Trade Policy: Instruments and Impacts

Appleyard & Field (& Cobbs): Chapters 1314 Krugman & Obstfeld: Chapter 8

Todays Lecture
1.

Instruments of trade policy

1.
2. 3.

Tariffs Quotas Other Non-tariff Barriers to Trade

Partial Equilibrium: Small Country Partial Equilibrium: Large Country General Equilibrium: Small Country General Equilibrium: Large Country
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2.

Impact of trade policies

1. 2.

3.
4.

Tariffs
Imports tariffs o specific tariff:
(a monetary sum that must be paid to import 1 physical unit of a product) Advantage: easy to collect Disadvantage: doesnt take price changes into account

ad valorem tariff: (a percentage of the monetary value of 1 unit of import)

Advantage: takes price changes into account Disadvantage: Need to know the monetary value of the good and seller is tempted to undervalue the price

Other instruments o Import subsidy negative import tariff o Export tariff/subsidy (levied/paid on home-produced goods that are destined for export)
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Features of Tariff Schedules

Preferential duties o products form certain countries are subject to lower tariffs than the normal tariff rate o Generalized System of Preferences (GSP) for developing countries Most-favoured-nation (MFN) treatment = normal

trade relations (NTR)

o

if country A grants country B the status of mostfavoured nation, it means that Bs exports will face tariff that are no higher (nor lower) than those applied to any other country that A calls a MFN (Economics A-Z in The
Economist website)
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Non-tariff Barriers to Trade (1)

Import Quotas o a government agency allocates the rights to import o limits the number of goods (not the price) for a given time period Voluntary export restraints (VER) o foreign suppliers agree to voluntary refrain from sending some exports Government procurement provisions o restriction on purchasing foreign products by the domestic government agencies Domestic content provisions o a given percentage of the value of a good must consist of domestic components or labour
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Non-tariff Barriers to Trade (2)

Administrative classification
o

different tariffs to different product categories + leeway for customs officials to decide on classification

Restrictions on services trade

Trade-related investment measures

Domestic policies affecting trade
o

health, environment and safety standards; packaging and labeling requirements; inconsistent treatment of intellectual property rights; subsidies to domestic firms...
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etc.

Impact of Trade Policy: Levels of Study

Partial Equilibrium analysis

analysing one market and ignoring the subsequent or secondary effects

General equilibrium analysis

analysing all markets simultaneously (but still holding
technology, endowments etc. constant)

Note that here market means a market for one good (which can be sold in many countries). We will use both approaches to study onecountry and two-country cases. The difference is that in general equilibrium analysis we take also into account what happens in the markets of goods not subject to trade policy.
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Consumer and Producer Surplus

Price (P)

In a partial equilibrium approach we can use the concepts of consumer and producer surplus Both reflect the fact that there is only one market price Hence, there are consumers who would have been willing to pay more for the product Similarly, all but the last unit is produced with lesser marginal cost than the market price received

S=
marginal cost of production

consumer surplus producer surplus

Quantity (Q)
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The Impact of Import Tariff: The Small-Country* Case

* Small country = cannot affect world prices Loss of consumer surplus SD
P

Increase of producer surplus and government income SD

Loss of consumer surplus Pint Pint

DD
imports after tariff imports in free trade Q imports after tariff

tariff to the government

(1+)Pint

(1+)Pint increase of producer surplus

DD
Q
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imports in free trade

The Impact of Import Tariff: The Small-Country Case

Introducing a tariff Domestic price increases Domestic quantity supplied increases Domestic quantity demanded falls Increase of government revenues Distributional effect o surplus is transferred from the consumers to the producers and the government Consumers lose more than producers and government

win: deadweight loss

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The Impact of Import Quota: The Small-Country Case

For every quota there is an
tariff there is an equivalent quota)

equivalent tariff (and for every

SD

The changes in consumer

and produce surplus are equivalent to that of a tariff However, the increase of government revenue may be lost (depending on how the quotas are allocated)

PQ

Pint

DD
quota imports in free trade Q
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The Impact of Subsidy to ImportCompeting Industry (Small Country Case)

P

SD

SD

Cost to the government P P

increase of producer surplus

DD
imports after the subsidy imports in free trade
Q imports after the subsidy

DD
Q

imports in free trade

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The Impact of Subsidy to ImportCompeting Industry (Small Country Case)

Equivalent subsidy = producers are subsidised to produce the

same amount as they would under a tariff

Equal increase in the producer surplus as under tariffs Large cost to the government No impact on price no impact on consumer surplus

Cost to the government is larger than the increase of producer

surplus, i.e. there is a loss of efficiency However, this cost is less than the loss of consumer surplus in the tariff/quota case subsidies are more efficient than tariffs/quotas

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Large country, partial equilibrium Single Market, Two Countries

P Country A SA SB P Country B

DB

DA

Q
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Single Market, Two Countries

P Country A SA SB P Country B

DB

DA

Countries A and B have different supply curves (cost of production) and demand curves 15 (preferences). In free trade equilibrium the world price is such that country B is willing to export the same quantity as country A is willing to import.

Single Market, Two Countries, Tariff

P Country A SA SB P Country B

DB
tariff

DA

Price in Country A = Price in country B + tariff. If the price in country B would remain constant after a tariff is set, country B would be willing to export more that country A would be willing 16 to import price in country B must decrease (next slide)

Effect of a Tariff in a Single Market and Two-Countries

P Country A DA SA DB
PA PFT

Country B

SB C
price decrease in country B

tariff
PB

Country A: Loss of consumer surplus = e+a+D+b; increase of producer surplus = e; Increase of government revenue = C+D. Gain for Country A = gainslosses = (e+C+D)-(e+a+D+b) = C a b. That is, if C > a + b country A has gained from the imposition of the tariff (due to lower prices of imports 17 before tariff).

Impact of Elasticises
P Country A DA SA SB P Country B

PA PFT

DB e a D b
tariff
PB

price decrease in country B

The more elastic in the exporting market and the more inelastic in the importing market supply and demand are, the less chances the importing country has on gaining from tariff

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The Impact of Import Quota

Graphically identical to the case of tariff The difference is in, who gets areas D (country As
government revenue from the tariff) and C (loss of country Bs producer surplus that is transferred to country A in the tariff setting)

Voluntary export restraints (VER) can be seen as a way

for the exporting country to capture areas C and D

o

Then, if this gain is greater than the deadweight loss of the exporter (triangles around C), the exporting country will gain from the quota

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General Equilibrium Analysis

Partial Equilibrium analysis

analysing one market and ignoring the subsequent or secondary effects

General equilibrium analysis

analysing all markets simultaneously (but still holding
technology, endowments etc. constant)

Note that here market means a market for one good (which can be sold in many countries). We will use both approaches to study onecountry and two-country cases. The difference is that in general equilibrium analysis we take also into account what happens in the markets of goods not subject to trade policy.
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General Equilibrium Effects of a Tariff for a Small Country

Import tariff on good Y changes the price ratio Producers adjust from point PFT to Pt Since the tariff doesnt change world prices, countrys real income changes to (PX/PY)t Consumers maximize given domestic prices and real income and move to a lower utility level Note that real income is determined by the world prices

Good Y

CFT
Ct Pt
PX/(1+)PY

PFT

(PX/PY)FT

Ct Pt CFT

PFT

Good X

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General Equilibrium Effects of a Subsidy for a Small Country

Assume the government subsidizes producer of good Y to impose the same production pattern as with the tariff The real income of the country remains the same Consumers face world prices and are able to consume at a higher utility level

Good Y

CFT CS PS
PX/(1+)PY

PFT

(PX/PY)FT

CS

PS CFT

PFT

Good X

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Terms of Trade Effect of a Tariff

Imposing a tariff shifts
country is now willing to trade less for all terms of trade)

offer curve inwards (the

Imports to country 1 exports from country 2

(PX/PY)E = TOTE

(PX/PY)E = TOTE

The tariff imposing countrys terms of trade improve (the price of exports decrease), which may offset the, at least in part, the decrease of welfare due to efficiency loss

Country 2s offer curve

Good Y:

Country 1s offer curve

Good X:
Exports from country 1 Imports to country 2
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Terms of Trade Effect of a Quota

Country 1 sets a

quota for imports of good Y country 1s offer curve becomes horizontal at the quota level Country 1s terms of trade improve

(PX/PY)E = TOTE

(PX/PY)E = TOTE

Imports to country 1 exports from country 2

Country 2s offer curve

Good Y:

Country 1s offer curve

Good X:
Exports from country 1 Imports to country 2
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Terms of Trade Effect of a Voluntary Export Restraints

Country 2 uses

voluntary export restraints (VER) to limit exports of good Y country 2s offer curve becomes horizontal country 2s terms of trade improve

(PX/PY)E

Imports to country 1 exports from country 2

Country 2s offer curve

(PX/PY)E

Good Y:

Country 1s offer curve

Good X:
Exports from country 1 Imports to country 2
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Other Effects of Protection

Restricting imports is likely to result decrease of

exports as well
o o

Reallocation of domestic resources Retaliation by the trading partners Transfer from the consumers to the import-competing producers HO-model: transfer from the abundant factor to the scarce factor
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Distributional Effects
o o