International Economics

By Robert J. Carbaugh
9th Edition

Chapter 5:
Tariffs

Copyright 2004, South-Western College Publishing

Tariffs

Why restrict trade?

Benefits of free trade come in the long
term, and are usually spread widely across
society
Costs of free trade are felt rapidly and are
usually concentrated in specific sectors of
the economy

Carbaugh, Chap. 5

Tariffs

Defining tariffs
A tariff is a tax (duty) levied on products as
they move between nations
Import tariff - levied on imports
Export tariff - levied on exported goods as they
leave the country
Protective tariff - designed to insulate domestic
producers from competition
Revenue tariff - intended to raise funds for the
government budget (no longer important in
industrial countries)
Carbaugh, Chap. 5

Tariffs

Types of tariff
Specific tariff ( )
Fixed monetary fee per unit of the
product
Example: A specific tariff of $10 on
each imported bicycle with an
international price of $100 means
that customs officials collect the
fixed sum of $10.
Carbaugh, Chap. 5

 Ad valorem tariff ( )
Levied as a percentage of the value of the
product
Example: A 20% ad valorem tariff on bicycles
generates a $20 payment on each $100
imported bicycle.

Compound tariff ( )
A combination of the above, often levied on
finished goods whose components are also
subject to tariff if imported separately
Carbaugh, Chap. 5

Tariffs

Effective rate of protection

The impact of a tariff is often different from
its stated amount
The effective tariff rate is an indicator of the
actual level of protection that a nominal
tariff rate provides the domestic importcompeting producers.

Carbaugh, Chap. 5

 Effective rate of protection

One must consider both the effects of tariffs on the
final price of a good, and the effects of tariffs on the
costs of inputs used in production.
The actual protection provided by a tariff will not
equal the tariff rate if imported intermediate goods
are used in the production of the protected good.
Example: A European airplane that sells for $50
million has cost $60 million to produce. Half of the
purchase price of the aircraft represents the cost of
components purchased from other countries. A
subsidy of $10 million from the European government
cuts the cost of the value added to purchasers of the
airplane from $30 to $20 million. Thus, the effective
rate of protection is (30-20)/20 = 50%.
Carbaugh, Chap. 5
7

Tariffs

Effective rate of protection (contd)

Domestic producers may use imported inputs
or intermediate goods subject to various tariffs,
which affects the calculation

When tariff rates are low on raw materials

and components, but high on finished
goods, the effective tariff rate on finished
goods is actually much higher than it
appears from the nominal rate
This is referred to as tariff escalation
Carbaugh, Chap. 5

Tariffs

Avoiding and postponing tariffs (US)

Production sharing and special treatment
for foreign assembly using domestic
components
Bonded warehouses
Foreign trade zones

Carbaugh, Chap. 5

Costs and Benefits of a Tariff

A tariff raises the price of a good in the importing
country and lowers it in the exporting country.
As a result of these price changes:
Consumers lose in the importing country and gain in the
exporting country
Producers gain in the importing country and lose in the
exporting country
Government imposing the tariff gains revenue

To measure and compare these costs and

benefits, we need to define consumer and
producer surplus.
Carbaugh, Chap. 5

10

Tariffs

Tariff welfare effects

Consumer surplus
The difference between the price buyers would
be willing to pay and what they actually pay

Producer surplus
The revenue producers receive above the
minimum amount required to induce them to
produce a good

Carbaugh, Chap. 5

11

Tariffs

Consumer and producer surplus

Carbaugh, Chap. 5

12

Basic Tariff Analysis

Useful definitions:
The terms of trade is the relative price of the exportable
good expressed in units of the importable good.
A small country is a country that cannot affect its terms
of trade no matter how much it trades with the rest of the
world.

The analytical framework will be based on either of

the following:
Two large countries trading with each other
A small country trading with the rest of the world
Carbaugh, Chap. 5

13

Welfare effects of tariffs

Tariff trade and welfare effects

Carbaugh, Chap. 5

14

Welfare effects of tariffs

Tariff trade and welfare effects

Carbaugh, Chap. 5

15

Tariff effects

Who pays for import restrictions?

Domestic consumers face increased costs
Low income consumers are especially hurt by
tariffs on low-cost imports

Overall net loss for the economy (deadweight

loss)
Export industries face higher costs for inputs
Cost of living increases
Other nations may retaliate, further restricting
trade
Carbaugh, Chap. 5

16

Reasons for tariffs

Arguments for trade restrictions

Job protection
Protect against cheap foreign labor
Fairness in trade - level playing field
Protect domestic standard of living
Equalization of production costs
Infant-industry protection
Political and social reasons
Carbaugh, Chap. 5

17

Reasons for tariffs

Politics of protectionism
Supply of protectionism (trade policy)
depends on:
the cost to society of restricting trade
the political importance of the importcompeting industries
Magnitude of the adjustment costs from free
trade
Public sympathy for those sectors hurt by free
trade
Carbaugh, Chap. 5

18

Reasons for tariffs

Politics of protectionism
Demand for protectionism depends on:
The amount of the import-competing industrys
comparative disadvantage
The level of import penetration
The level of concentration in the affected sector
The degree of export dependence in the sector

Carbaugh, Chap. 5

19