Transcript import tariffs and quotas under imperfect competition 1

9
IMPORT TARIFFS AND
QUOTAS UNDER
IMPERFECT COMPETITION
1
Tariffs and Quotas
with Home Monopoly
2
Infant Industry
Protection
3
Tariffs with Foreign
Monopoly
4
Policy Response to
Dumping
5
Conclusions
Chapter Outline
• Introduction
• Tariffs and Quotas with Home Monopoly
 No-Trade Equilibrium
 Comparison with Perfect Competition
 Free-Trade Equilibrium
 Comparison with Perfect Competition
 Effect of Home Tariff
 Comparison with Perfect Competition
 Home Loss due to the Tariff
 Effect of a Home Quota
 Home Loss due to the Quota
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Chapter Outline
• Infant Industry Protection
 Free-Trade Equilibrium
 Equilibrium Today
 Tariff Equilibrium
 Equilibrium Today
 Equilibrium in the Future
 Effect of the Tariff on Welfare
 Protecting the Automobile Industry in China
 Protection in China
 Cost to Consumers
 Gain to Producers
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Chapter Outline
 Computers in Brazil
 Prices in Brazil
 Consumer and Producer Surplus
 Other Losses
 U.S. Tariff on Heavyweight Motorcycles
 Calculation of Deadweight Loss
 Future Gain in Producer Surplus
 Was Protection Successful?
• Tariffs with Foreign Monopoly
 Foreign Monopoly
 Free-Trade equilibrium
 Effect of a Tariff on Home Price
 Effect of the Tariff on Home Welfare
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Chapter Outline
• Policy Response to Dumping




Antidumping Duty
Countervailing Duty
Comparison with Safeguard Tariff
Calculation of Antidumping Duty
• Conclusions
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Learning Objectives
• Understand the implications of import tariffs and
quotas in markets with imperfect competition.
• Understand the different effects trade policies
have on Home prices in imperfectly competitive
markets compared to perfectly competitive
markets.
• Understand the “non-equivalence” between the
effects of tariffs and the effects of quotas in
imperfectly competitive markets.
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Learning Objectives
• Know what an infant industry is.
• Understand the implications in using trade policies
in the case of infant industries.
• Know what a discriminating monopoly is and its
role in dumping.
• Know what an antidumping duty is.
• Know how to calculate the antidumping duty.
• Understand the effects when a tariff is applied
against a Foreign discriminating monopoly.
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Introduction
• In 2005, China overtook Japan as the second
largest automobile market in the world.
• Strong competition between foreign firms located
in China, local producers, and import sales have
resulted in new models and a fall in prices.
 China’s middle class can now afford cars.
 Of 5.9 million cars sold in China in 2005, 5.76 million
were produced domestically.
 In 1985, only 5200 were produced.
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Introduction
• When China joined the WTO, it lowered tariffs on
autos, which had been as high as 80-100%,
down to 25%.
• Quotas were revisited as well.
• To fully understand the effects of the import tariffs
and quotas on the automobile market, we have to
drop our perfect competition assumption.
• In allowing for imperfect competition, we will
assume here the extreme case of a single
producer to see how trade policies affect welfare.
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Introduction
• We will first assume a Home monopoly and will
show how quotas and tariffs have different effects
on Home prices.
 The choice therefore matters and this “non-equivalence”
among tariffs and quotas must be taken into account.
• We will then consider an infant industry.
 An industry too young to have achieved its lowest costs.
 Again assume one firm.
 By increasing its output today, the firm will learn how to
produce more efficiently and have lower costs in the
future.
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Introduction
• Our question is then, should a government
impose a temporary tariff or quota today to protect
an infant industry from competition, keeping it in
business long enough to learn how to achieve
lower costs in the future?
• We then consider a Foreign monopoly and the
effect of an import tariff applied by the Home
country.
 We will show it is similar to the large-country case in
Chapter 8.
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Introduction
• A specific example of a foreign monopolist is the
Foreign discriminating monopoly.
 Charges a lower price at Home than in its local market.
 Dumps its product into the Home market.
• In this case, we might see an anti-dumping duty.
 A tariff applied against a Foreign discriminating
monopoly.
• We will show these are unlikely to result in gains
for the Home country.
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Tariffs and Quotas with Home Monopoly
• We will assume a Home monopolist.
 A single firm selling a homogeneous good.
 Firm has influence over the price charged—charges
prices above marginal costs.
• Free trade introduced many new firms into the
market, which eliminated the monopolist’s ability
to change a price greater than MC.
 Free trade results in a perfectly competitive Home
market.
• However, because the firm has market power,
tariffs and quotas affect the trade equilibrium
differently.
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Tariffs and Quotas with Home Monopoly
• With a tariff, the Home monopolist still competes
against a large number of importers, limiting its
market power.
• With a quota, once the quota is reached, the
monopolist is the only producer able to sell in the
Home market.
 The monopolist is again able to exercise its market
power.
• This section looks at Home equilibrium with and
without trade, and explains the difference
between tariffs and quotas.
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Tariffs and Quotas with Home Monopoly
• No-Trade Equilibrium
 We can see this in figure 9.1.
 We see a standard monopoly graph with upwardsloping marginal costs.
 Remember that because the demand the monopolist
faces is downward sloping, they must lower the price to
sell more.
 This means that the marginal revenue, the revenue
received from selling the next unit, will always be lower
than the price.
 Monopolist maximizes profits at the quantity where MR
= MC.
 Price is then determined from the demand curve.
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Tariffs and Quotas with Home Monopoly
• Comparison with Perfect Competition
 If we suppose there are many firms in the industry and
they all have the same cost conditions as the
monopolist, we can show where this market would
produce if it were perfectly competitive.
 The no-trade equilibrium with perfect competition
occurs where supply (MC) equals demand.
 We can see in figure 9.1 that the competitive price, PC
is lower than the monopoly price, PM.
 Also the competitive quantity, QC, is higher than the
monopoly quantity, QM.
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Tariffs and Quotas with Home Monopoly
Figure 9.1
Price
Monopoly
equilibrium
Monopoly
equilibrium
A perfectlyno-trade
competitive
market
produces
QM where
MR=MC.
would produce
where
MC = DPM
comes
D QC.
giving from
PC and
Notice that quantity is lower and price
is higher in a monopoly than in a
perfectly competitive market.
A
Marginal
cost, MC
PM
B
PC
Perfect competition
equilibrium
Marginal
revenue,
MR
QM
QC
Home
demand, D
Quantity
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Tariffs and Quotas with Home Monopoly
• Free Trade Equilibrium
 Assume Home is a small country, facing a fixed world
price of PW.
 Figure 9.2 shows the horizontal world price line, X*, the
Foreign export supply curve.
 The is also the new demand curve facing the Home
monopolist, the original home demand, D no longer
applies.
 Home’s new MR is the same as the new demand curve,
so X* = MR*.
 MR* = MC at point B, supplying S1.
 Home consumers demand D1, leading to Home imports
of M1 = D1 - S1.
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Tariffs and Quotas with Home Monopoly
• Comparison with Perfect Competition
 Remember we assume the cost conditions facing the
competitive firms are the same.
 A perfectly competitive industry will take PW and supply
where that price intersects the marginal cost curve, at
S1 with consumers demanding D1.
 Under free trade for a small country then, a Home
monopolist produces the same quantity and charges
the same price as would a perfectly competitive
industry.
 The monopolist loses its control over price and behaves
the same as a perfectly competitive industry with the
same marginal costs.
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Tariffs and Quotas with Home Monopoly
Figure 9.2
Underfree
freetrade,
trade,Home
the Monopolist
will
With
faces
take fixed
worldsupply
price, of
PWX*
, and
set is
it
Foreign
export
which
equal
to MC to determine
quantity,
the
Monopolist’s
new demand
and S1.
MR curve
This is the same result as a perfectly
competitive market would give.
Price
No-Trade
Monopoly
Free Trade
Equilibrium
A
PM
MC
B
PW
At PW, consumers demand
D1 which leads to imports of
M1 = D1 – S1.
X* = MR*
MR
D
M1
QM
S1
D1
Quantity
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Tariffs and Quotas with Home Monopoly
• Suppose Home imposes a tariff, t, on imports:
 Price at Home increase from PW to PW+t.
 The foreign export supply curve shifts up to X*+t.
 Again this is the new demand curve and marginal
revenue curve for the monopolist.
 Maximizing profits where MR=MC at point C gives
Home supply of S2 and a Home demand of D2.
 Since Home production increases and Home demand
falls, imports fall to M2 = D2 – S2.
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Tariffs and Quotas with Home Monopoly
At the new price, supply rises to S2, demand falls
the D2, and imports fall to M2 = D2-S2.
Figure 9.3
Price
With the tariff, price increases by t, X*+t
becomes the new Demand and MR
curve faced by the Home monopolist.
Equilibrium
With Tariff
MC
We have a new trade
equilibrium with the tariff, at C.
PM
Free Trade
Equilibrium
C
PW+t
PW
X*+t = MR*
B
X*
M2
D
M1
S1
S2
D2
D1
Quantity
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Tariffs and Quotas with Home Monopoly
• Comparison with Perfect Competition
 Again assuming S=MC, the competitive equilibrium will
be where P=MC, which gives the quantity Q2 at PW+t.
 So, with a tariff, a Home monopolist will produce the
same quantity at the same price as a perfectly
competitive industry.
• Home Loss due to the Tariff
 Since the equilibrium outcomes are the same for a
monopolist and a perfect competitor under a tariff, we
would expect that the losses would be the same as well.
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Tariffs and Quotas with Home Monopoly
• Home Loss due to the Tariff
 As before, we look at the changes in surplus to both
producers and consumers, and the gain to government
in the form of tax revenue.
 With a higher price, consumer surplus falls by the
amount (a+b+c+d) and producer surplus rises by (a).
 The government gains revenue equal to the tariff, t,
times the amount of imports, M2, giving the area (c).
 As before that leads to a deadweight loss of (b+d).
 We can see this again in figure 9.3.
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Tariffs and Quotas with Home Monopoly
Figure 9.3
Price
Consumer surplus falls by a+b+c+d.
Producer surplus rises by a.
Government revenue increases by c.
We are again left with a deadweight loss of b+d.
MC
PM
X*+t = MR*
PW+t
a
c
b
PW
d
X*
M2
D
M1
S1
S2
D2
D1
Quantity
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Tariffs and Quotas with Home Monopoly
• Effect of Home Quota
 Now we can look at the effect of a quota and compare it
to the effect of a tariff.
 The quota will end up with higher prices for Home
consumers since it allows the monopolist to keep its
market power, which we know leads to higher prices.
 This is another reason why the WTO has encouraged
countries to replace quotas with tariffs.
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Tariffs and Quotas with Home Monopoly
• Effect of a Quota
 In figure 9.4 we begin with the free trade equilibrium at
B and the tariff equilibrium at C.
 We choose a quota that will give us the same import as
the tariff, M2.
 The effective demand curve facing the Home
monopolist under the quota is now the old demand
curve, D, minus the quota, M2.
 The monopolist still retains the ability to influence price
and will choose its profit-maximizing price along D-M2.
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Tariffs and Quotas with Home Monopoly
• Effect of a Quota
 Adding the MR curve for the effective demand curve DM2, allows us to find the profit maximizing price and
quantity for the Monopolist.
 MR=MC at point E with S3 and a price of P3.
 Comparing the tariff equilibrium at C with the quota
equilibrium at E shows us the differences.
 The price is higher: P3>PW+t.
 This reflects the ability of the monopolist to raise its price once
the quota amount has been imported.
 This occurs even though the quota allows in the same amount
of imports that were brought in under that tariff.
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Tariffs and Quotas with Home Monopoly
• Effect of a Quota
 Since the price is higher under the quota, the
monopolist will definitely produce a lower quantity
under the quota, S3<S2.
 In fact, it is even possible for the quantity under the
quota to fall below the no-trade quantity. This will
depend on the demand, and therefore, the MR curve.
 If S3<S1 is possible, then workers would not even be
protected under a quota, which is typically one of the
expectations of a trade restriction.
 Employment would actually fall under this type of quota.
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Tariffs and Quotas with Home Monopoly
Under a tariff, the monopolist produces at C, selling S2,
charging PW+t. Consumers demand D2, giving M2 imports.
Figure 9.4
Price
MC
Under free
Quota,
original
demand,
Under
trade,
the monopolist
D, shifts back
the amount
of
produces
at B,by
selling
S1, charging
the world
quota,price,
M2. New
demand at
the
PW. Consumers
D-M2 with
MRM1 imports.
demand
D1new
, giving
Quota, M2
P3
With a quota, the monopolist sets
quantity where new MR=MC, at E
and S3, with price from new
demand, P3. At P3, demand is D3,
giving Imports of M2, same as tariff.
C
PW+t
B
PW
E
D
MR
S3 S1 S2
Imports, Quota
D - M2
D3
D2 D1
Quantity
Imports, Tariff. M2
Imports, Free Trade, M1
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Tariffs and Quotas with Home Monopoly
• Home Loss due to the Quota
 Since price rises more with a quota than a tariff, it is
clear that consumers will lose more surplus under a
quota than they would under a tariff.
 Although we will not make a detailed calculation, you
can expect that the deadweight loss will always be
higher for a quota than for a tariff.
 The higher price benefits the monopolist but harms the
Home consumers and creates an extra deadweight loss,
due to the exercise of its monopoly power.
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Tariffs and Quotas with Home Monopoly
• Home Loss due to the Quota
 Given that the monopolist is charging a higher price,
quota rents will increase as well.
 Quota rents are measured by the difference between
P3 and PW times the number of imports, M2.
 In the case of a Home monopoly, quota rents are
higher than the tax revenue would be under a tariff.
 Also remember that quota rents often go to the Foreign
producers or are just wasted on rent-seeking activities.
 The next application looks at an example in detail.
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U.S. Imports of Japanese Automobiles
APPLICATION
• A well-known VER occurred in the 1980s when
the U.S. limited the imports of cars from Japan.
• In the early 1980s, the U.S. suffered a deep
recession and unemployment in the auto industry
rose sharply.
• In 1980, the United Automobile Workers and Ford
Motor Company applied to the International Trade
Commission (ITC) for protection under Article XIX
of GATT and Section 201 of U.S. trade laws.
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U.S. Imports of Japanese Automobiles
APPLICATION
• The ITC determined that the U.S. recession was a more
important cause of injury to the auto industry than
increased imports.
 It did not recommend that the auto industry receive protection.
• In response, several congressmen from states with auto
plants pursued other means.
• A bill was introduced in the U.S. Senate to restrict imports.
• Aware of this, the Japanese government announced it
would “voluntarily” limit Japan’s export of autos to the U.S.
 By 1988, Japanese exports were below the VER because Japanese firms
were producing their cars in the U.S.
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U.S. Imports of Japanese Automobiles
APPLICATION
• Price and Quality of Imports
 Under the VER, the average price rose $2,900 from
1980 and 1985.
 Of that, $1,100 was due to quota rents earned by
Japanese producers.
 $1,650 was due to quality improvements in Japanese
cars.
 $150 reflects the amount that prices would have risen
under free trade.
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U.S. Imports of Japanese Automobiles
APPLICATION
• Quota Rents
 If we take the quota rents per car and multiply it by the
number of imports, we can estimate the total rents to be
about $2.2 billion.
 This is the lower estimate of the annual cost of quota
rents for autos we saw in Table 8.4.
 The Japanese firms’ stock prices rose during the VER
period, after it was clear that the Japanese government
would administer the quotas to each producer.
 Japanese firms had a strong incentive to export the
more expensive models—quality upgrading.
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U.S. Imports of Japanese Automobiles
APPLICATION
• Price of U.S. Cars
 Under the VER, the average price of U.S. cars rose
very rapidly—43% increase from 1979 to 1981.
 This was due to the exercise of market power by the
U.S. producers, who were sheltered by the quota.
 The quality of U.S. cars did not rise by as much as the
quality of Japanese imports seen in figure 9.5.
 The fact that the U.S. and Japanese firms were both
able to raise prices substantially indicates the policy
was VERY costly to U.S. consumers.
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U.S. Imports of Japanese Automobiles
APPLICATION
Figure 9.5
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U.S. Imports of Japanese Automobiles
APPLICATION
Figure 9.6
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U.S. Imports of Japanese Automobiles
APPLICATION
• The GATT and WTO
 Because the export restraint was enforced by the
Japanese instead of the U.S., it did not necessarily
violate Article XI of GATT.
 Countries should not use quotas to restrict imports, but this was
not a quota.
 This loophole was closed when the WTO was
established.
 As a result of this rule, VERs can no longer be used
unless they are a part of some other agreement in the
WTO.
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Infant Industry Protection
• Despite losses, nearly all countries use tariffs in
the early stages of economic development, often
in industries composed of a small number of firms.
 This means they are more often acting under conditions
of imperfect competition.
• Why? They argue that their industries are too
young to withstand foreign competition.
 If given time to grow, the industries will be able to
compete in the future.
 Some short-term protection from imports is needed.
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Infant Industry Protection
• This is called the infant industry case for
protection.
• In this case, we will assume only one Home firm.
• Increasing output today will lead to lower costs in
the future through learning.
• Should the Home government intervene with
protection? We will consider two cases where it is
potentially justified.
1. A tariff today increases Home production and lowers
future costs.
2. A tariff today increases output and reduces future
costs for other firms in the industry or other industries.
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Infant Industry Protection
• Let’s assume that if a firm is protected today, we
will get an increase in Home output.
• This will then help the firm to learn better
production techniques and reduce costs in the
future.
• For infant industry protection to be justified, the
firm’s learning shifts down the entire average cost
curve to the point where it is competitive at the
world prices, even without a tariff.
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Infant Industry Protection
• But, if the firm’s costs are going to fall in the future,
why doesn’t it just borrow today against future
profits?
• An essential piece of the infant industry argument
is that the firm needs to earn non-negative profits
each period to avoid bankruptcy.
 There must be some reason the firm cannot cover
losses by borrowing against future profits.
• In this case, the trade protection is just offsetting
an imperfection in the capital market.
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Infant Industry Protection
• Now what about the case where a tariff in one
period will lead to an increase in output and
reductions in future costs for other firms in the
industry, or even for firms in other industries?
• This is a type of externality that exists when firms
learn from each other’s successes.
 An innovation in one area helps lower costs in other
areas.
• We call this knowledge spillover—firms mimic
the successful innovations of other firms.
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Infant Industry Protection
• When there are spillovers, the tariff is promoting a
positive externality.
• Because firms learn from each other, each firm on
its own does not have much incentive to invest in
learning through increasing production today.
• A tariff is needed to offset this externality by
increasing production, allowing for these
spillovers to occur between firms - leading to cost
reductions.
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Infant Industry Protection
• In both of these cases, the infant industry
argument supporting trade restrictions depends
on the existence of some form of market failure.
• This market failure creates a potential role for
government policy.
• However, if the capital market will not provide a
loan to the firm, it must not believe it will be
profitable in the future.
 If that is true, why would the government have better
information about that firm’s future prospects?
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Infant Industry Protection
• Similarly, can we expect the government to know
the extent of spillovers and determine if they are
enough to justify trade protection?
• We should be skeptical about the ability of
government to distinguish the industries that
deserve infant-industry protection from those that
do not.
• Furthermore, these market failures do not
guarantee that the protection is worthwhile.
 We still need to compare the costs of protection today
with the benefits of protection in the future.
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Infant Industry Protection
• Free-Trade Equilibrium
 Figure 9.7 shows a Home firm with its current and
proposed future situation.
 We will assume Home is a small country and therefore
faces fixed world prices for its imports.
 We will also assume that increasing output today will
lead to a reduction in costs in the future.
 Equilibrium today
 With free trade the Home firm faces PW = MR producing where
PW crosses its MC, supplying S1.
 Given that at S1 average costs are higher than PW, we know the
firm is suffering losses and would shut down today instead of
producing S1.
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Infant Industry Protection
• Tariff Equilibrium
 To prevent the firm from shutting down, the Home
government could apply an import tariff or quota to
raise the Home price.
 We assume this increased output allows the firm to
learn better production techniques so its future costs
are reduced.
 From before we know the Home government should
choose the tariff, since under the quota the home firm
will produce less and raise prices more.
 Remember we assume that the firm’s learning depends
on increasing its production.
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Infant Industry Protection
• Equilibrium Today
 If a tariff, t, is applied then Home price rises to PW+t as
before.
 Assume that PW+t just covers the firms average costs.
 The firm produces S2 and since PW+t equals AC at that
quantity, the firm makes zero profits.
• Equilibrium in the Future
 At S2, the firm can lower its costs in the future.
 The effect of learning on production costs is shown by a
downward shift in the AC curve to AC′.
 This means the firm can produce S3 without tariff
protection at PW and still cover its AC.
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Infant Industry Protection
• Effect of the Tariff on Welfare
 As would be expected, the tariff leads to a deadweight
loss measured by (b+d).
 In order to determine welfare in this case, we also have
to consider the gain from having the firm operating in
the future.
 We do this by measuring producer surplus in panel b,
area (e).
 This is the present value of the firm’s future producer surplus.
 It is the amount that would be forgone if the firm shut down
today.
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Infant Industry Protection
Figure 9.7
Today,
panel (a),
the (b),
firm the
loses
money
at the
world
price PW
In the Future,
panel
firms
average
costs
fall.
The
country
imposes
a tariff
so now profits
makingatzero
economic
They
can now
earn zero
economic
the world
price
W
W
profits,
at P the
+t, with
dead weight
loss of b+d
P , without
tariff,aearning
e in producer
surplus.
Price
Price
MC
MC
AC
PW+t
PW
AC’
d
b
e
D
D
S1 S2
(a) Today
D1 D2
Quantity
S3
D1
Quantity
(b) Future
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Infant Industry Protection
• Effect of the Tariff on Welfare
 To evaluate whether the tariff has been successful, we
need to compare the future gain with the present losses.
 We need to compare e with (b+d).
 If e is greater than (b+d), then it was worthwhile.
 If e is less than (b+d), then the costs of protection today
do not justify the future benefits.
 The challenge for government policy is to try and
distinguish worthwhile cases from those that are not.
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Examples of Infant Industry Protection
APPLICATION
• We will consider three examples of infant industry
protection that have occurred.
 The automobile industry in China
 The computer industry in Brazil
 Harley-Davidson motorcycles in the U.S.
• Although we normally think of developing
countries using the infant industry argument, it is
not necessarily always the case.
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Examples of Infant Industry Protection
APPLICATION
• Harley-Davidson does not really fit the infant
industry description since it had been in operation
for about 80 years before it was in trouble.
• By including this case, we are able to make a
precise calculation of the effect of the tariff on
consumers and producers, to determine if the
infant industry protection was successful.
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Examples of Infant Industry Protection
APPLICATION
• Protecting the Automobile Industry in China
 Until China joined the WTO in 2001, China had
protected many of its industries with strict tariffs and
quotas.
 Tariffs on autos were as high as 260% in the early
1980s, and fell to 80–100% by 1996.
 By 2006, tariff on autos had been reduced to 25% and
import quotas had been eliminated.
 Is China’s success in the automobile industry a case of
infant industry protection success?
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Examples of Infant Industry Protection
APPLICATION
• Protecting the Auto Industry in China
 In the 1980s, China permitted a number of joint
ventures between foreign firms and local Chinese
partners.
 This provided a window for foreign manufacturers to tap
the China market, but there were limits on their
participation.
 Foreign manufacturers could not own majority stake in a
manufacturing plant.
 Chinese kept control of distribution networks for the jointlyproduced autos.
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Examples of Infant Industry Protection
APPLICATION
• Protecting the Auto Industry in China
 These regulations combined with the high tariffs helped
achieve success for some of the new joint ventures.
 Volkswagen’s Shanghai plant was by far the winner under
these rules.
 It produced over 200,000 vehicles per year—more than twice
as much as any other plant.
 Other local restrictions on engine size also helped ensure that
only Volkswagen's models could be sold in the Shanghai
market.
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Examples of Infant Industry Protection
APPLICATION
• Protecting the Auto Industry in China
 Volkswagen’s competitors did not fare as well.
 Beijing Jeep never produced more than 20,000.
 Peugeot ended up withdrawing.
 Since then, Volkswagen opened a new plant and other
factories reached agreements with Honda and
Daihatsu.
 Today Toyota, General Motors, and Ford are either
producing or planning on producing in China.
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Examples of Infant Industry Protection
APPLICATION
• Costs to Consumers
 Tariffs and quotas used in China kept imports fairly low
throughout the 1990’s ranging from a high of 222,000 to
a low of 27,500 autos.
 Given the high tariffs, import prices were nearly
doubled.
 But the quotas had at least as great an impact on
prices of imports and domestically produced cars.
 Remember our analysis of quotas and local monopolies
and then remember that Volkswagen enjoyed a local
monopoly in Shanghai.
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Examples of Infant Industry Protection
APPLICATION
• Costs to Consumers
 This caused prices in the Shanghai market to increase
substantially.
 Figure 9.8 shows the estimated markups of price over
average costs for autos sold in China from 1995 to
2001.
 The ones for Shanghai Volkswagen were the highest.
 It is clear the monopoly power allowed them to
substantially raise prices.
 This is what our theory told us would happen.
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Examples of Infant Industry Protection
APPLICATION
Figure 9.8
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Examples of Infant Industry Protection
APPLICATION
• Costs to Consumers
 Also, some of the models produced by Shanghai
Volkswagen during the 1990s were outdated models.
 That plant had the highest production through 2001,
despite high prices and outdated models.
 A large number of consumers in the Shanghai area bore the
costs of that local protection.
 Clearly the Home monopoly benefited from the
protection, but at the expense of consumers.
 Additionally we can see how protection creates
disincentives for innovation.
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Examples of Infant Industry Protection
APPLICATION
• Gains to Producers
 In order to justify all the protective measures in the auto
industry, they should lead to a large enough drop in
future production costs that protection is no longer
needed.
 There is some evidence that these measures did help:
 Tariffs are now only at 25%.
 Some producers are making plans to export cars from China.
 It must be true that average costs have fallen enough to reach
world prices.
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Examples of Infant Industry Protection
APPLICATION
• Gains to Producers
 Now, did the fall in average costs occur due to
protection or did it happen for some other reason?
 The early firms entered China because that was the
only way to sell in China since the protection levels
were so high.
 Local costs did fall as the Chinese partners learned
from the technology transferred from their foreign
partners.
 Shanghai Automotive, the previous partner of
Volkswagen and General Motors, will soon begin
building and selling its own brand of car in China.
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Examples of Infant Industry Protection
APPLICATION
• Gains to Producers
 This clearly shows that the technology transfer helped
the local firms and that the foreign firms might not have
come into China without the high protection levels.
 Some of the current firms are purchasing ready-made
plants from other countries in their first mass production
and export of cars.
 This shows that the first exports from China will not
come from firms that benefited from the technology
transfer.
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Examples of Infant Industry Protection
APPLICATION
• Gains to Producers
 Clearly there are other reasons that China is doing
so well in the auto industry.
 At least as important as the tariffs is the rapid
growth in China’s income level.
 This has increased domestic sales and the
number of firms entering the market.
 Consumers are not the ones demanding the
newest models built with the most efficient
techniques.
• In the end, we cannot really answer whether
the trade restrictions were responsible for
China’s current successes.
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Thanks to Detroit, China is Poised to Lead
HEADLINES
• Volkswagen and other producers used to send
outdated equipment to China and produce models
that were no longer demanded in the West.
• Competition in China now has become so fierce
that auto manufacturers have to introduce their
newest models as quickly as they would in other
markets.
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Thanks to Detroit, China is Poised to Lead
HEADLINES
• When Ford opened a factory in China three years
ago, it just copied an older factory it had been
using in Philippines.
• This year Ford opened a new factory identical to
one of its most advanced factories.
• The Chinese managers are not even happy with
that—the automotive industry is expanding and
modernizing so quickly that some current firms
are having difficulty keeping up.
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Thanks to Detroit, China is Poised to Lead
HEADLINES
• One requirement to export autos is to develop a
highly competitive and efficient domestic market
that demands excellent quality, and China has
managed to do that.
• Many foreign car companies are introducing their
best technology in their plants in China.
 This is not just to compete with each other but also with
purely local companies.
• These foreign firms have always been wary of
transferring proprietary technology to make hybrid
engines in China for fear it will be copied.
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Thanks to Detroit, China is Poised to Lead
HEADLINES
• Although Toyota is still quite cautious, China is
still the only place besides Japan where they are
assembling the Prius, arguably its most important
car in a decade.
• Volkswagen said it would jointly develop a hybrid
minivan for the Chinese market with Shanghai
Automotive.
 This will clearly give the Chinese a good look at the
technology.
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Thanks to Detroit, China is Poised to Lead
HEADLINES
• Shanghai Automotive announced it was going to
begin selling its own brand of cars while keeping
its joint ventures.
• It is expected other Chinese companies will follow
suit.
• Chinese automakers are also buying modern
technology and design themselves.
• When MG-Rover Group of Britain entered
bankruptcy proceedings last year, a Chinese
company was the high bidder to take control of
Rover and its fairly modern engine-producing
subsidiary and to move it to China.
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Examples of Infant Industry Protection
• Computers in Brazil
 One case where infant industry protection has not been
successful is the computer industry in Brazil.
 In 1977, the Brazilian government began a program to
protect domestic computer firms.
 It was thought that achieving national autonomy in the
computer industry was essential for strategic military
reasons.
 Imports of PC’s were banned.
 Domestic firms had to buy from local suppliers whenever
possible.
 Foreign producers of PC’s were not allowed to operate in Brazil.
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Examples of Infant Industry Protection
• Computers in Brazil
 The ban lasted until the early 1990s.
 This was a period of rapid innovation in the computer
industry worldwide with large drops in the cost of
computing power.
 Figure 9.9 shows the effective price of computing
power in the U.S. and Brazil from 1982 to 1992, which
fell rapidly in both countries.
 This is the effective price because it reflects the improvements
over time in the PC.
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Examples of Infant Industry Protection
Figure 9.9
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Examples of Infant Industry Protection
• Prices in Brazil
 Brazilian firms were very good at reverse engineering
the IBM PC’s sold from the U.S.
 But this took time and since Brazilian firms had to use
local suppliers for many parts, it added to the costs of
production.
 Figure 9.9 shows that Brazil never achieved the same
low prices as the U.S.
 Brazil was never able to produce computers at
competitive prices without tariff protection.
 That alone tells us the infant industry protection failed.
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Examples of Infant Industry Protection
• Consumer and Producer Surplus
 Table 9.1 shows the welfare calculation for Brazil and
other details of the PC industry.
 From the table you can see that in 1984 Brazil’s price
was almost twice that of the U.S. price.
 Although this lead to increased producer surplus, the
loss in consumer surplus led to a net loss of about $51
million.
 The industry was never able to produce in the absence
of tariffs, so there are no future gains (like area e) that
can be used to counter the losses.
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Examples of Infant Industry Protection
Table 9.1
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Examples of Infant Industry Protection
• Other Losses
 The higher prices in Brazil imposed costs on industries
that relied on computers and they become increasingly
dissatisfied with the government policies.
 President Fernando Collor de Mello abolished the
infant industry protection immediately after he was
elected.
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Examples of Infant Industry Protection
• Other Losses
 A number of reasons have been given for the failure of
this policy to develop an efficient industry in Brazil.
1. Imported materials such as silicon chips were expensive to
obtain.
2. This was also true of domestically-produced parts that local
firms were required to use.
3. Local regulations limited the entry of new firms in the industry.
 Clearly it is difficult to successfully nurture an infant
industry using tariffs.
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Examples of Infant Industry Protection
• U.S. Tariff on Heavyweight Motorcycles
 In 1983, Harley-Davidson was suffering losses due to a
long period of lagging productivity and intense
competition from Japanese producers.
 In the early 1980s, foreign firms were engaged in a
global price war that spilled over into the U.S. market.
 Inventories of imported heavyweight cycles rose
dramatically.
 Harley-Davidson applied to the ITC for Section 201
protection.
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Examples of Infant Industry Protection
• U.S. Tariff on Heavyweight Motorcycles
 The ITC determined that there were over 9 months
worth of inventory of Japanese motorcycles already in
the U.S. and recommended to President Reagan that
import protection be placed on heavyweight
motorcycles.
 This is one of the few times that threat of injury by
imports has been used as justification for tariffs under
Section 201 of the U.S. trade law.
 President Reagan approved the tariffs.
 These tariffs were initially very high, but they declined over five
years.
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Examples of Infant Industry Protection
• U.S. Tariff on Heavyweight Motorcycles
 The tariff was scheduled to end in April of 1988.
 Harley-Davidson petitioned the ITC to end the tariff one
year early.
 By that time, they had cut costs and introduced new
and very popular products so profitability had been
restored.
 Amid great fanfare, President Reagan declared that the
tariff had been a successful case of protection.
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Examples of Infant Industry Protection
• Calculation of Deadweight Loss
 Was the tariff on heavyweight motorcycles a success?
 We need to compare the deadweight loss of the tariff
with the future gain in producer surplus.
 We will use the formula we derived in Chapter 8,
measuring deadweight loss relative to the import value:
DWL 1  t 
  W %M
PM
2P 
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Examples of Infant Industry Protection
• Table 9.2 gives information on imports of
heavyweight cycles.
• The percentage drop in import quantity between
1982 and 1983 was about 17% with a tariff of
45%.
• The deadweight loss relative to input value is
measured as :
DWL 1  t
  W
PM
2P
1

%M  (0.45 * 0.17)  3.8%
2

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Examples of Infant Industry Protection
Table 9.2
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Examples of Infant Industry Protection
• Average import sales over that time were $431.
Multiplying the percentage loss by average
imports, we get the deadweight loss in 1983 of
$16.3 million.
• Adding up all the DWL’s, we obtain a total loss of
$112.5 million over the 4 years of the tariff.
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Examples of Infant Industry Protection
• Future Gains in Producer Surplus
 We can evaluate the future gains in producer surplus
by examining the stock market value of the firm around
the time that the tariff was removed.
 During the time of the tariff, the management of HarleyDavidson reduced costs through several methods,
many of which were copied from the Japanese firms.
 These changes allowed Harley-Davidson to transform
losses in 1981–1982 into profits for 1983 and the
following years.
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Examples of Infant Industry Protection
• Future Gains in Producer Surplus
 In July 1986, Harley-Davidson became a public
corporation and issued stock on the American Stock
Exchange.
 2 million shares at $11 per share totaling $22 million.
 The sum of these stock and debt issues is $112.3
million, which we can interpret as the present
discounted value of the producer surplus of the firm.
 This estimate of area (e) is nearly equal to the
consumer surplus loss of $112.5 million.
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Examples of Infant Industry Protection
• Future Gains in Producer Surplus
 A month after a second stock was offered, it rose from
$19 per share.
 Using that price for outstanding stock plus $70 in repaid
debt, we bet $131 million as the future producer surplus.
 By this calculation, the future gain in producer surplus
from tariff protection to Harley-Davidson exceeds the
deadweight loss of the tariff.
 Harley-Davidson has grown every year since and now
the Japanese copy from them.
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Examples of Infant Industry Protection
• Was Protection Successful?
 When we made the criteria that protection is successful
if the producer surplus outweighs the deadweight loss,
we assume the company would not have survived
otherwise.
 It is well documented that Harley-Davidson was on the
brink of bankruptcy before the tariff.
 Citibank had decided that it would not extent more loans to
cover Harley’s losses.
 However, if Harley-Davidson had filed for bankruptcy, it
might still have emerged to prosper again.
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Examples of Infant Industry Protection
• Was Protection Successful?
 Bankruptcy does not mean the company must stop
producing.
 If they had gone bankrupt without the tariff, some of all
of the future gains in producer surplus might have been
realized.
 We cannot be certain whether the turn around of
Harley-Davidson required the use of the tariff or not.
 In general, we agree that the harm caused by the tariff
was small compared with the potential benefits of
avoiding bankruptcy, which allowed Harley to become a
very successful company.
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Tariffs with Foreign Monopoly
• Now let’s consider what happens when we treat a
Foreign exporting firm as a monopoly.
• We will show that applying a tariff under a Foreign
monopoly leads to an outcome similar to the large
country case in Chapter 8.
 The tariff will lower the price charged by the Foreign
exporter.
 A tariff may now benefit the Home country.
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Tariffs with Foreign Monopoly
• Foreign Monopoly
 Assume no competing Home firm
 Home demand, D in figure 9.10, is supplied entirely by the
foreign monopolist.
 This is not very realistic, since normally a tariff is
considered when there is also a Home firm - but this
makes the analysis simpler.
• Free Trade Equilibrium
 The Foreign monopolist maximizes profits in its export
market where Home MR = Foreign MC*.
 This is point A in figure 9.10 showing exports of X1
charging a price of P1.
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Tariffs with Foreign Monopoly
• Effect of a Tariff on Home Price
 If a tariff, t, is implemented, then marginal cost for the
exporter in the Home market increases to MC*+t.
 The new profit maximizing level of output is at point B
with import prices now at P2.
 The increase in price from P1 to P2 is less than the
amount of the tariff, t.
 In this case, the net-of-tariff price received by the
foreign exporter, P3 = P2 – t, has fallen from its previous
level of P1 since price rises by less than the tariff.
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Tariffs with Foreign Monopoly
MC rises by the amount of the tariff, t.
Figure 9.10
Loss in consumer surplus is (c+d) and
gain in government revenue is (c).
Price
Increase in P
is less than t,
the increase
in MC
c
Price falls for the exporter to P3, so
importing country gets terms-of-trade
gains equal to (e).
d
P2
P1
P3 = P2 – t
Welfare depends on (e) versus (d).
e
B
MC*+t
t
t
MC*
A
MR
X2 X1
D
Foreign Exports
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Tariffs with Foreign Monopoly
• Effect of a Tariff on Home Price
 Since the Home country is paying a lower net-of-tariff
price for its imports, it has experienced a terms-of-trade
gain as a result of the tariff.
 Since the Foreign firm is facing a downward-sloping
demand curve, as price increases, the quantity
demanded falls, so price will not increase by the full
amount of the tariff.
 The Foreign firm is making a strategic decision to
absorb part of the tariff itself and pass only a portion of
it onto the Home market in order to maximize its profits.
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Tariffs with Foreign Monopoly
• Effect of the Tariff on Home Welfare
 With the increase in price, consumers are worse off and
consumer surplus falls by (c+d).
 The increase in price will benefit Home firms, but we
have assumed there are no Home firms.
 Tariff revenue equals the tariff, t, times the amount of
imports X2, which is area (c+e).
Fall in Home consumer surplus
Rise in Home government revenue
Net change in Home welfare
(c+d)
(c+e)
(e-d)
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Tariffs with Foreign Monopoly
• Effect of a Tariff on Home Welfare
 We can interpret area (e) as the terms-of-trade gain for
the Home country.
 The area (d) is the deadweight loss due to the tariff.
 Again if the terms-of-trade gain exceeds the
deadweight loss, then Home is better of due to the tariff.
 As we saw in the large country case, Home welfare
initially rises for small tariffs.
 We can again use the automobile industry and show
how a tariff can affect prices charged by a Foreign
monopolist.
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Import Tariffs on Japanese Trucks
APPLICATION
• We just learned that a tariff on a Foreign monopolist can
have a positive terms-of-trade effect for the Home country.
• To what extent do Foreign exporters actually behave that
way?
• We can look at the effects of the 25% tariff on imported
Japanese compact trucks imposed by the U.S. in the early
1980’s and still in place today.
• For cars, the VER with Japan was pursued, but for
compact trucks, it turned out another form of protection
was possible.
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Import Tariffs on Japanese Trucks
APPLICATION
• At the time, most of the trucks were imported as
cab/chassis with some final assembly needed.
• They were classified as “parts of trucks” which
carried a 4% tariff rate.
• Another category of truck, “complete or unfinished
trucks”, faced a tariff of 25%.
• This created an irresistible opportunity to
reclassify the trucks to get the higher tariff and
that is exactly what the U.S. Customs Service did.
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Import Tariffs on Japanese Trucks
APPLICATION
• This reclassification raised the tariff rates on all
Japanese trucks.
• According to one estimate, the tariff on trucks was
only partially reflected in U.S. prices.
 Of the 21% increase, only 12% was passed through to
U.S. consumer prices. 9% was absorbed by Japanese
producers.
• Therefore, this tariff lead to the terms-of-trade
gain for the U.S. predicted by our theory.
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Policy Response to Dumping
• Our discussion of a Foreign monopolist brings us
back to the topic of dumping we discussed in
Chapter 6.
• Dumping occurs when a firm is exporting goods at
a price that is below the price in its local market,
or below its average cost of production.
• We now want to understand the policy response
in the Home importing country.
• Under the WTO, an importing country is entitled to
apply an antidumping tariff anytime that a foreign
firm is dumping its product.
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Policy Response to Dumping
• An imported product is being dumped if its price is
below the price that the exporter charges in its
own local market.
• If the exporter’s local price is not available, then
dumping is determined by comparing the import
price to:
i. A price charged for the product in a third market, or
ii. The exporter’s average costs of production
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Policy Response to Dumping
• Anti-dumping Duty
 The amount of the antidumping duty is calculated as
the difference between the exporter’s local price and
the “dumped” price in the importing country.
 The purpose of the duty is to raise the price of the
dumped good and protect domestic producers.
 The fact that the higher price also raises prices for
domestic consumers and causes a deadweight loss for
the importing country is not taken into account when
deciding on whether or not to apply the tariff.
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Policy Response to Dumping
• Countervailing Duty
 Used when the Foreign government subsidizes its own
exporting firms so that they can charge lower prices for
the exports.
 All you need to know about export subsidies for now is
that they tend to lower the prices charged by exporters.
 Under WTO rules, the importing country can then
respond to export subsidies with a countervailing duty.
 Again the purpose of which is to raise prices of imports back up
to what it would have been without the subsidy.
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Policy Response to Dumping
• Comparison with Safeguard Tariff
 It is important to recognize that the tariff on compact
trucks was not an antidumping duty.
 It was actually a safeguard tariff.
 Given that the tariff was set over 20 years ago and still
holds, it confirms our assumption that Foreign firms
treat the tariff as fixed.
 This assumption does not hold for anti-dumping duties.
 Evidence shows that Foreign firms often do change
their prices, and increase the price charged in the
importing country even before an antidumping tariff is
applied.
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Policy Response to Dumping
• Calculation of Antidumping Duty
 To see why firms increase prices before an
antidumping duty is applied we need to see how the
duty is calculated.
 The duty is based on the Foreign firm’s local price.
 For example, if the local price is $10 and the export
price to Home is $6, the antidumping duty is $4—the
difference in the local price and the export price.
 This method creates an incentive for the Foreign firm to
raise its export price even before the tariff is applied so
the duty will be lower.
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Policy Response to Dumping
• Calculation of Antidumping Duty
 So using our same example, if they charge an export
price of $8 instead of $6 but keep the local price at $10,
the duty is now only $2.
 A price of $10, would avoid the duty all together.
 This increase in the import price results in a terms-oftrade loss for the Home country.
 We illustrate this in figure 9.11
 As price rises from P1 to P2 the result is a gain to Home firms
of (a), but a loss to Home consumers of (a+b+c+d).
 If no duty, then no revenue to the Home government.
 (b+c+d) is now the deadweight loss which is higher than the
tariff.
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Policy Response to Dumping
Foreign exporters increase
their prices to Home due to
the threat of anti-dumping
duties, which decreases
imports from M1 to M2.
Figure 9.11
S
Price
P
b
d
b+d
P2
c
c
a
c
P1
M
D
S1 S2
D2 D1 Quantity
(a) Home market
M2
M1
Imports
(b) Import market
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Policy Response to Dumping
• The loss of (c) is the extra costs associated with
the threat of an antidumping duty.
• The fact that Foreign firms will raise their prices to
reduce the potential duty gives Home firms an
incentive to charge Foreign firms with dumping,
even if none is occurring.
• Just the threat of dumping is often enough for
Foreign firms to raise prices and therefore reduce
competition in the market for that good.
• These incentives lead to excessive filings of
antidumping and countervailing duty cases.
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Antidumping/Countervailing duties
versus Safeguard Tariffs
APPLICATION
• In Chapter 8 we discussed the “safeguard” provision of
GATT and Section 201 of U.S. trade law.
 This provision, which permits temporary tariffs to be applied, is
used infrequently.
 Table 9.3 shows that only 19 safeguard or “escape clause” cases
were filed in the U.S.
 Of the 19 cases filed, the ITC made a negative recommendation in
12 cases.
 One of which was for the Japanese compact trucks.
 The remaining 7 cases went to the President for a final ruling who
recommended import protection in only 5 cases.
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Antidumping/Countervailing duties
versus Safeguard Tariffs
APPLICATION
Table 9.3
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Antidumping/Countervailing duties
versus Safeguard Tariffs
APPLICATION
• The infrequent use of the safeguard provision can be
contrasted with the many cases of antidumping and
countervailing duties, also listed in Table 9.3.
• Over 1980–1988, there were more than 400
antidumping cases filed in the U.S. and over 300
countervailing duty cases.
• To have antidumping duties applied, a case must first
go the U.S. Department of Commerce, which rules on
whether imports are selling domestically at “less than
fair value.”
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Antidumping/Countervailing duties
versus Safeguard Tariffs
APPLICATION
• The rulings were positive in 94% of cases during
this period.
• The case is then brought before the ITC, which
must rule on whether imports have caused
“material injury” to the domestic industry.
• This criterion is much easier to meet than that for
a safeguard tariff, and therefore, the ITC more
frequently rules in favor of antidumping duties.
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Antidumping/Countervailing duties
versus Safeguard Tariffs
APPLICATION
• Furthermore, the application of duties does not
require the additional approval of the President.
• Of the 400 antidumping cases, about 150 were
rejected and another 150 had duties levied.
• The remaining cases fall into a third category—
those that are withdrawn prior to a ruling by the
ITC.
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Antidumping/Countervailing duties
versus Safeguard Tariffs
APPLICATION
• The U.S. antidumping law permits U.S. firms to withdraw
their case and, acting through an intermediary at the
Department of Commerce, agree with the foreign firm on
the level of prices and market shares.
• As we should expect, these withdrawn and settled cases
result in significant increases in market prices for the
importing country.
• Since it seems most of the cases are either ruled favorably
or are settled with the exporting firm, it is clear why firms
make claims of dumping so often.
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U.S to Impose new Duties on Chinese Goods
HEADLINES
• The U.S. Commerce Department is imposing
tariffs on Chinese imports of coated paper.
• There has been a long standing policy to not
apply duties to subsidized goods from non-market
economies.
• The current trade deficit with China, which
reached $233 billion last year, has angered some
and has lead to demands for a tougher response
to Chinese export subsidies.
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U.S to Impose new Duties on Chinese Goods
HEADLINES
• Home producers feel they have an unfair disadvantage
competing with Foreign firms who have been subsidized.
• Many believe the Chinese government subsidies are what
are fueling the country’s exports.
• With the Commerce Department’s long standing position,
it was too difficult to determine levels of subsidies in nonmarket economies, which China is considered under U.S.
trade laws.
• However, many argue this no longer makes sense when it
comes to China.
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Conclusions
• We can contrast the results we saw in Chapter 8
under perfect competition with the results here
assuming imperfect competition.
 With a tariff, a Home monopolist can increase its price
by the amount of the tariff, but cannot exercise its
monopoly power.
 With a quota, the Home firm is able to charge a higher
price than it could with a tariff, because it enjoys a
“sheltered” market.
 Import quota leads to higher costs for Home consumers
than tariff.
 Tariff and Quota are no longer “equivalent” policies.
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Conclusions
• With a Foreign monopoly, results are similar to
the large country case in Chapter 8.
 A tariff leads to a fall in price received by the Foreign
monopolist.
 Price paid at Home rises by less than the tariff.
 Home importer obtains a terms-of-trade gain.
 For small tariffs, Home can gain as deadweight loss is
lower than terms-of-trade gain.
• A specific example of a tariff on a Foreign
monopoly was on a discriminating monopoly.
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Conclusions
• The WTO allows countries to respond with tariffs
if dumping is occurring in their countries.
 An anti-dumping duty.
 However, the potential for Home gains are unlikely to
arise, due to the way the duties are applied.
 The typical outcome are that Foreign exporters raise
prices even when the duty is not applied, leading to
Home losses.
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Conclusions
• Finally we considered the infant industry
argument for the implementation of trade policy.
• Examples studied were automobiles in China,
computers in Brazil, and Harley-Davidson
motorcycles in the U.S.
• There were mixed results in determining the
usefulness of the trade policy and whether or not
the losses justify the gains.
• It is likely there are other options with less
deadweight loss.
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Key Points
1. Free trade will lead a Home monopoly in a small
country to act in the same way as a perfectly
competitive industry.
2. Quotas are not equivalent to tariffs when the
Home firm is a monopolist.
3. An infant industry is a firm that requires
protection in order to compete at world prices
today.
4. When a tariff is applied against a Foreign
monopolist, the results are similar to the large
country case analyzed in Chapter 8.
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Key Points
5. Dumping is a practice of selling goods abroad at
a price that is below a firm’s domestic price, or
below its average cost of production. Countries
respond with anti-dumping duties.
6. Antidumping duties are calculated as the
difference between a Foreign monopolist’s local
price and its export price. Foreign firms often
raise their export prices.
7. In the U.S. and other countries, the use of
antidumping tariffs far exceed the use of
safeguard tariffs.
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