- All nations impose some restrictions in the form of tariff (i.e., import tariff and export tariff) and non-tariff barriers (i.e., import quota, dumping, international cartels and export subsidies) on the free flow of international trade.
- Since these restrictions and regulations deal with the nation’s trade or commerce, they are generally known as trade or commercial policy. Trade restrictions are invariably rationalise in terms of national welfare.
- A tariff is a tax or duty levied on the traded commodity as it crosses a national boundary. In this chapter we deal with tariffs, and in the next chapter we discuss other trade restrictions. An import tariff is a duty on the imported commodity, while an export tariff is a duty on the exported commodity. Import tariffs are more important than export tariffs, and most of our discussion will deal with import tariffs.
- Export tariffs are prohibited by the U.S. Constitution but are often applied by developing countries on their traditional exports (such as Ghana on its cocoa and Brazil on its coffee) to get better prices and raise revenues. Developing nations rely heavily on export tariffs to raise revenues because of their ease of collection. Conversely, industrial countries invariably impose tariffs or other trade restrictions to protect some (usually labor-intensive) industry, while using mostly income taxes to raise revenues.
- However, practically these are advocated by those special groups in the nations that stand to benefit from such restrictions. In this, we analyse the effects of a tariff on production, consumption, trade (i.e., import) and welfare in the nation imposing the tariff and on its trade partner (s).
Partial Equilibrium Analysis of Tariff: Small Country case
The partial equilibrium analysis of a tariff is most appropriate when a nation is too small to affect the world prices and operating with too small industry to affect the rest of the economy. In other words, we can say that partial equilibrium analysis relate to a small industry in a small nation.
- There is a small nation with small industry so that it cannot affect the world prices and the rest of the economy
- It imposes tariff on one commodity.
- The demand and supply curve of a commodity relate to the country, import tariff.
- Demand and supply curves are given and constant in the sense that consumers’ tastes, incomes and prices of other commodities are fixed from demand side and changes in cost conditions such as externalities, technological innovation supply side.
- Free trade foreign supply curve is perfectly (or infinitely) elastic with respect to price.
- Domestic country does not impose any tariff on the imported materials required for producing the commodity.
- The foreign price of the commodity remains unchanged.
- Domestically produced goods and imported commodity are perfect substitute.
- There is no transport cost
Descriptions of the Figure
- The partial equilibrium effects of a tariff can be analyzed with Figure 1, in which DX is the demand curve and SX is the supply curve of commodity X in Nation 2.
- The same type of analysis for Nation 1 is left as an end-of-chapter problem.
- Nation 2 is now assumed to be small and so is industry X.
- In the absence of trade, the intersection of DX and SX defines equilibrium point E, at which 30X is demanded and supplied at PX = $3 in Nation 2. With free trade at the world price of PX = $1, Nation 2 will consume 70X (AB), of which 10X (AC) is produced domestically and the remainder of 60X (CB) is imported.
- The horizontal dashed line SF represents the infinitely elastic free trade foreign supply curve of commodity X to Nation 2.
- If Nation 2 now imposes a 100 percent ad valorem tariff on the imports of commodity X, PX in Nation 2 will rise to $2. At PX = $2, Nation 2 will consume 50X (GH ), of which 20X (GJ ) is produced domestically and the remainder of 30X (JH ) is imported. The horizontal dashed line SF + T represents the new tariff-inclusive foreign supply curve of commodity X to Nation 2.
- Thus, the consumption effect of a tariff (i.e., the reduction in domestic consumption) equals 20X (BN); the production effect (i.e., the expansion of domestic production resulting from the tariff) equals 10X (CM ); the trade effect (i.e., the decline in imports) equals 30X (BN + CM ); and the revenue effect (i.e., the revenue collected by the government) equals $30 ($1 on each of the 30X imported, or MJHN).
- Note that for the same $1 increase in PX in Nation 2 as a result of the tariff, the more elastic and flatter DX is, the greater is the consumption effect (see the figure 1).
- Similarly, the more elastic SX is, the greater is the production effect. Thus, the more elastic DX and SX are in Nation 2, the greater is the trade effect of the tariff (i.e., the greater is the reduction in Nation 2’s imports of commodity X) and the smaller is the revenue effect of the tariff.