Lecture 3 notes - Trade and Rates of Protection PDF

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Trade and Rates of Protection...

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Effective versus Nominal Rates of Protection The amount of protection given to any one product depends not only on the tariff rate but also on whether the tariffs on the inputs used to produce it. Suppose, for example the USA decided to impose a tariff on the import of computers. If American computers have foreign parts in them, the amount of protection they receive from a tariff depends also on whether there are imported tariffs on imported goods. Economists distinguish between the effective rate of protection and the nominal rate of protection. The effective rate of protection takes into account both the nominal rate and any tariffs in intermediate inputs. The effective rate of protection is related to the concept of value added, which is the price of a good minus the costs of the intermediate goods to produce it. Value added measures the contributions of capital and labour at a given stage of production, The effective rate of protectionism is defined as: (VA*-VA)/VA where VA is the amount of domestic value added under Free Trade VA* is the amount of domestic value added after taking into account all tariffs, both on final goods and intermediate products Example:    

computers sell for $1,000 and foreign producers are willing to sell to USA all it wants at that price to make a laptop, American producers must import $600 dollars of parts USA decides to impose a 20% tariff on computers USA decides to impose a 50% tariff on imported parts Nominal and Effective Rates of Protection No tariff A 20% Tariff on the A 20% Tariff plus a Final Product 50% Tariff on imported inputs $1,000 $1200 $1200

Price of a computer Value of foreign $600 $600 $900 inputs Domestic value $400 $600 $300 added Effective rate of 0 50% -25% protection Negative effective rates of protection are not uncommon and typically result from tariffs that are enacted in piecemeal fashion over a long period of time.

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Suppose that, for a country, the free trade price of good X is $1,000 and the free trade prices of the only two inputs (both of which are imported) to the production process of good X are $400 for good W and $200 for good Y. Assume that one unit each of good W and good Y is necessary for the production of one unit of good X. Suppose now that the country introduces a tariff structure that imposes a 20 percent nominal tariff on good X, an 8 percent tariff on good W, and a 6% tariff on good Y. 1) Using the formula and table in the previous example, calculate the Effective Rate of Protection (ERP). 2) For what purpose might the ERP of an industry be more useful to an economist than the nominal tariff rate on imports of the industry’s product? 3) What conclusions do you draw from the examples of ERP provided?

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