign export supply curve X* is horizontal at the
world price PW.
 This means that Home can import an amount at the price PW
without having an impact on that price.
 In free-trade-equilibrium, home demand is D1, Home
supply is S1, and imports are M1.
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Import Tariffs for a Small Country
• Effect of the Tariff
 With an import tariff of t dollars, the export supply curve
facing Home shifts up by exactly the amount of the
tariff.
 The new export supply curve shifts up to X*+t.
 The new intersection now occurs at the price of PW+t
and the import quantity of M2.
 The import tariff has reduced the amount imported,
from M1 under free trade to M2 under the tariff, due to
the higher price.
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Import Tariffs for a Small Country
• Effect of the Tariff
 At the higher import price, the quantity demanded at
Home falls and the quantity supplied at Home rises
from S1 to S2. .
 However, as firms increase the quantity produced, the
marginal costs of production rise.
 The home supply curve reflects marginal costs so the
Home price rises along S until firms are supplying
quantity S2 at a MC just equal to the new price, PW+t.
 The domestic price will equal the import price.
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Import Tariffs for a Small Country
• Effect of the Tariff
 Home price rises to PW+t thereby decreasing the
quantity demanded at Home
 Higher prices increase the quantity supplied at Home.
 Less excess demand therefore imports fall.
 Foreign exporters still receive the “net-of-tariff” price,
PW.
 These changes affect producer and consumer surplus,
and overall Home welfare.
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Import Tariffs for a Small Country
Figure 8.4
Home price rises by the amount
of the tariff.
No-trade
equilibrium
Price
Price
S
Home supply increases and
Home demand decreases 
Imports fall to M2
A
C
PW+t
X*+t
B
Foreign export
supply, X*
PW
D
S1 S2
D2
M2
D1
Quantity
M
M2
M1
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Imports
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Import Tariffs for a Small Country
• Effect of the Tariff on Consumer Surplus
 With the tariff, consumers now pay the higher price,
PW+t, and their surplus is the area under the demand
curve and above the higher price, PW+t.
 The fall in consumer surplus due to the tariff is the area
in-between the two prices and to the left of Home
demand, (a+b+c+d) in panel (a.1) of figure 8.5.
 This area is the amount that consumers lose due to the
higher price caused by the tariff.
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Import Tariffs for a Small Country
Figure 8.5 (a.1)
No-trade
equilibrium
Lost consumer surplus due
to the higher price with the
tariff is equal to the shaded
area (a+b+c+d)
Price
S
A
b
d
PW+t
a
c
PW
D
S1
S2
D2
D1
Quantity
M2
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Import Tariffs for a Small Country
• Effect of the Tariff on Producer Surplus
 With the tariff, producer surplus is the area above the
supply and below the higher price, PW+t.
 Since the tariff increases Home price, firms can sell
more goods, and producer surplus increases
 This area, a in figure 8.5 (a.2), is the amount that Home
firms gain due to the higher price caused by the tariff.
 Increases in producer surplus can benefit Home
workers but at the expense of consumers.
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Import Tariffs for a Small Country
Figure 8.5 (a.2)
No-trade
equilibrium
The gain in producer
surplus due to the higher
price with the tariff is equal
to the shaded area (a)
Price
S
A
b
d
PW+t
a
c
PW
D
S1
S2
D2
D1
Quantity
M2
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Import Tariffs for a Small Country
• Effect of the Tariff on Government Revenue
 In addition to the tariff’s impact on consumers and
producers, it also affects government revenue.
 The amount of revenue collected is the tariff t times the
quantity of imports (D2 – S2).
 In figure 8.5 panel (a.3), the revenue is shown by area
c.
 The collection of revenue is a gain for the government
in the importing country.
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Import Tariffs for a Small Country
Figure 8.5 (a.3)
The gain in government
revenue due to the tariff is
equal to the shaded area
(c)
No-trade
equilibrium
Price
S
This equals the tariff, t,
times the quantity of
imports, M2
A
b
d
PW+t
a
c
PW
D
S1
S2
D2
D1
Quantity
M2
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Import Tariffs for a Small Country
• Overall Effect of the Tariff on Welfare
 We can now summarize the total impact of the tariff on
the welfare of the Home importing country by adding
the gains and losses for each party.
 Note, we do not care whether the consumers facing
higher prices are rich or poor, and do not care whether
the specific factors in the industry earn a lot or a little.
 Under this approach, transferring one dollar from
consumer to producer surplus will have no impact on
overall welfare.
 We are simply evaluating the efficiency of the tariff.
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Import Tariffs for a Small Country
• Overall Effect of the Tariff on Welfare
 The overall impact of the tariff in the small country can
be summarized as follows:
Fall in consumer surplus
Rise in producer surplus
Rise in government revenue
Net effect on Home welfare
-(a+b+c+d)
+a
+c
-(b+d)
• The areas b and d in figure 8.5 (a) correspond to
the triangle (b+d) in figure 8.5 (b) and is the net
welfare loss.
 We refer to this area as a deadweight loss—it is not
offset by a gain elsewhere in the economy.
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Import Tariffs for a Small Country
Figure 8.5 (a)
The deadweight loss is the
loss to Home that is not
offset by a corresponding
gain
No-trade
equilibrium
Price
S
a is a transfer from
consumers to producers
A
b
c is a transfer from
consumers to government
d
PW+t
a
(b+d) is deadweight loss—
losses not offset by other
gains
c
PW
D
S1
S2
D2
D1
Quantity
M2
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Import Tariffs for a Small Country
Figure 8.5 (b)
Price
Dead weight loss
due to tariff, b+d
X*+ t
C
X*
M
M2
M1
Imports
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Import Tariffs for a Small Country
• Overall Effect of the Tariff on Welfare
 The area a is effectively a transfer from consumers to
producers via the higher domestic prices induced by
the tariff.
 The area c, the gain in government revenue, is a
transfer from consumers to the government.
 The deadweight loss, (b+d), is measured by the two
triangles b and d.
 The two triangles can each be given a precise
interpretation.
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Import Tariffs for a Small Country
• Production Loss
 The base of b is the net increase in Home supply due
to the tariff, from S1 to S2.
 The height of this triangle is the increase in marginal
costs due to the increase in supply.
 The fact that marginal costs are greater than world
price means that this country is producing the extra
supply inefficiently.
 Fewer resources would be used if imported rather than
produced at home.
 The area of b is the production loss or efficiency loss—
due to producing at marginal costs above world price.
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Import Tariffs for a Small Country
• Consumption Loss
 The triangle d also has a precise definition.
 Due to the tariff, the price increase from, PW to PW+t
reduces quantity consumed at Home from D1 to D2.
 The area of the triangle can be interpreted as the drop
in consumer surplus for those individuals who are no
longer able to consume the units from D1 to D2 because
of the higher price.
 We refer to this drop in consumer surplus as the
consumption loss for the economy.
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Why are Tariffs Used?
• Finding that tariffs always lead to deadweight
losses for small countries explains why most
economists are opposed to them.
• Why then do so many countries use tariffs?
 One idea is that developing countries do not have any
other source of revenue.
 Import tariffs are “easy-to-collect” because every country has
customs agents at major ports checking the goods crossing the
borders.
 However, to the extent that developing countries
recognize that tariffs have a higher deadweight loss, we
would expect that over time they will shift away from
such “easy-to-collect” taxes.
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Why are Tariffs Used?
• Why then do so many countries use tariffs?
 A second reason is politics.
 If the government cares more about producer surplus
than consumer surplus, it might decide to use the tariff
despite the deadweight loss it incurs.
 The benefits to producers (and their workers) are
typically more concentrated on specific firms and states
than the costs to consumers, which are spread
nationwide.
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Globalization and Developing Countries
SIDE BAR
• Developing countries rely on “easy-to-collect”
tariffs over “hard-to-collect” income and valueadded taxes.
• As globalization expands, we would expect these
countries to move away from tariffs to the more
hard-to-collect revenues.
• According to one research study, the ratio of tax
revenue to GDP obtained from easy-to-collect
taxes fell by about 20% in developing countries
between the 1980s and 1990s.
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Globalization and Developing Countries
SIDE BAR
• At the same time the ratio of tax revenue to GDP from
“hard-to-collect” revenue rose by 9% in the developing
countries.
• The loss from “easy-to-collect” taxes was not enough to
make up for the gain from “hard-to-collect” taxes.
 It is harder to improve the performance of “hard-to-collect” taxes
than it is to shift away from the “easy-to-collect” taxes for low
income countries.
• High- and middle-income countries were able to obtain a
net increase in tax revenue from this process.
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U.S. Tariffs on Steel
APPLICATION
• We can use our small country model from above
to calculate a rough estimate of how costly these
tariffs were in terms of welfare.
• We will estimate the deadweight loss due to the
U.S. steel tariff in place from March 2002 to
December 2003.
• President Bush requested that the U.S.
International Trade Commission (ITC) initiate a
Section 201 investigation into the steel industry.
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U.S. Tariffs on Steel
APPLICATION
• The ITC determined that the conditions were met
and recommended that tariffs be put in place to
protect the U.S. steel industry.
• The tariffs varied across products, ranging from
10 to 20%—shown in Table 8.1—then falling over
time to be eliminated after 3 years.
• The ITC decision showed it thought that the
losses from rising imports and falling prices met
the conditions of “serious injury.”
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U.S. Tariffs on Steel
APPLICATION
• President Bush took the recommendation of the
ITC but applied even higher tariffs, ranging from
8% to 30%.
• Knowing the U.S. trading partners would be upset
by this, President Bush exempted some countries
from the tariffs.
 These included Canada, Mexico, Jordan, and Israel,
which all have free trade agreements with the U.S., and
100 small developing countries that were exporting only
a very small amount of steel to the U.S.
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U.S. Tariffs on Steel
APPLICATION
Table 8.1
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U.S. Tariffs on Steel
APPLICATION
• Deadweight Loss due to the Steel Tariff
 We need to estimate the areas of triangle b+d we found
in figure 8.5(b).
 The base is the change in imports, ΔM, and the height
is the increase in domestic price, ΔP = t.
 Deadweight loss then equals DWL = ½ t ΔM.
 It is convenient to measure the deadweight loss relative
to the value of imports, which is PW*M.
 We will also use the percentage tariff, t/PW, and the
percentage change in the quantity of imports, % ΔM =
ΔM/M.
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U.S. Tariffs on Steel
APPLICATION
Figure 8.5 (b)
Price
We can measure DWL
with the area of the
triangle b+d from figure
8.5 (b)
Deadweight loss due
to the tariff, b+d
DWL = ½ t ΔM
PW+t
c
t
PW
M
M2
M1
Imports
ΔM
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U.S. Tariffs on Steel
APPLICATION
• Using these definitions, the deadweight loss
relative to the value of imports can be rewritten
as:
DWL  1  tM
1 t
  W
  W
W
P M 2 P M 2 P

%M

• The most commonly used products had a
tariff of 30%, so the percentage increase in
the price is t/PW = 0.3, leading to %ΔM = 0.3.
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U.S. Tariffs on Steel
APPLICATION
• This leads to a DWL of
DWL 1  t 
1
  W %M  (0.3)(0.3)  4.5%
W
P M 2 P 
2
• The value of steel imports affected by the
tariff was about $4.7 billion prior to March
2002 and $3.5 billion after March 2002.
 Average imports over the two years were then
$4.1 billion.
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U.S. Tariffs on Steel
APPLICATION
• Applying the DWL of 4.5% to the average import
value of $4.1 billion, then the dollar magnitude of
deadweight loss is equal to $185 million.
• This deadweight loss reflects the net annual loss
to the U.S. from applying the tariff.
 A steel worker might think this is ok to protect jobs, but
consumers would not agree.
2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor
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U.S. Tariffs on Steel
APPLICATION
• Response of the European Countries
 The tariffs on steel most heavily affected Europe,
Japan, and South Korea, along with some developing
countries.
 The countries in the European Union therefore took
action by bringing the case to the WTO.
 The WTO has a formal dispute settlement procedure,
under which countries can bring complaint and have it
evaluated.
 The WTO ruled that the U.S. had failed to prove its
steel industry had been harmed by imports and
therefore did not have the right to impose the tariffs.
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U.S. Tariffs on Steel
APPLICATION
• Response of the European Countries
 Even if we accept that there might be an argument on
equity or fairness grounds for temporarily protecting an
industry facing import competition, it is hard to argue
that such protection should occur due to a change in
exchange rates.
 The appreciation of the dollar lowered prices for all
other imports too, so many industries faced
competition.
 Why should the steel industry be protected and not the
others?
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U.S. Tariffs on Steel
APPLICATION
• Response of the European Countries
 The WTO ruling entitled the European Union and other
countries to retaliate against the U.S. by imposing
tariffs of their own against U.S. exports.
 The EU quickly began to draw up a list of products and
naturally picked products that would have the greatest
impact on the U.S.
 The threat of tariffs led President Bush to reconsider
the U.S. tariffs on steel, and on December 5, 2003, he
announced that they would be suspended.
 You can see how this chain of events could lead to a
tariff war.
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Europe’s Little List
HEADLINES
• How are steel and orange juice related?
• When the WTO ruled that the U.S. tariffs on steel
violated international trade law, it allowed the
European Union to implement $2.2 billion in
retaliatory taxes on U.S. exports.
• On the list were oranges and orange juice, big
exports of Florida, a major swing state with Jeb
Bush as Governor—the President’s brother.
• Michigan and Wisconsin apples and California
farm products were also on the list.
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Europe’s Little List
HEADLINES
• Another industrial group targeted was the makers
of industrial farm equipment like John Deere and
Caterpillar—both based in the key electoral state
of Illinois.
• Toilet paper might seem like an odd item for the
hit list, but is part of the paper industry, which was
targeted because it affected a number of
important states.
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Import Tariffs for a Large Country
• Under the small country assumption that we have
used so far, the importing country is always
harmed due to the tariff.
 The small country is a world price taker.
• If we consider a large enough importing country or
a large country, however, then we might expect
that its tariff will change the world price.
 Its imports are large enough that it can affect world
price with a change in its imports.
© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor
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Import Tariffs for a Large Country
• Foreign Export Supply
 If the Home country is large, then the Foreign export
supply curve X* is no longer horizontal at the world
price PW.
 We need to derive the foreign export supply curve
using the Foreign market demand and supply curves.
 In panel (a) of figure 8.6, we show the Foreign demand
curve D* and supply curve S*, giving price of PA* at A*.
 At this point, Foreign exports are zero.
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Import Tariffs for a Large Country
• Foreign Export Supply
 Suppose the world price is PW above PA*.
 At the higher price, Foreign quantity demanded is lower
at D1*, but quantity supplied by foreign firms is higher at
S1*.
 Foreign excess supply of X1* = S1* - D1*, will be
exported at the price of PW at point B*.
 Connecting A* and B* gives the upward sloping Foreign
export supply curve, X*.
 Combining with Home import demand, M, we get an
equilibrium at PW and X1*. *
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Import Tariffs for a Large Country
Figure 8.6
(b) World Mkt
(a) Foreign Mkt
Pric
e
World price increases to PW,
increasing exports to X1*
This gives us our Foreign
export supply curve for the
large country
Price
At the world price, PA*,
exports are zero at A*’
Foreign export
supply, X*
S*
D*
B*
PW
Home import
demand, M
PA*
A*'
A*
D1*
S1*
Quantity
X1*
Exports
Foreign exports, X1*
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Import Tariffs for a Large Country
• Effect of the Tariff
 Figure 8.7 we show the effect when Home applies a
tariff of t dollars on imports.
 The tariff increases the cost to Foreign producers of
supplying to the Home market.
 Foreign export supply curve shifts up by exactly the
amount of the tariff, shifting from X* to X*+t.
 The new supply crosses demand at C, giving a new
Home price.
 However, notice that the price that Foreign producers
receive, P*, ends up below the original free trade price.
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Import Tariffs for a Large Country
• Effect of the Tariff
 The price Home pays for its imports P*+t rises by less
than the amount of the tariff, t, as compared to the
initial world price, PW.
 This is because the price received by
foreign exporters, P*, has fallen as compared to the
initial world price, PW.
 Foreign producers are essentially “absorbing” a part of
the tariff, by lowering their price from PW to P*.
 The tariff drives a wedge between what Home
consumers pay and what foreign producers receive,
with the difference, t, going to the Home government.
© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor
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Import Tariffs for a Large Country
Figure 8.7
(without welfare effects)
(a) Home market
(b) Foreign market
Price
Price
No-trade
equilibrium
X*+t
S
A
X*
t
C
P*+t
t
t
PW
P*
B*
C*
D
M
S1 S2
D2 D1
Quantity
M2
M1
Imports
M2
M1
© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor
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Import Tariffs for a Large Country
• Terms of Trade
 Remember terms of trade is the ratio of export prices to
import prices.
 In order to measure terms of trade, we want to use the
net-of-tariff import price, P*.
 Since P* is lower than PW, it follows that the Home
terms of trade has increased.
 We might expect, therefore, that the Home country
gains from the tariff
 We need to analyze the impact of the tariff on Home
consumers, producers, and government revenue.
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Import Tariffs for a Large Country
• Home Welfare
 The higher Home price makes consumers worse off,
lowering consumer surplus (shown by (a+b+c+d) in
figure 8.7).
 Home firms are better off with the higher price and
increased surplus, a.
 Revenue collected from the tariff equals the amount of
the tariff, t, times the new amount of imports, M2, giving
total revenue of (c+e).
 Summing all the gains and losses, we obtain the overall
impact of the tariff in the large country.
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Import Tariffs for a Large Country
• Home Welfare
Fall in consumer surplus
Rise in producer surplus
Rise in government revenue
Net effect on Home welfaree
-(a+b+c+d)
+a
+(c + e)
– (b+d) + (e)
• The triangle (b+d) is the deadweight loss due to
the tariff.
• But notice, there is a source of gain, e, that offsets
part of the loss.
• If e > (b+d), then Home is better off.
• If e < (b+d), then Home is worse off.
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Import Tariffs for a Large Country
Figure 8.7
(with welfare effects)
If the gain of e is greater than the loss of (b+d), Home gains
(a) Home market
(b) Foreign market
No-trade
equilibrium
Price
Price
X*+t
S
b+d
A
t
X*
C
P*+t
a
c
b
PW
P*
d
e
B*
e
D
C*
M
S1 S2
D2 D1
Quantity
M2
M1
© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor
Imports
80 of 136
Import Tariffs for a Large Country
• Home Welfare
 We see that a large importer might gain due to the
application of a tariff.
 However, for the large country, any net gain due to the
tariff comes at the expense of the Foreign exporters.
 Although Home might gain from the tariff, Foreign
definitely loses
© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor
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Import Tariffs for a Large Country
• Foreign and World Welfare
 The Foreign loss, measured by (e+f) also in figure 8.7,
is the loss in Foreign producer surplus from selling
fewer goods to Home at a lower price.
 The area e is the terms-of-trade gain for Home but an
equivalent terms-of-trade loss for Foreign.
 Additionally, there is an extra deadweight loss in
Foreign of f, giving a combined total greater than the
benefits to Home.
 Therefore, it is sometimes called the “beggar thy neighbor”
tariff.
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Import Tariffs for a Large Country
Figure 8.7
(with welfare effects)
Foreign loses (e+f) as loss of Foreign producer surplus,
from selling fewer goods at a lower price
(a) Home market
(b) Foreign market
No-trade
equilibrium
Price
Price
X*+t
S
b+d
A
t
X*
C
P*+t
a
c
b
PW
P*
d
e
B*
e
D
C*
f
M
S1 S2
D2 D1
Quantity
M2
M1
© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor
Imports
83 of 136
Import Tariffs for a Large Country
• Foreign and World Welfare
 Adding together the change in Home and Foreign
welfare, e cancels out leaving a net loss to world
welfare of (b+d+f).
 We saw this triangle in panel (b) of figure 8.7, which is
the deadweight loss for the world.
 The fact that the large country tariff leads to a world
deadweight loss is another reason that most
economists oppose the use of tariffs.
© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor
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U.S. Tariffs on Steel Once Again
APPLICATION
• Returning to the U.S. tariff on steel, we can
reevaluate the effect on U.S. welfare in the largecountry case.
• If the U.S. is a large enough importer of steel,
then the foreign export price will fall and the U.S.
import price will rise by less than the tariff.
 It is possible that the U.S. gained from the tariff.
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U.S. Tariffs on Steel Once Again
APPLICATION
• Optimal Tariff
 We can compute the deadweight loss (area b+d) and
the terms-of-trade gain (area e) for each imported steel
product.
 This would give us the information to see if the U.S.
gained from the steel tariffs.
 Rather than do all these calculations, however, we can
use the concept of the optimal tariff.
 This is the tariff that leads to the maximum increase in
welfare for the importing country.
 We have shown that for a small tariff, a large country
can gain. But if the tariff is too large, the country will still
lose.
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U.S. Tariffs on Steel Once Again
APPLICATION
• Optimal Tariff
 Figure 8.8 graphs Home welfare against the level of the
tariff.
 Free trade is at point B where the tariff is zero.
 Starting at B, increasing the tariff can increase the
importer’s welfare, to a point.
 If the tariff is too large, then welfare will fall below the
free trade level of welfare.
 For example, a prohibitive tariff is one so high there are no
imports—this is point A.
 Given this, you can see that the highest point of welfare
for the importing country is shown by C.
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U.S. Tariffs on Steel Once Again
APPLICATION
The Optimal tariff maximizes
the Importer’s welfare, Point C
Figure 8.8
Terms of trade gain
exceeds deadweight
loss
Importer’s
Welfare
Too high of a tariff will decrease
importer’s welfare and can
increase to the point where
there is no trade
C
Terms of trade gain is
less than deadweight
loss
B'
Free Trade
B
A
No Trade
Optimal
Tariff
Prohibitive
Tariff
Tariff
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U.S. Tariffs on Steel Once Again
APPLICATION
• Optimal Tariff Formula
 The optimal tariff depends on the elasticity of Foreign
export supply, EX*.
 This is the percentage change in the quantity exported in
response to a percent change in the world price of the export.
 If the export supply curve is very steep, there is little response
in quantity supplied—inelastic—EX* is low.
 If the export supply curve is very flat, there is a large response
in quantity supplied—elastic—EX* is high.
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U.S. Tariffs on Steel Once Again
APPLICATION
• Optimal Tariff Formula
Optimal Tariff = 1/EX*.
 For a small importing country, the elasticity of Foreign
export supply is infinite, and so the optimal tariff is zero.
 As the elasticity of Foreign export supply decreases,
Foreign export supply curve is steeper, the optimal tariff
is higher.
 With a steep Foreign export supply curve, Foreign exporters will
lower their price more in response to the tariff.
2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor
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U.S. Tariffs on Steel Once Again
APPLICATION
• Optimal Tariffs for Steel
 If we apply this formula to the U.S. steel tariffs, we can
see how the tariffs applied compare to the theoretical
optimal tariff.
 Table 8.2 shows various steel products along with their
respective elasticities of export supply to the U.S.
 We can compare the actual tariff to the optimal tariff to
see where there were gains and where there were
losses from the tariffs.
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U.S. Tariffs on Steel Once Again
APPLICATION
• For alloy steel flat-rolled products, the actual tariff
was 30%, which is far below the optimal tariff.
 The terms of trade gain for that product was higher than
the deadweight loss.
 U.S. welfare is above its free trade level.
• In summary, two products had terms of trade
greater than the deadweight loss, but the third
had a larger deadweight loss.
 The first two illustrate the large country case, while the
third illustrates the small country case.
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U.S. Tariffs on Steel Once Again
APPLICATION
Table 8.2
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U.S. Tariffs on Steel Once Again
APPLICATION
• Even if there was an overall terms of trade gain
for the U.S. when adding up across all steel
products, that gain would be at the expense of the
European countries and other steel exporters.
• By allowing exporting countries to retaliate with
tariffs, the WTO prevents importers from using
optimal tariffs to their own advantage.
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Import Quotas
• On January 1, 2005, China was poised to become
the world’s largest exporter of textiles and
apparel.
 On that date, the Multifibre Arrangement (MFA) was
abolished.
 Under the MFA, import quotas restricted the amount of
nearly every textile and apparel product that was
imported to Canada, Europe, and the U.S.
 The quotas were to protect their own domestic firms
producing those products.
 With the end of the MFA, China was ready to enjoy
greatly increased imports.
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Import Quotas
• The threat of import competition from China led
the U.S. and Europe to negotiate new quotas with
China.
• There are other examples of quotas
 Europe had a quota on the imports of bananas that
allowed for a greater number of bananas to enter from
its former colonies in Africa than from Latin America.
 In 2005, this quota became a tariff.
• In the next section, we explain how quotas affect
the importing and exporting countries, and
examine the differences between quotas and
tariffs.
© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor
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Europe Reaches Deal on Banana Imports
HEADLINES
• The European Union changed their trade barriers
to allow banana imports from countries that were
once European colonies and to restrict imports
from other countries, primarily in Latin America.
• The proposal was to implement one import tariff
but no quotas on bananas except for former
French, British, and Portuguese colonies, which
will continue to enjoy duty-free access.
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Europe Reaches Deal on Banana Imports
HEADLINES
• This change replaces the prior trade policy that
was a mixture of tariffs and quotas, but is still
higher than the Latin American countries are
content with.
• The European countries are split over what to do
about these policies.
 Some want to protect their own growers’ interests and
others want to keep prices low for consumers.
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Sweet Opportunity
HEADLINES
• The current U.S. sugar program guarantees that
American sugar producers receive a set price for
their product.
• If they are not able to sell all their sugar at the
“break-even” price after accounting for their loans,
they can sell the excess to the U.S. Department of
Agriculture.
• To keep from storing a large stock of sugar, the
U.S. regulates supply by imposing import quotas
on sugar.
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Sweet Opportunity
HEADLINES
• But, the U.S. price of sugar has been two to three
times higher than the world price of sugar for
about 25 years.
• The longer the protection holds, the more
inefficient the U.S. producers become, and the
more powerful they become as a special interest
group.
• Given that the current world price of sugar has
increased and put foreign producers on par with
the U.S., there is an opportunity to do away with
the sugar program.
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Import Quotas
• Import Quota in a Small Country
• Free Trade Equilibrium
 Figure 8.9 (a) shows the free-trade-equilibrium at a
world price of PW, home quantity demanded of D1,
quantity supplied of S1, with imports of M1 as before.
 Assuming the country is small means the world price is
not affected by the import quota so the Foreign export
supply curve, X*, is horizontal at PW.
 We can see the free trade amount of imports in panel
(b) as well: M1 at PW.
© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor
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Import Quotas
Figure 8.9
(without quota) At PW, Home Supplies
S1, Demands D1, and
Imports M1
No-trade
equilibrium
In free trade equilibrium for a small
country, Foreign faces a horizontal
export supply curve, X*, at the
world price PW
S
Price
Price
A
B
PW
Home import
demand, M
D
S1
D1
M1
(a) Home market
Foreign export
supply, X*
Quantity
M1
Imports
(b) Import market
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Import Quotas
• Effect of the Quota
 Suppose the import quota of M2<M1 is imposed.
 Quantity imported cannot exceed this amount.
 The essentially gives us a vertical supply curve, X in
panel b (at prices above PW).
 Fixes the import quantity at M2.
 The vertical export supply curve now intersects import
demand at point C, which establishes the Home price
of P2.
 In panel a, the price of P2 leads firms to increase the
quantity supplied to S2 and consumers to decrease
their quantity demanded to D2.
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Import Quotas
• Effect of the Tariff
 The import quota leads to an increase in the Home
price and a reduction in Home imports, just like the
tariff.
 We can see what the equivalent tariff, the tariff that
would be set to give the same quantity and price as the
quota, would be: t = P2 – PW.
 For every level of import quota, there is an equivalent
import tariff.
© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor
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Import Quotas
• Effect on Welfare
 The rise in price from the quota leads to a fall in
consumer surplus: (a+b+c+d).
 The increase in price facing Home producers leads to a
gain in producer surplus: a.
 What changes with the quota is the area c which was
government revenue under the tariff.
 With a quota, whoever is actually importing the good
will be able to earn c, the difference between the world
price and the higher Home price times the imports sold
in the Home market.
© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor
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Import Quotas
Figure 8.9
Consumers
loseshigher
surplus
of (a+b+c+d),
theQuota,
new
price
Pexport
The
new
Export
Supply
curve
2,
WithAt
the
the Foreign
Always
have
a
deadweight
producers
gain
(a). increases
Home
Supply
to quota
crosses
the
Import
Demand
curve
at
supply
becomes
vertical
loss of (b+d) like the
tariffat the
S2,price
Demand
decreases
towhat
aquantity
new
and depends
quantity
of
Welfare
of
Home
onimports
D2 and
imports fall to M2
happens
to (c).
(with quota)
No-trade
equilibrium
S
Price
Price
X
F
o
r
A
d
e
b
i C
b+d
P2
g
a
c
c n
B
e
PW
x
p
o
D
r
t
Quantity
D2 D1
S1 S2
M
M1
s 2
u
p Import market
(b)
(a) Home market
p
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Foreign export
supply, X*
Home import
demand, M
Imports
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Import Quotas
•
•
The difference between these two prices is the
rent associated with the quota.
Area c represents the total quota rents.
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Import Quotas
•
There are four possible ways these rents can be
allocated.
1. Giving the Quota to Home Firms:

Quota licenses can be given to Home firms

Permits to import the quantity allowed under the quota system.

The net effects on Home welfare due to the quota are then as
follows:
Fall in consumer surplus
-(a+b+c+d)
Rise in producer surplus
+a
Quota rents earned at Home
+c
Net effect on Home welfare: -(b+d)


This is the same loss we saw with a tariff.
(b+d) is still a deadweight loss associated with the quota.
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Import Quotas
2. Rent Seeking
 Because of the gains associated with owning a quota
license, firms have an incentive to engage in
inefficient activities in order to obtain them.
 How licenses are allocated matters.
a. If licenses are allocated in proportion to each firm’s
production, Home firms will likely produce more than they
can sell just to obtain the import licenses for the following
year.
b. Firms might engage in bribery or other lobbying activities to
obtain the licenses.
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Import Quotas
 Some suggest that the waste of resources devoted to
rent seeking could be as large as the value of the rents
themselves, c.
 If rent seeking occurs, welfare loss of quota is:
Fall in consumer surplus
Rise in producer surplus
Net effect on Home welfare:
-(a+b+c+d)
+a
-(b+c+d)
 This loss is larger than a tariff.
 It is thought rent seeking is worse in developing
countries.
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Import Quotas
3. Auctioning the Quota


The government of the importing country to auction off
the quota licenses.
In a well-organized, competitive auction, the revenue
collected should exactly equal the value of the rents.
Fall in consumer surplus
Rise in producer surplus
Auction revenue earned at Home
Net effect on Home welfare:

-(a+b+c+d)
+a
+c
-(b+d)
This is the same loss as the tariff.
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Auctioning Import Quotas in
Australia and New Zealand
APPLICATION
• During the 1980s, Australia and New Zealand
both auctioned the quota licenses to import
specific goods.
• Table 8.3 shows the value of imports covered by
quotas curing 1981–1987.
• In 1988, New Zealand announced plans to phase
out import quotas as part of a liberalization of
trade, and all quota licenses were eliminated by
1992.
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Auctioning Import Quotas in
Australia and New Zealand
APPLICATION
• Table 8.3 also shows the value of bids for the
quota licenses.
 These are estimates of rents.
• If we take the ratio of the value of bids to the
value of imports covered by the quota, we
obtain an estimate of the tariff equivalent to
the quota.
 These are shown in the final column of table 8.3
• Since there was no penalty from not following
through, some firms decided not to purchase
the licenses after all.
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Auctioning Import Quotas in
Australia and New Zealand
APPLICATION
Table 8.3
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Auctioning Import Quotas in
Australia and New Zealand
APPLICATION
• The government therefore did not collect all the
winning bids as revenue.
• For those that did buy their licenses, they could
be resold and some were at much higher prices.
• This makes it appear that the government was not
collecting all of the rents in area c.
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Import Quotas
4. “Voluntary” Export Restraint
 The importing country can give authority for
implementing the quota to the exporting government.
 This is often called a “voluntary” export restraint (VER)
or a “voluntary” restraint agreement (VRA).
 In the 1980s the U.S. used this type of arrangement to
restrict imports of Japanese automobiles.

The Japanese government told each Japanese firm how much
it could export to the U.S.
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Import Quotas
• With VERs, quota rents are earned by foreign
producers, making Home welfare:
Fall in consumer surplus
Rise in producer surplus
Net effect on Home welfare:
-(a+b+c+d)
+a
-(b+c+d)
• This is a higher net loss than with a tariff.
• Why would an importing country do this?
 It is typically political—the exporting country is less
likely to retaliate since they gain the area c.
 This can often avoid a tariff or quota war.
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Import Quotas
• Costs of Import Quotas in the U.S.
 Table 8.4 presents some estimates of Home
deadweight losses and quota rents for some major U.S.
quotas in the 1980’s.
 In all cases except Dairy, the rents were earned by
Foreign exporters.
 Adding up the costs in the table, the total U.S.
deadweight loss due to these quotas ranged from $8–
$12 billion annually.
 Quota rents transferred another $7–$17 billion to
foreigners.
 Some, but not all, of these costs are relevant today
since many of the quotas are no longer in place.
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Import Quotas
Table 8.4
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China and the Multifibre Arrangement
APPLICATION
• One of the principles of GATT was that countries
should not use quotas to restrict imports.
• The MFA was a major exception to that which
allowed the industrialized countries to restrict
imports of textile and apparel products from the
developing countries.
• Organized under GATT, importing countries could
join the MFA and arrange quotas bilaterally or
unilaterally.
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China and the Multifibre Arrangement
APPLICATION
• While the amount of the quotas was occasionally revised
upward, they did not keep up with the increasing ability of
new supplying countries to sell.
• Under the Uruguay round of WTO, developing countries
were able to negotiate an end to this system of import
quotas.
• Given that China was a large supplier of textiles, the
expiration of the MFA meant that China could export as
much as it wanted – or so it thought.
• Some developing countries and large producers in
importing countries were concerned with the potential of
Chinese exports on their economies.
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China and the Multifibre Arrangement
APPLICATION
• Growth in Exports from China
 Immediately after January 1, 2005, exports of textiles
and apparel from China grew rapidly.
 In 2005, China’s textile and apparel imports to the U.S.
rose by more than 40% compared to 2004.
 Figure 8.10 (a) shows the change in the value of
exports of textiles and apparel from different countries.
Note China.
 The increases from China came at the expense of
some higher-cost exporters, some of whose exports to
the U.S. declined by 10 to 20%.
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China and the Multifibre Arrangement
APPLICATION
Figure 8.10
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China and the Multifibre Arrangement
APPLICATION
• Panel (b) of figure 8.10 shows the percentage
change in the prices of textiles and apparel
products from each country, depending on
whether the products were subject to the MFA
quota before January 1, 2005, or not.
• China had the largest drop in the prices from 2004
to 2005.
• Many other countries had a substantial fall in their
prices due to the end of the MFA quota.
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China and the Multifibre Arrangement
APPLICATION
Figure 8.10
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China and the Multifibre Arrangement
APPLICATION
• Welfare Cost of the MFA
 Given the drop in prices in 2005, it is possible to
estimate the welfare loss due to the MFA.
 Quota rents were earned by foreign exporting firms,
giving a welfare loss to Home of area (b+c+d) shown in
figure 8.9 previously
 Using the price drops from figure 8.10 (b+c+d), the U.S.
is estimated at $6.5 to $16.2 billion in 2005 from the
MFA.
 Averaging out all losses and dividing among
households gives an estimate of $100 per household,
or 7% of total annual spending on apparel.
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China and the Multifibre Arrangement
APPLICATION
• Import Quality
 There was also an interesting pattern to the price
drops: the price dropped the most for the lower- priced
items.
 An inexpensive T-shirt had a greater drop in price than a more
expensively priced item.
 U.S. demand shifted towards the lower-priced items
imported from China: there was “quality downgrading”
in the exports from China.
 When a quota like the MFA is applied, there is an effect
on quality.
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China and the Multifibre Arrangement
APPLICATION
• Import Quality
 Remember that quotas are set on the quantity, not the
quality of items that are imported.
 This means that exporting countries have an incentive
to upgrade the quality of the product.
 Selling a higher value good for the same quantity will
still meet the quota limit but will bring more money back
home.
 MFAs bring “quality upgrading” in the exports
 Similarly, when the MFA is removed, you will see
“quality downgrading.”
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China and the Multifibre Arrangement
APPLICATION
• Reaction of the United States and Europe
 The EU threatened to impose new quotas on Chinese
exports.
 In response, China agreed on June 11, 2005 to
”voluntarily” restrict exports limiting the growth of textile
exports to about 10% per year through the end of 2008.
 The U.S. had the ability to negotiate a new system of
quotas because China had joined the WTO in 2001.
 The U.S. deal limited growth to 7.5% until 2008.
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Conclusions
• A tariff on imports is the most commonly used
trade policy tool.
• First considered a small country with no effect on
world price.
 The price faced by consumers and producers in the
importing country will rise by the full amount of the tariff.
 There is a drop in consumer surplus, a rise in producer
surplus, and the government collects revenue.
 Results in net loss for the importing country.
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Conclusions
• Why are tariffs used?
 Easy way for governments to raise revenue, especially
in developing countries.
 The government might care more about protecting firms
than avoiding loses for consumers.
 The small-country assumption may not hold in
practice—countries may be large enough to gain from a
tariff.
• If a country is large enough, they can have an
effect on the world price.
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Conclusions
 In this case, prices rise by less than the full amount of
the tariff.
 It is therefore possible for a small tariff to generate
welfare gains for the importing country.
 This does come at the expense of the foreign
exporters—“beggar thy neighbor” policy.
 Overall there are still world losses.
• Countries also may choose quotas, which restrict
the quantity of imports into a country.
 WTO has tried to restrict the use of quotas.
 Deletion of MFA quotas still lead to new quotas against
China.
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Conclusions
• Import quotas lead to similar welfare effects of
tariffs.
 Increase domestic price with loss for consumers and
gains for producers.
 Quota rents instead of guaranteed government
revenues.
 If resources are wasted by firms to gains rents,
additional deadweight losses are incurred.
 It is more common for foreign exporters to earn the
quota rents – VER.
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Key Points
1. The government of a country a can use laws and
regulations, called trade policies, to affect
international trade flows.
2. The rules governing grade policies in most
countries are outlined by the General Agreement
on Tariffs and Trade (GATT), now the World
Trade Organization (WTO).
3. In a small country, the world price faced is fixed,
so the price faced by consumers and producers
will rise by the full amount of the tariff.
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Key Points
4. The use of a tariff by a small importing country
always leads to a net loss in welfare.
5. In a large country, the change in imports from a
tariff will lower world price so the price to the
importing country does not rise by the full
amount of the tariff.
6. The use of a tariff for a large country can lead to
a net gain in welfare.
7. The optimal tariff is the tariff amount that
maximizes welfare for the importer.
8. The formula for the optimal tariff shows that it
depends inversely on the foreign export supply
elasticity.
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Key Points
9. Import quotas restrict the quantity of a particular
import, thereby increasing the domestic price,
benefiting domestic production and creating a
benefit for those who are allowed to import the
quantity allotted. Benefits are quota rents.
10. Assuming perfectly competitive markets for
goods, quotas are similar to tariffs since the
restriction in the amount imported leads to a
higher domestic price. Rents, however, can be
earned by the foreign country and can create
additional dead weight losses.
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