THE INSTRUMENTS OF TRADE POLICY

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TARIFFS

A tax levied when a good is imported.

Can be specific – a charge for each unit of imported goods.

Can be ad valorem - a fraction of the value of imported goods.

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HOME’S IMPORT DEMAND CURVE

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FOREIGN’S EXPORT SUPPLY CURVE

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IN EQUILIBRIUM, IMPORT DEMAND = EXPORT SUPPLY

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THE EFFECTS OF A TARIFF Acts like a transportation cost.

Makes the price rise in the Home market and fall in the Foreign market.

The price in the Home market rises from PW under free trade to PT with the tariff Home producers supply more and Home

consumers demand less

the quantity of imports falls

If the Home country is large, the price in the Foreign market falls because of the new tariff Their quantity of exports thus falls 9-6

A TARIFF IN A SMALL COUNTRY

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If we assume that the country is “small,” it has no effect on the foreign (world) price

EFFECTIVE RATE OF PROTECTION

The change in value that firms in an industry add to the production process when trade policy changes

a 25% tariff on imported cars allows car manufacturers at home to charge $10,000 instead of $8,000

I production factors cost $6,000, the value added increased from $2,000 to $4,000 – a 100% increase.

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COSTS AND BENEFITS OF TARIFFS AT HOME

Hurts consumers –decreases consumer surplus

Benefits producers – increases producer surplus

Benefits the government – increases tax revenues

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CHANGE IN WELFARE DUE TO THE TARIFF IS E – (B + D)

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The rectangle e represents the terms of trade gain.

The welfare effect of a tariff can only be ambiguous for a large country.

EXPORT SUBSIDY

Can also be specific or ad valorem.

Raises the price in the exporting country; decreases consumer surplus; increases producer surplus.

Government incurs higher expenditure

If a large country: lowers the price paid in importing countries

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EFFECTS OF AN EXPORT SUBSIDY

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Net loss: areas b + d + e + f + g

Again, e + f + g is miniscule if the country is small

IMPORT QUOTA A restriction on the quantity of a good that

may be imported.

Usually enforced by issuing licenses or quota rights.

The government only receives revenues if it can collect quota rents

Raises the price of the import as the quantity demanded exceeds the quantity supplied.

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EFFECTS OF THE U.S. IMPORT QUOTA ON SUGAR

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VOLUNTARY EXPORT RESTRAINT

Works like an import quota

Officially imposed by the exporting country but usually requested by the importing country.

The profits or rents from this policy are earned by foreign governments or foreign producers. Foreigners sell a restricted quantity at an increased

price.

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LOCAL CONTENT REQUIREMENT A regulation that requires a specified fraction of

a final good to be produced domestically.

In the World Trade Organization language, this is called “rules of origin”

For domestic producers of inputs, it is a protection, just like an import quota.

From firms that must buy home inputs, it raises the price of their inputs.

This price rise is largely passed on to consumers.

The policy provides neither government revenue nor quota rents.

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OTHER TRADE POLICIES

Export credit subsidies A subsidized loan to exporters U.S. Export-Import Bank subsidizes loans to U.S.

exporters.

Government procurement Government agencies are obligated to purchase from

home suppliers.

Bureaucratic regulations Safety, health, quality, or customs regulations.

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FOR EACH TRADE BARRIER, THE PRICE RISES IN THE HOME COUNTRY ADOPTING THE POLICY

Home producers supply more and gain. Home consumers demand less and lose. The world price falls when Home is a “large”

country that affects world prices. Tariffs generate government revenue; export

subsidies drain it; import quotas may have no effect.

All trade barriers create production and consumption distortions.

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