Transcript Study Guide 7

Welcome to Econ 414
International Economics
Study Guide
Week Seven
Chapter 6
1
What is a tariff?
• Tax on imported goods
• Why?
– Revenue for Government
– Protect domestic suppliers of similar
goods from foreign completion
• Protect jobs
2
What are the types of tariff?
1. Specific tariffs
 Tax per unit
• specific tariff is regressive. Why?
– A specific tariff of $1,000 on each
imported auto
• a high percentage of the value of less
expensive cars
• a low percentage of the value of highpriced cars
3
Under specific tariff, what type of cars
will be imported less? Expensive cars?
Cheap cars?
• Cheap cars
– A specific tariff encourages domestic
producers to produce less expensive
goods.
4
What are the types of tariff?
2. Ad valorem tariffs
– Taxes = fraction of the value of the imported
goods
• A 5% tariff on an international price of $10,000
means that customs officials collect the fixed
$500
sum of _________.
– Importers have an incentive to under-voice
the price of the imported good.
– Ad valorem tariffs are more difficult for a
country to administer than specific tariffs.
5
What are the types of tariff?
3. Compound tariffs
– a combination of an ad valorem and a
specific tariff
– Common on agricultural products whose
prices tend to fluctuate.
6
What are different methods of
valuing imports?
1. Free alongside (FAS) price
•
The price of the imported good in the exporting
nation before loading the good for shipment to
the importing country
2. Free on Board (FOB) price
•
FAS + the cost of loading the good in the
means of transportation
7
What are different methods of
valuing imports?
3. Cost, Insurance, and Freight
(CIF) price
• FOB + all inter-country
transportation costs up to the
importing country’s port of entry.
8
What is consumer surplus (CS)?
Price
P1
Consumer Surplus
The difference between
the highest price
consumers would be
willing to pay (Price on
demand curve) and the
market price.
Graphically, it is equal to
the area under the
demand curve and above
the price
P
D
Q
Quantity
The higher the CS
Better off
the ___________
the consumers
9
What is producer surplus (PS)?
The difference between
the market price and
lowest price producers
will sell a good (price on
the supply curve).
Graphically, it is equal to
the area under the price
and above the supply
curve
The higher the PS the
Better off
___________
the
producers
Price of Cloth
S
E
P
Producer
Surplus
P2
Q
Quantity of Cloth
10
The combined effect
Price
P1
Consumer Surplus
S
E
P
Producer
Surplus
D
P2
Q
Quantity
11
How does a free trade affect consumer surplus
and producer surplus?
Price
10
a
b
8
Price
S
S
E
d
8
c
Imports
4
a’
Exports
b’
d’
c’
E’
India
D
US
D
Quantity
CS ↑ by b+ d, PS ↓ by b
Quantity
12
CS↓ by b’, PS ↑ by b’ + d’
What are the economic effects
of tariffs?
1. Case of small importing nation

Note: A small nation can import as much as it
likes at the same international price.
– World Prices = €8.
– Domestic government imposes a specific
tariff on imported good in the amount of
€2/unit
– Domestic Price = 8 + 2 = €10
13
What are the economic effects of
tariffs in a small importing
-a+b+c+d: loss in CS
nation?
= €75
- a: added to PS= €25
- b: cost of resources
S transferred from their
best use to the
production of 5 more
units of the good= €5
- c: government
revenue = €40
-d: loss to consumers
= €5
- a + c: redistributed
D effect
- b+d: dead-weight
loss
Price
20
E
10
a
Tariff = 2
c
b
8
d
2
10
15
35
40
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Quantity
What are the economic effects of tariffs
2. Case of large importing nation
• Note: A large nation can influence the international
price.
– World Prices = €8.
– Domestic government imposes a specific tariff
on imported good in the amount of €2 .
– World supplier reduces the price to €7
– Domestic Price after tariff= 7+ 2 = €9
15
What are the economic effects of tariffs
in a large importing nation?
Price
20
E
9
Tariff = 2
a
c
b
8
d
f
7
2
10
15
35
40
-a+b+c+d: loss in CS
= €37.5
- a: added to PS=
S
€12.5
- b: efficiency loss=
€2.5
- c+ f: government
revenue = €40
-d: loss to consumers
= €2.5
- a + c: redistributed
effect
D - b+d: dead-weight
loss
-f: loss in exporter’s
revenue
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Quantity
The Effective Rate of
Protection
• Effective Rate of Protection
ERP = (Tf – aTc)/(1-a)
which,
Tf = tariff rate on imported final product
Tc = tariff rate on the imported components
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The Effective
Rate of Protection
• Example: Consider two DVD players; one
produced in the U.S. and one produced in a
foreign country. Both DVD players sell for $100
in the U.S. with half of that price represents the
cost of components purchased from a third
country. An ad valorem tariff of 20% imposed by
the U.S. raises the value added from $50 to $70.
Thus, the effective rate of protection is (7050)/50 = 40%.
18
Arguments for Tariffs
• Infant Government Argument
– Developing countries use tariffs as a way to generate revenue.
• National Defense Argument
– Certain industries need to be protected from foreign competition
to ensure an adequate output of the industry in the case of
conflict.
– Two problems arise with this argument:
• It is hard to identify the industries that are essential for national
defense.
• A tariff is a costly means of protection. Instead, a domestic
production subsidy should be used to encourage domestic
production of the good.
– The next slide depicts the effects of a domestic production industry.
19
Arguments for Tariffs
• Infant Industries
– From World War II until the 1970s many developing countries
attempted to accelerate their development by limiting imports of
manufactured goods to foster a manufacturing sector serving the
domestic market.
– The most important economic argument for protecting
manufacturing industries is the infant industry argument.
• Senile Industry Protection
– Many developed countries protect industries that are old.
• For example, the apparel industry in most developed countries
experience this type of protection.
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Arguments for Tariffs
Figure 6-6: The Effects of a Domestic Production Subsidy
Price of Cloth
S
S’
P1
Subsidy
E
P
G
Pt
Tariff = T
a
c
b
Pw
d
F
D
P2
Q1
Q3
Q
Q4
Q2
Quantity of Cloth
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Arguments for Tariffs
• Tariffs, Trade and Jobs
– The imposition of a tariff in a particular industry produces more
jobs in that particular industry but fewer jobs in other industries.
• The overall level of employment is unchanged in the short-run
whereas in the long-run it may decrease.
• An economy with a lot of tariffs will usually grow more slowly than a
more open economy.
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