Preview Types of tariffs Effects of tariffs when domestic consumers fully pay Effects of tariffs when foreign producers partially pay Optimal tariff Effective rate of protection 8 2 Types of tariffs ID: 539587
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Slide1
Costs and benefits of tariffsSlide2
PreviewTypes of tariffs
Effects of tariffs when domestic consumers fully pay
Effects of tariffs when foreign producers partially pay
Optimal tariffEffective rate of protection
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2Slide3
Types of tariffsA
tariff
is a tax on goods and services produced abroad and sold domestically.
It is also sometimes called a
duty
.
Products that do not have tariffs/taxes are called duty free.Tariffs or duties are usually collected by customs officials at the port of entry.See http://www.customs.go.kr/
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3Slide4
Types of tariffsA
specific tariff
is an amount of money per unit of the imported product.
for example, 3,000원
p
er kg of rice
An ad valorem tariff is a percentage of the estimated value of the imported product.for example, 5% of the value of riceTariffs generally raise the domestic price of imported products above the price in international markets, and generally domestic consumers pay all or part of the tariff.
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Types of tariffs
Most favored nation
(MFN)
tariffs are tariffs that each member of the World Trade Organization (WTO) promises
to
apply to all other members, as it applies to the country to which it gives its
lowest
or
most favorable
rate.
But exceptions include tariff rates used in a preferential trade agreement and for very poor countries.
Some countries impose higher tariffs on products from countries that are not part of the WTO.
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5Slide6
Types of tariffs
Preferential tariffs
are exceptions to the MFN tariffs and are lower than MFN tariffs.
They allowed by the WTO for
members of a preferential trading agreement:
customs union (with a common external tariff policy) or a free trade area (with no common external tariff policy).
very poor countries.
The largest of set of unilateral preferential tariffs for poor countries is the Generalized System of Preferences (GSP),
which lists the countries and the types of goods on which preferential tariffs may be applied.
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Types of tariffs
A
bound tariff
is the maximum (potential) tariff that a country promises to charge WTO members now or in the future.
WTO members are allowed to raise or to lower their tariff rates over time, but they promise to raise them only up to the bound tariff rate.
Bound tariffs are not necessarily actual tariffs; they are the maximum potential tariffs for WTO members.
In other words, the actual tariff rate is less than or equal to the bound tariff rate for WTO members.
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Types of tariffs
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8
Preferential tariff rate
Most favored nation tariff rate
Tariff rate for non-WTO members
bound tariff rate
percentSlide9
Types of tariffsIf the domestic government imposes or raises a tariff, in response
foreign governments might not impose their own tariffs, or they might impose them as “retaliation”.
foreign producers might keep the price of their product the same,
or not, if they want to accommodate domestic consumers in order to maintain their shares in the domestic market.
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Tariffs when domestic consumers fully payFirst, let’s assume that foreign producers do not change the price of their product, so that domestic consumers must pay all of the tariff.
Foreign suppliers might not change the price of their product because events in the domestic market (like the imposition of a tariff) have no significant influence on the price that foreign suppliers want to charge.
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Tariffs when domestic consumers fully pay
Because tariffs generally raise the domestic price of imported products,
the quantity of imported products should fall, and
domestic consumers will be worse off because some can no longer afford to buy imported or domestic products.
those who continue to buy imported products need to pay more.
some will switch to less desirable and more expensive substitutes that were produced domestically.
some will need to pay more for domestic substitutes due to scarcity or lack of competition in the domestic market.
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Tariffs when domestic consumers fully pay
Because tariffs generally raise the domestic price of imported products, domestic import-competing firms can respond by
raising the prices of their own products,
producing and selling more of their own products,
doing both.
By making imported products less “competitive” in the domestic market, a tariff should make domestic import-competing firms better off.
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Tariffs when domestic consumers fully pay
Because tariffs allow the government (customs officials) to collect money/revenue,
it should be better off.
It can use this money/revenue to pay for various projects or simply to pay customs officials higher salaries.
Because administering and enforcing the tariff uses real resources (ex., people), the government can self-finance the administration and enforcement with tariff revenue.
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Tariffs when domestic consumers fully pay
We can represent these ideas through a simple supply-demand diagram:
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Tariffs when domestic consumers fully pay
Price of citrus fruit
0
Quantity of citrus fruit
Domestic
supply
Domestic
demand
Tariff
Imports
without tariff
Price with tariff
Imports
with tariff
Q
S
World
price
Price without
tariff
Q
S
Q
D
Q
D
In this case, we assume that domestic consumers pay all of the tariff, so the price in the domestic market rises by the full amount of the tariff.Slide16
Tariffs when domestic consumers fully pay
0
Domestic
supply
Domestic
demand
Imports
without tariff
World
price
Q
S
Q
D
Producer surplus
before tariff
Consumer surplus
before tariff
Price without tariff
Price of citrus fruit
Quantity of citrus fruitSlide17
Tariffs when domestic consumers fully pay
A
B
0
Domestic
demand
Tariff
Imports
without tariff
Imports
with tariff
Consumer surplus
after tariff
C
G
Producer
surplus after
tariff
World
price
Domestic
supply
Q
S
Price with tariff
Q
D
Q
D
Q
S
Price without tariff
Price of citrus fruit
Quantity of citrus fruitSlide18
Tariffs when domestic consumers fully pay
E
0
Domestic
supply
Domestic
demand
Imports
without tariff
World
price
Q
S
Imports
with tariff
Q
S
Q
D
Q
D
Tariff revenue
Price with tariff
Price without tariff
Tariff
Price of citrus fruit
Quantity of citrus fruitSlide19
Tariffs when domestic consumers fully pay
C
G
A
E
D
F
B
0
Domestic
supply
Domestic
demand
Price with tariff
Tariff
Imports
without tariff
Price without tariff
World
price
Imports
with tariff
Q
S
Q
S
Q
D
Q
D
Losses from consumers who are no longer able to afford citrus fruit.
Price of citrus fruit
Quantity of citrus fruit
Losses from some consumers
who are forced to buy
more expensive domestic citrus fruit.Slide20
Tariffs when domestic consumers fully pay
Consumers lose because
some consumers can no longer afford to buy the product.
The loss for these consumers is represented by area F.
some consumers buy a product that was produced less efficiently and more expensively by domestic producers.
The loss from less efficient production and more expensive products is represented by areas C + D, which is called the
efficiency loss of the tariff.some
consumers
must
pay a higher price
for
imported
products with the tariff instead of buying from foreign firms duty free.
The loss for these consumers is represented by area E and is called the
import markup loss
.
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Tariffs when domestic consumers fully pay
The full loss for consumers is C + D + E + F and is called the
consumption loss
of the tariff.Losses C and E for consumers are offset by gains from producers and from tariff revenue.
But losses D and F are not offset: they are called
deadweight losses
.8-21Slide22
Tariffs when domestic consumers fully pay
Tariffs benefit some groups, which is principally why they are used, even though they create deadweight losses for the economy.
The government collects tariff revenue, which is represented by area E.
Area E is directly above Q
2
D
– Q2S , the distance representing the smaller amount of imports.Import-competing producers are able to increase their prices and sell more, the benefit of which is represented by area C.The distance Q
2
S
– Q
1
S
represents increased domestic production and sales, and part of the reduction of imports.
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Tariffs when domestic consumers fully pay
This analysis assumes that each group’s welfare is equally weighted.
We view and measure the (monetary) value of benefits and losses of consumers, producers and the government equally and objectively.
One group’s or person’s loss is not weighted more than one group’s or person’s benefit.
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Tariffs when domestic consumers fully pay
But in practice some people favor one group more than the other.
Since the government sets policy, it might favor its own interests over the interests of consumers and increase a tariff for its benefit.
If import-competing firms are politically influential, they can lobby the government to increase a tariff for their benefit at the expense of consumers.
Millions of consumers, however, have difficulty organizing and lobbying for lower tariffs.
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Tariffs when foreign producers partially pay
When a country is large and important in a market, its actions can affect the market price.
In particular, if it sets a tariff on a product, the price in international markets can fall because (quantity) demand(
ed) of the product falls significantly due to the more expensive price that domestic consumers must pay.
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Tariffs when foreign producers partially pay
Foreign
firms
might respond to a tariff by reducing their prices for domestic consumers, because they believe this is necessary to maintain the market share in the domestic market.
or because the demand of their products has significantly decreased.
For example, if the US place a tariff on the cars from Korea, Korean producers/sellers might have to lower their prices due to the loss in the (quantity) demand(
ed) in the US market, which is large and important for the Korean producers/sellers.
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Tariffs when foreign producers partially pay
Formally, economists say that a buyer with power to influence the market price has
monopsony
power
.
A single buyer in a market, which would have the maximum amount of power, is called a
monopsony. A large and important country, one with monopsony
power, can cause foreign sellers to lower their prices and earn tariff revenue at the same time.
Even in competitive markets, a large reduction in demand can force sellers to lower their prices.
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Tariffs when foreign producers partially pay
On the other hand, foreign firms might respond to a tariff simply by selling fewer exports (domestic imports) instead of reducing prices.
When foreign firms do not change their prices at all, then domestic consumers fully pay for the tariff.
In this case, buyers in the domestic market (and the government that represents them) have no monopsony power.
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Tariffs when foreign producers partially pay
But tariffs set by a large and important country still have costs.
As long as the prices with the tariffs increase in the domestic market, domestic consumers will lose.
In particular, there are still losses from less efficient/more expensive production and from the fact that some consumers can no longer afford to buy the more expensive products.
However, if price increases are smaller relative to a case where foreign sellers do not lower their prices, then the losses for consumers are smaller.
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Tariffs when foreign producers partially pay
A
E
1
B
0
C
Domestic
supply
Price accepted by foreign firms
G
Domestic demand
Price
paid by domestic consumers
Imports
without tariff
Price without tariff
Lower price received by foreign sellers
Imports with tariff
Q
S
Q
S
Q
D
Q
D
Price of citrus fruit
Quantity of citrus fruit
E
2
Tariff
Higher price paid by domestic consumers
Consumer surplus
after tariff
Producer
surplus after
tariff
Tariff
burden for domestic consumers
Tariff
burden for foreign sellersSlide31
Tariffs when foreign producers partially pay
C
A
E
1
D
F
B
0
Domestic
supply
Domestic demand
Price
paid by domestic consumers
Imports
without tariff
Price without tariff
Lower price received by foreign sellers
Imports with tariff
Q
S
Q
S
Q
D
Q
D
Price of citrus fruit
Quantity of citrus fruit
Price accepted by foreign firms
E
2
Tariff
Higher price paid by domestic consumers
Losses from consumers who are no longer able to afford citrus fruit.
Losses from some consumers who are forced to buy more expensive domestic citrus fruit.
GSlide32
Tariffs when foreign producers partially pay
As before, losses for domestic consumers result from
being no longer able to afford more expensive domestic or foreign products (area F).
being forced to
buy
a
less efficiently and more expensively produced domestic product instead of a similar foreign product, and being forced to buy a more expensive domestic product due to scarcity or lack of competition, even if they bought the domestic product previously (areas C + D).being forced to pay more for the imported product (area E
1
).
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Tariffs when foreign producers partially pay
As before, some of these losses are offset by gains for others, but some are not.
D
omestic producers/sellers gain because domestic consumers are forced to buy a more expensive product.
They can sell more and charge a more expensive price, a gain represented by area C.
T
he domestic government earns tariff revenue, represented by area E1 + E2.
But because foreign producers/sellers are willing to lower their prices, they effectively absorb some of the cost of the tariff and allow domestic consumers to save: E
1
< E.
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Tariffs when foreign producers partially pay
Losses for foreign producers/sellers result from
a decrease in the price (profit) of their exports (domestic imports), which makes them share the burden of the tariff with domestic consumers.
a decrease the quantity of their exports (domestic imports), which also results in a loss in profit.
We can measure this loss in profit by the loss in revenue (the full price
x
quantity that could have been sold) minus the (marginal) cost of production for the units not sold.8-
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Tariffs when foreign producers partially pay
We can represent the losses for foreign producers/ sellers and for domestic consumers that are not offset by representing
the (marginal) cost of production for foreign producers/ sellers, represented by an export supply function.
the (marginal) willingness to buy/pay by domestic consumers, represented by an import demand function.
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Tariffs when foreign producers partially pay
E
2
E
1
0
Foreign supply of exports
Domestic demand of imports
Price of citrus fruit
Quantity of citrus fruit
represents the marginal cost of production
(lower than for domestic firms)
represents the (marginal) willingness to pay/buy
Quantity of i
mports with tariff
Price
paid by domestic consumers
Price without tariff
Price in accepted by foreign firms
Quantity of i
mports without tariff
Tariff
burden for domestic consumers: cost due to higher prices paid
Tariff
burden fo
r foreign producers/sellers
: cost due to lower prices (profit) received Slide37
Tariffs when foreign producers partially pay
H
E
2
E
1
D+
F
0
Foreign supply of exports
Domestic demand of imports
Price of citrus fruit
Quantity of citrus fruit
represents the (marginal) willingness to pay/buy
Quantity of i
mports with tariff
Price
paid by domestic consumers
Price without tariff
Price in accepted by foreign firms
Quantity of i
mports without tariff
Losses for domestic consumers who no longer buy imports that are not offset by domestic firm gains or tariff revenue
Losses for foreign producers/ sellers: decrease in profit from a decreased quantity of exports
represents the marginal cost of production
(lower than for domestic firms)Slide38
Optimal tariffThe smaller deadweight losses for domestic consumers could be completely offset by tariff revenue:
The tariff revenue earned by the government that is effectively paid by foreign producers/sellers when they lower their prices (area E
2
) can be larger than consumer losses that are not offset by gains of others (areas D + F).
So the domestic country as a whole can benefit from the tariff,
at the expense of foreign firms who suffer from their own deadweight losses (area H) and losses from being forced to lower their prices (area E
2).8-
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Optimal tariffWhen the domestic government can take advantage of the willingness of foreign producers/sellers to lower their prices in response to a tariff, it can calculate the
optimal tariff
:
the tariff that forces foreign firms to lower their prices the most so that losses for domestic consumers are the smallest relative to tariff revenue earned by the domestic government.
However, this analysis assumes that foreign governments will not respond likewise.
Such “retaliation” would hurt domestic firms, possibly erasing any gains from a tariff imposed by the domestic government.
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Optimal tariffTo calculate the optimal tariff, we consider a change in the current tariff (possibly at zero) and
the marginal (extra) gains from having foreign firms lower their prices relative to
the marginal losses for consumers from a more expensive product.
A rule from calculus says that when we have achieved the optimal tariff, then
marginal gains – marginal losses = 0
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Optimal tariffLet
the current tariff be
t
0 and dt be
a
change in the tariff.M be the current quantity of imports and dM be the change in imports from a change in the tariff.P be the current price charged by (and received by) foreign firms and
dP
be
the change in
this price from a change in the tariff.
P*
be the price paid by consumers and received by foreign firms without a tariff (with free trade).
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Optimal tariffthen
marginal gains from a change in the tariff, caused by foreign firms lowering the prices of their products, is represented by
M
×dP/
dt
.
total marginal losses from a change in the tariff, for domestic consumers buying less and foreign firms selling less, is represented by t0P ×
dM
/
dt
.
domestic marginal losses from a change in the tariff, caused by domestic consumers buying less, is represented by ((
P + t
0
P
)–
P*
)×
dM
/
dt
.
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Optimal tariffSetting the marginal gains equal to the total marginal losses and solving for
t
0
shows that
t
0
= (M ×dP/dt)/(P ×dM/
dt
)
t
0
= (
M/P)
×(
dP
/
dt
)
/(
dM
/
dt
)
Setting the marginal gains equal to only domestic marginal losses and solving for t0 shows that:((P + t0P)–P*)×dM/dt = M ×dP/dt
(P + t0P)–P* = M ×(dP/dt)/(dM/dt)t0 = (M/P) ×(dP/dt)/(dM/dt) + P*/P – 1
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Optimal tariff
0
Foreign supply of exports
Domestic demand of imports
Price of citrus fruit
Quantity of citrus fruit
represents the (marginal) willingness to pay/buy
represents the marginal cost of production
(lower than for domestic firms)
P
M
dP
/
dt
dM
/
dt
t
0
P
Total marginal losses of a higher tariff for domestic consumers and foreign firms
Marginal gains of higher tariff from foreign firms lowering the prices of their products.
((
P
+
t
0
P
) –
P*
)
Domestic marginal losses of a higher tariff from domestic consumers buying fewer imports Slide45
Effective rate of protectionTariffs can be applied to products that compete with those which a firm sells, as well as to inputs to production—materials and components—that a firm buys to make its products.
The tariffs on competing products allow a firm to increase its price and its income/revenue.
The tariffs on the inputs increase the costs of the producer.
The
effective rate of protection
compares the tariffs on products that compete with those which a firm
sells with the tariffs on inputs to production that a firm buys.
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Effective rate of protection
To calculate the effective rate of protection for a firm, we calculate the change in the price earned and the cost paid from a change in tariffs:
where
∆
P
sell
= change in price earned as a seller ∆Cbuy = change in cost paid as a buyerPsell_0 = original price earned as a seller
C
buy_0
= original cost paid as a buyer
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Effective rate of protection
The difference between the price that a producer sells a product for and the cost that it pays for its inputs to production is called
value added
.
It represents the additional value created in a good or service from the production process.
It also represents the value of the income/revenue earned by the firm for producing and selling the product.
The original value added equals Psell_0 – Cbuy_0The new value added equals P
sell_1
– C
buy_1
where ∆
P
sell = Psell_1
- P
sell_0
where ∆
C
buy
= C
buy_1
- C
buy_0
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Effective rate of protection
8-
48
costs of
inputs to production
value added per unit sold: income earned by producers
without tariffs
costs of
inputs to production
value added per unit sold: income earned by producers
with tariffs
effect of the tariff on inputs to production
effect of both tariffsSlide49
Effective rate of protection
The effective rate of protection can also be calculated with value added:
where
v 1
= P
sell_1
- Cbuy_1v 0 = Psell_0 - Cbuy_0
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Effective rate of protectionThe effective rate of protection can be negative,
implying that the prices on the inputs
to production
increase more than the prices on the products that the firm sells.
or implying that the prices on the products that the firm sells
decrease
more than the prices on the inputs to production.8-50Slide51
Summary
Tariffs are taxes/duties on imported products that raise their prices for domestic consumers.
Tariffs also raise the prices of domestic substitutes and allow importing-competing firms to produce more with less competition.
Tariffs allow the government to raise revenue, which it can use to finance the administration/enforcement of the tariff or to finance other projects.
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Summary
Tariffs create various kinds of losses for domestic consumers:
some can no longer afford to buy imported products or domestic substitutes because the prices of both increase.
some must pay
more
for imported products.some must buy less efficiently and more expensively produced domestic products instead of imported products.
some continue to buy domestic products, but must pay more due to scarcity or lack of competition in the domestic market.
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Summary
The efficiency loss of the tariff represents the fact that some domestic consumers
must buy less efficiently and more expensively produced domestic products instead of imported products.
continue to buy domestic products, but must pay more due to scarcity or lack of competition in the domestic market.
The import markup loss of the tariff represents the fact that some domestic consumers
must pay
more for
imported
products.
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53Slide54
Summary
The
deadweight loss
of
the tariff represents the fact
that
some domestic consumers can no longer afford to buy imported products or domestic substitutes because the prices of both increase.
some domestic consumers must buy less efficiently and more expensively produced domestic products instead of imported products.
some losses for domestic consumers are not offset by gains for domestic firms and the government.
foreign firms are no longer able to profitably produce and sell as much with the tariff.
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Summary
If a country has
monopsony
power, its tariffs will force foreign firms to lower their prices, which will reduce losses for domestic consumers,
while still allowing the domestic government to earn tariff revenue.
A country can have so much
monopsony power that its tariff revenue can be larger than deadweight losses for domestic consumers, and the country as a whole can gain at the expense of foreign firms.
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55Slide56
Summary
An optimal tariff is one that forces foreign firms to lower their prices so that losses for domestic consumers are the smallest relative to tariff revenue earned by the domestic government.
At the optimal tariff, gains in tariff revenue from marginal changes in the tariff = domestic consumer losses
from marginal changes
in the tariff.
However, when trying to use an optimal tariff, the domestic government needs to be careful about retaliation from foreign governments.
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56Slide57
Summary
The effective rate of protection compares the tariffs on the products that a firm sells with the tariffs on the inputs to production that a firm buys.
The difference between the price that a producer sells a product for and the cost that it pays for its inputs to production is called value added.
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