Tariff Instruments

1. Tariff Instruments Eco 3024F Krugman & Obstfeld Ch 8

2. Outline • Introduction: Relevance of tariffs • Types of tariffs • Partial equilibrium analysis of tariffs • Costs and benefits of tariffs • LATER: • Analysis of Tariffs (GE framework) • Trade policy in presence of monopolies 8-2

3. “Trade theory is about identifying whose hand is in whose pocket. Trade policy is about who should take it out” (Finger, 1981). “Tariff -- A scale of taxes on imports, designed to protect the domestic producer against the greed of his consumer”. From Ambrose Bierce, The Devil's Dictionary:

4. Why do we need to worry about tariffs and tariff policy? • Tariffs a key policy instrument used for industrial development • Department of trade and industry’s “National Industrial Policy Framework” • Trade negotiations • WTO negotiations • African countries negotiating new “economic partnership agreements” (EPAs) with EU • Regional integration schemes (SADC Customs union by 2010) • 3. Business operations: imported goods used in production and consumption

5. Tariffs & other charges • Goods imported into most countries are subject to different charges • Customs duties • Excise duties • Levies • Flue cured tobacco: 3.3c/kg + 75.9c/kg (special levy) • Lentils: 9.60 R/T + 2.5 R/T (special levy) • VAT or sales tax

6. Types of import tariffs (Customs duties) • Ad valorem tariff : PD = PW (1 + t) • Levied as a constant percentage of the monetary value of 1 unit of the imported good. • Oranges: 5% • But because it is based on the value of the good, an importer may understate the value while customs may overvalue as a counter measure. • Specific tariff: PD = PW + t • Import duty that assigns a fixed monetary (Rand) tax per physical unit of the good imported. • Blue veined cheese: 500c/kg • It may be collected with ease because only physical quantity of imports needs to be known and not their monetary value • However, protection varies with value of imported good. So inflation lessens strength of tariff

7. Types of import tariffs (Customs duties) Compound tariffs • Ad valorem PLUS specific tariff • E.g. wheat flour :10% plus 29.4c/kg • Mixed tariff • Either ad valorem OR specific (normally the one which yields higher protection) • E.g. Fish, fresh or chilled: 25% or 70c/kg

9. Supply, Demand & Trade in a Single Industry • Assume • Perfect competition in mkt for laptops. • Two countries in world producing laptops – SA & US • Initially No trade • Price of laptops in US lower than in SA • With trade SA will import laptops • Import demand curve for laptops from SA • With trade, US will export laptops • Export supply curve for laptops from US 8-9

10. Import demand curve Import demand curve (MD): SA demand –SA supply= Import demand by SA (from US) Import demand curve is downward sloping....why? What happens if P is above A? 8-10

11. Export supply curve B • Export supply curve (XS): • US supply – US demand = Exports supplied to SA (by US) Export supply curve is upward sloping....why? What is happening at point B? 8-11

12. World Equilibrium At Pw , XS=MD in SA Will Pw be the mkt clearing price in US as well? 8-12

13. Partial equilibrium analysis of impact of tariffs

14. The Effects of a Tariff • Suppose SA imposes tariff on computer imports • This is like a tax on the price of good imported or like the effect of transport costs (Imported price=foreign price + tariff) • Will introduce price wedge between domestic price (PT) and foreign price (P*T) • PT – P*T = t • What price adjusts, (PT) or (P*T)? • As domestic price increases, quantity demanded falls in SA • As quantity demanded falls, so quantity supplied by US falls leading to possible foreign price decrease 8-14

15. The Effects of a Tariff (cont.) • Price of the good in foreign (US) markets should fall if there is a significant drop in the quantity demanded of the good caused by the domestic (SA) tariff. • Extent of decline in foreign price depends on elasticity of foreign export supply and elasticity of import demand 8-15

16. The Effects of a Tariff (cont.) Domestic price rises and quantity of imports demanded falls Foreign price falls and quantity of exports supplied falls Gap between domestic and international price equals tariff wedge 8-16

17. Welfare: Who wins and who loses?

18. Welfare: Who wins and who loses?

20. Cost and Benefit using a small country model • Assumptions • Small country is unable to influence world price Pworld through changes in production and/or consumption • Implies: small countries face horizontal (infinitely elastic) Export supply curves

21. Consumer surplus, with tariffs Consumer surplus, no tariffs Consumer surplus loss PW (1+t) A B C D PW Q1 Q2 Q3 Q4 Imports at PW Small country supply and demand Price D S Quantity

22. Producer surplus gain Government revenue gain PW +t A B C D PW Dead weight loss Q1 Q2 Q3 Q4 Small country supply and demand Price D S Quantity Consumer loss-producer gain - government revenue = dead weight loss (B+D)

23. Small country: conclusion • Tariffs raise domestic production by raising the price received • Consumers pay for this through higher prices • Governments gain from tariff revenue, which they can transfer back to consumers • But price distortions lead to inefficient allocation of resources for consumers and producers • Whose hand is in whose pocket? • Tariffs lead to a transfer of surplus from consumers to producers 8-23

24. Consumer surplus loss PW* +t A C B D t PW PW* Q1 Q2 Q3 Q4 Tariffs in large countries Price D S E Quantity

25. Producer surplus gain Government revenue gain PW* +t t PW PW* Q1 Q2 Q3 Q4 Tariffs in large countries Price D S A C B D E Quantity Consumer loss - producer gain - government revenue = B+D-E

26. Large country: conclusion • Tariffs lower the world price • Foreign producers bear some of cost of tariff through lower world prices • Terms of trade improvement for Home • Tariffs still cause production and consumption efficiency losses • BUT, if terms of trade improvement are large enough (area E), then the economy can gain • Would you advise such a strategy? Why not?