TASMANIAN SCHOOL OFBUSINESS AND ECONOMICSBEA105 International EconomicsWeek 7: Trade policy: Analysis of tariffmeasures on largeeconomies vs small openeconomies.Overview• Tariffs• The effects of a tariff on a small open economy– Producers– Consumers– Welfare Implications• A Large Country Imposes a Small Tariff2 Week 7 Trade policy. CRICOS Provider Code 00586B 9/04/2021Tariffs• What are tariffs?– Trade barrier – tax imposed on imported goods.• What are their effects?– Who are the gainers and losers from tariffs?• Identify a country that has no tariff?• Which type of products usually have high tariff rate?• Average tariff rates are higher on developed ordeveloping countries?3 Week 7 Trade policy. CRICOS Provider Code 00586B 9/04/2021Tariffs – Australia• Tariff classification (abf.gov.au)• Australia’s free trade agreements (FTAs) |Australian Government Department of ForeignAffairs and Trade (dfat.gov.au)4 Week 7 Trade policy. CRICOS Provider Code 00586B 9/04/2021Tariffs• If government places a tax on imports of a product:• Who will be better-off: producers or consumers?• How does the identified group benefit from trade?5 Week 7 Trade policy. CRICOS Provider Code 00586B 9/04/2021The effects of free trade on a small openeconomy• The Australian market for bicycles with freetrade.• A small open economy – so will it be a pricetaker or price maker in the world market?6 Week 7 Trade policy. CRICOS Provider Code 00586B 9/04/2021The effects of free trade on a small openeconomy7 Week 7 Trade policy. CRICOS Provider Code 00586B 9/04/2021How was the worldprice determined?So who are thegainers and who arethe losers under freetrade?Identify theconsumer surplusand producersurplus under freetrade?The effects of a tariff on a small open economy• The Australian market for bicycles with tariff.– Assume a tariff of 10% was imposed on importedbikes• In dollar term, how much tariff is imposed on a bike?• So who are the gainers and who are the losers?• Identify the consumer surplus and producer surplusunder tariff?8 Week 7 Trade policy. CRICOS Provider Code 00586B 9/04/2021The effects of a tariff on domestic producers9 Week 7 Trade policy. CRICOS Provider Code 00586B 9/04/2021The effects of a tariff on domestic consumers10 Week 7 Trade policy. CRICOS Provider Code 00586B 9/04/2021The welfare effects of a tariff11 Week 7 Trade policy. CRICOS Provider Code 00586B 9/04/2021 GroupWith free tradeWith tariffNet effect of atariffConsumersProducersGovernmentAustralia as awhole The Tariff as Government Revenue• Tariff brings revenue to the country’sgovernment (as long as the tariff is not so highas to prohibit all imports),– Revenue equals the unit amount of the tariff times thevolume of imports with the tariff (area c in thediagram)• This revenue could be used to pay for extragovernment spending, matched by an equal cutin some other tax, or serve as extra income12 Week 7 Trade policy. CRICOS Provider Code 00586B 9/04/2021The Net National Loss from a Tariff in TwoEquivalent Diagrams13 Week 7 Trade policy. CRICOS Provider Code 00586B 9/04/2021The National Effects from Tariff• Why is there a net loss equals to area b and d ?• Area d : consumption effect» Inefficiency for those consumers squeezed outof the market due to a artificially raised price.• Area b : production effect» The cost of drawing domestic resources awayfrom other more efficient uses.14 Week 7 Trade policy. CRICOS Provider Code 00586B 9/04/2021The Net National Loss From a Tariff• One-dollar, one-vote metric: Every dollar ofgain or loss is just as important as every otherdollar of gain or loss, regardless of who thegainers or losers are.15 Week 7 Trade policy. CRICOS Provider Code 00586B 9/04/2021The Net National Loss From a Tariff• Consumption effect of the tariff shows the loss to theconsumers in the importing nation based on thereduction in their total consumption (area d in thediagram).• Production effect of the tariff is the amount by whichthe cost of drawing domestic resources away from otheruses exceeds the savings from not paying foreigners tobuy extra units (area b in the diagram).16 Week 7 Trade policy. CRICOS Provider Code 00586B 9/04/2021A Statement“A tariff on imports of a product hurts domesticconsumers of this product more than it benefitsdomestic producers of the product”Do you agree or disagree? Why?17 Week 7 Trade policy. CRICOS Provider Code 00586B 9/04/2021A Large Country Imposes a Small Tariff• A large economy like the US can have amonopsony power on some of its importedgoods – eg the auto market.• If the US impose tariff on imported goods –noticeable adverse effects on the world marketknown as the terms-of-trade-effect18 Week 7 Trade policy. CRICOS Provider Code 00586B 9/04/2021A Large Country Imposes a Small Tariff• Assume the US impose a tariff of $6 per bike.– What is the effect of on the domestic price?– What is the effect on the national well-being – i.e.consumers, producers and the government?– Who really pays the tariff?– What is the overall effect on the large importingcountry?19 Week 7 Trade policy. CRICOS Provider Code 00586B 9/04/2021A Large Country Imposes a Small Tariff20 Week 7 Trade policy. CRICOS Provider Code 00586B 9/04/2021A Nationally Optimal Tariff21 Week 7 Trade policy. CRICOS Provider Code 00586B 9/04/2021A Nationally Optimal Tariff• The level of exploitation:• If the foreign supply curve is perfectly elastic, the optimaltariff is zero and there is no room for exploitation• The more inelastic the foreign supply curve, the higher thelevel of the optimal tariff rate.• The optimal tariff is still unambiguously bad because:I. A net loss to the world economyII. Foreign governments may retaliate.22 Week 7 Trade policy. CRICOS Provider Code 00586B 9/04/2021A Final Question• Under free trade, a large country produces 1 millionleather bags per year and imports another 2 millionbags per year at the world price of $60 per bag.Assume that the country imposes a specific tariff of$5 per bag. As a result, the per-unit price of leatherbags decreases to $58 in the international marketand the import of leather bags drops to 1.6 million.The domestic production, on the other hand,increases to 1.1 million.• Calculate the tariff revenue collected by thedomestic government.23 Week 7 Trade policy. CRICOS Provider Code 00586B 9/04/2021Conclusion• In this lecture we have covered the following:• Tariffs– The effects of a tariff on a small open economy– Producers– Consumers– Welfare Implications• A Large Country Imposes a Small Tariff24 Week 7 Trade policy. CRICOS Provider Code 00586B 9/04/2021
