Topic 4 tariffs - Summary Introduction to International Economics PDF

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Sample Exam Questions: TariffsDefinition: “A tariff is a tax or duty levied on the traded commodity as it crosses a national border.” Salvatore (2012)Q1. Discuss the three major types of tariffs. What are the usefulness of each type of tariff and to what goods might they apply to.Export & im...

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Sample Exam Questions: Tariffs Definition: “A tariff is a tax or duty levied on the traded commodity as it crosses a national border.” Salvatore (2012) Q1. Discuss the three major types of tariffs. What are the usefulness of each type of tariff and to what goods might they apply to. Export & import tariffs - Import tariffs are more important than export tariffs. Export tariffs are prohibited by the U.S. Constitution but are often applied by developing countries on their traditional exports (Ghana on its cocoa and Brazil on its coffee) to get better prices and raise revenues. - Developing countries depend heavily on export tariffs to raise revenues because of their ease of collection. - On the other hand industrial countries invariably impose tariffs or other trade restrictions to protect some (usually labor-intensive) industry, while using mostly income taxes to raise revenues. Types of tariffs: Ad Valorem Tariff A tariff expressed as a fixed percentage of the value of a traded commodity. E.g. 10% ad valorem tariff on bicycles would result in the payment to customs officials of the sum of $10 on each $100 imported bicycles and the sum of $20 on each $200 imported bicycle. Europeans mainly rely on ad valorem tariffs. Ad valorem tariffs are now mandated on steel and aluminum imports from all countries. As of June 2018, 25% duty will be placed on imported steel and an additional 10% on aluminum. (Set by the US)

Specific Tariff A tariff expressed as a fixed sum per unit of a traded commodity. E.g. a specific tariff on imported bicycles of $10 means that custom officials collect the fixed sum of $10 on each imported bike regardless of the price. US use ad valorem and Specific equally. The US government levies a 51 cent specific tariff on every wristwatch imported into the US.

Compound Tariff A combination of ad valorem and specific tariff. E.g. a compound duty of 5% ad valorem and a specific duty of $10 on imported bicycles would result in the collection by custom officials of $15 on each $100 bike and $20 on each $200 imported bike.

Pakistan charges Rs. 0.88 per liter of some petroleum products plus 25 percent ad valorem.

Q2. Outline the difference between a nominal tariff and an effective tariff. How are effective tariffs calculated? Use an example. Definition: Nominal Tariff: A tariff (such as ad valorem) calculated on the price of a full commodity. Rate of effective protection: The tariff calculated on the domestic value added in the production of a commodity.

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Nominal Tariff is calculated on the value or price of the imported commodity. From the nominal tariff we can calculate the rate of effective or actual protection provided to the domestic industry. The rate of effective protection is the actual tariff calculated on the domestic value added or in the processing of the commodity taking place in the nation. Very often, a nation imports a raw material duty free or imposes a lower tariff rate on the importation of the raw material than on the importation of the final commodity produced with the imported input. The national does this in order to encourage domestic processing and employment. E.g. A nation may import wool duty free but impose a tariff on the importation of cloth in order to stimulate domestic production of cloth and domestic employment. Effective protection is calculated on the domestic value added which may exceed the nominal tariff which is calculated on the market price of the commodity. Domestic value added equals the price of the final commodity minus the cost of the imported inputs going into the production of the commodity. Nominal tariff rate indicates by how much the price of the final commodity increases as a result of the tariff. The Effective rate is important to producers because it indicates how much protection is actually provided to the domestic processing of the import-competing commodity).

Example: Imported wool used for suits = $80, FT price = $100, nominal tariff = 10% tariff on imported suites. P for domestic consumers = $110, $80 wool, $20 domestic added value & $10 tariff. Nominal tariff = 10% based on price of the final commodity ($10/$100 = 10%) Effective tariff = calculated based on value added domestically to the suit ($10/$20 = 50%) Consumers are concerned that the tariff increases the price of the suit while producers see the effective rate as being 50% of the domestic value added which represents a higher degree of protection than the nominal rate. It is this effective rate of tariff protection that is important to producers in stimulating the domestic production of suits in competition with imported suits. Q3. Distinguish between consumer surplus and producer surplus. Use illustrations. Definition: Consumer surplus: the difference between what consumers are willing to pay for a specific amount of a commodity and what they actually pay for it. Measured by the area under the demand curve above the going price. Producer surplus: A payment that need not be made in the long run in order to induce producers to supply a specific amount of a commodity or factor services. -

An increase in the price: results in a reduction in consumer surplus and an increase in producer surplus. By implementing a tariff, thus leads to a decrease in consumer surplus and an increase in producer surplus as producers are willing to sell more as the higher price acts as an incentive – also known as the subsidy effect of the tariff.

Q4. Discuss, using an illustration, the welfare effects of a tariff. Assume that the tariff is levied by a small nation that cannot influence the world price. Definition: Small nation is defined as one that does not affect the world price of the commodity it imports. *A Tariff in a small nation shifts the price line up. Moves along supply and demand lines. Effects of a tariff on a small nation: Consumption effect: The reduction in domestic consumption of a commodity resulting from the increase in its price due to a tariff. Production effect: The increase in domestic production of a commodity resulting from the increase in its price due to a tariff. Trade effect: The reduction in the volume of trade in the commodity resulting from a tariff. Decline in imports. Revenue effect: The revenue collected by the government from the tariff.

Costs and Benefits: Protection cost/Deadweight loss: The real losses in a nation’s welfare because of inefficiencies in production and distortions in consumption resulting from a tariff. - Some domestic resources are transferred from the more efficient production of exportable commodity Y to the less efficient production of importable commodity X in the nation. - Thus, the tariff redistributes income from domestic consumers (who pay the higher price) to domestic producers (who receive the higher price) and from the nation’s abundant factor to the nation’s scarce factor. This leads to inefficiency, referred to as Protection cost/Deadweight loss. *A small economy will always be worse off Q5. Discuss, using an illustration, the welfare effects of a tariff. Assume that the tariff is levied by a large nation that is capable of influencing the world price. How do the results differ from that of (3) above? Definition: Large Nation: A nation that affects the world price of the commodity by its trading. Part of the tariff will fall on domestic consumers in terms of an increased price, while part will fall on foreign producers as they will receive a lower price due to the tariff. P122. For a large nation, a tariff on an imported product may be partially shifted to the domestic consumer via a higher product price and partially absorbed by the foreign exporter via a lower export price. The extent by which a tariff is absorbed by the foreign exporter constitutes a welfare gain for the home country. This gain offsets some (all) of the deadweight welfare losses due to the tariff’s consumption and protective effects. -

If the tariff-imposing country is large, the reduction in import demand lowers the world price of the imported good. The importing and the exporting country are both affected by the tariff: The welfare losses from imposing the tariff are shared between both countries.

Arguments Against Tariffs: 2. Tariffs are inequitable - Impose the most severe costs on low-income families - Higher tariffs on cheap goods than luxuries - Affect different countries in different ways

1. Effects of import tariffs on exporters - Higher production costs – from imported inputs - Raise the cost of living

3. Free Trade Argument - If each nation produces what it does best and permits trade - In the long term  Lower prices  Higher levels of output, income, and consumption

Arguments for Tariffs: 1. Job protection argument - Job gains for only a few industries - Job losses spread across many industries

2. Protection against cheap foreign labor Low wages abroad makes it hard for domestic firms to compete with firms using cheap foreign labor Fails to recognize the links among efficiency, wages, and production costs

Q6 Arguments for and against the use of tariffs. Which in your view is best?

6. Infant-Industry Argument - Trading nations temporarily shield their newly developing industries from foreign competition - Once a protective tariff is imposed - very difficult to remove

3. Fairness in Trade: A Level Playing Field - Domestic producers say import restrictions are needed to offset foreign advantages, thus creating a level playing field

Most arguments justifying tariffs - Based on the assumption that the national welfare, as well as the individual’s welfare, will be enhanced

7. Non-Economic Arguments National security argument Cultural and

5. Equalization of Production Costs

4. Maintenance of the Domestic Standard of Living One nation imposes a tariff that improves its income and employment  At the expense of its trading partner’s living standard (beggar-thyneighbor policy) Retaliatory tariffs  Lower level of welfare for...