Tariffs and Quotas

Political Equilibrium Analysis.  We are only considering effects of tariffs and quotas on protected industry

Tariff-tax on imported good

Revenue tariff: imposed on good not produced domestically just there to make $

Specific tariff: fixed charge per unit imported ex: $100 per car

Ad Valorem tariff: percentage charge per value imported ex: 27 per car

Protective tariff: imposed to protect domestic industry

Protective and revenue=why you impose

Specific and ad valorem=how you impose

History: Oldest form of trade policy.  Initially used as source and government resource before creation of income tax.  Then used to protect domestic industries.  Use has declined, now non-barrier is more common

Consumer Surplus-the value received by consumers over and above what they are required to pay.  Everyone values each good differently.  This occurs because firms can’t charge each consumer a different price-car dealership.  It is the difference between what you’re willing to pay and what you end up paying.  It always above price and below the demand curve.

Producer Surplus-the difference between the minimum price a producer would accept and the price is actually receives.  Receive benefit that didn’t cost anything to them.  It always below price and above the supply curve.

How do you find Effects of Tariffs?:                                    Free Trade                     Post-tariff

Price to consumers Pw Pt

Domestic Consumption                                                Q2                                    Q2*

Domestic Production                                                            Q1                                    Q1*

Imports                                                                        Q1Q2

Consumer Surplus                                                            a+b+c+d+e+f                        e+f

Producer Surplus                                                            g                                    g+a

Government Revenue                                                0                                    c

Tariff Revenue

Efficiency Loss

Deadweight consumption loss                                    0                                    d

Deadweight production (efficiency loss)                        0                                    b


Net Welfare

Consumer Loss

Producer Gains

Quota Rents

In free trade, large countries may increase national welfare when they place a tariff on imports because large countries reduce the world price of the import when they levy a tariff

Other Potential Costs

1. Retaliation.  Loss of jobs in export industries and can escalate rapidly.

2. Innovation reduces competitive pressure on domestic firms.

3. Rent seeking uses lobbying to keep protection in place.  Use resources for nonproductive activities.  For example, if you are an industry that wants tariffs because other countries are undercover you have to go to congress, trying to get tariff: very expensive; inefficient.

Large country case is when one large enough to influence world price if there is a change in consumption.  Changes in quantity imported influence world price.  Imposition of tariff decreases with domestic consumption, which decreases imports, which decreases world

Quotas: Quantity restriction on imports.  Similar impact.  Import Quota: generates rents that might go to foreigners.


  1. Outright quantity limitation
  2. Import licensing requirement
    1. Forces importers to obtain government licenses
    2. Less transparent than quota Ex: Liquor license
    3. Voluntary Export Restraint (VER)
      1. Not always entirely voluntary
      2. Loosely limited by Uruguay Round

Economic Effects: No Government revenue from quota.  Instead, foreign producers earn greater profits: quota rents because they artificially limits supply which increases price.

Comparing Quotas and Tariffs

Like Tariffs: Domestic consumption of imported good.  Domestic production rises. Consumer price rises.  Unlike Tariffs: No gain in government revenue. If eventually consumer demand of a quota good increases, the price increases and produce surplus increases (with tariff price would stay).  Domestic firms prefer quotas to tariffs.

Hidden Protection: Trade Protection-Tariffs.  No Tariff Barriers-Quotas.  Non-tariff measures are any regulatory or policy rule (other than tariffs and quotas) that limits imports.  May be directly intended as trade-related, or exist for some other purpose but impact traded.  Complicated Custom procedures.  Environmental/consumer health precautions.  Ex: lead paint in China.  Technical Standards.

Tariff            Export Subsidy Import  Quota Voluntary

Producer Surplus                                    I            I            I            I

Consumer Surplus                                    D            D            D            D

Government Net Revenue                        I            D            None            None

National Welfare                                    Ambiguous D            Ambiguous            D

A tariff decreases the world price of imported goods and increases domestic price of imported goods.  It also decreases the quantity traded when a country is “large.”  An export subsidy.  World price of exported good decreases.  Domestic price of exported good increases.  Increases quantity produced when country is large.  The Welfare effect of a tariff, quota, and export subsidy can be measured by: Efficiency loss-consumption and production in terms of trade gain or loss

Chapter 7-Commercial Policy

Policies of protection Process: A firm or industry initiates an investigation into a foreign country/firm practices.  They can also talk to WTO.  2 Industries most commonly receiving protection are agriculture and clothing

Effective vs. Nominal Rates of Protection

Effective Rate of Protection-A measurement of the amount of protection provided to an industry by a country’s tariff schedule.  To measure: Effective rate= (value added tariff-value added)/value added.  Value Added: Contribution of capital and labor added to a finished price.  Value Added=Final Price-Price inputs.  Tariff Escalation is when industry levies a tariff of x but receives protection > x.  Small nominal final good tariff + large % of imported inputs=large effective rate of protection

Arguments for Tariffs:

  1. Infant Government-Government approach: In developed countries, tax revenue is relatively easy to collect.  In developing countries, tariffs are an attractive method of raising government revenue: goods pass through customs, administrative costs low, can act like a corporate income tax or luxury tax: target it to certain goods, used when getting started.
  2. National Defense-certain industries need to be protected to ensure adequate output in case of war. Problems: Difficult to identify essential industries; might over protect.  Costly means of accomplishing this end; production subsidy would be less expensive.
  3. Infant Industries-new industries in developing countries initially need protection to allow them to grow in the face of foreign competition.  Problems: Difficult to predict industries which will become competitive.  Difficult to determine industries with falling costs.  Industries may never grow up Manufacturing sector
  4. Senile Industries-to provide a method for older, comparatively disadvantaged to move resources to new industries without hurting the economy; Ex: Landlines, CD’s, VCR’s.  To help people with jobs in industry.  Easier to pick these firms than the infant firms.  Difficulty lies in the execution.  More efficient to directly aid firms and workers.
  5. Create and Protect Jobs-to create jobs, since tariffs increase domestic output and protect jobs from low wages abroad, economists hate this one.  Problems: Jobs in non-protected industries fall.  It’s a realignment not a net gain.  May be a long run decrease in employment due to inefficient use of resources in protected industries.  It’s expensive-other solutions=less costly (like subsidies).  Economies with more tariffs usually grow more slowly.  How do industries get away with this? Benefits are very concentrated
  6. Retaliation-for unfair trade practices.  Problems: Can lead to escalating trade wars. Free trade benefits all.  On the other hand, since free trade benefits all, if a tariff now will induce others to lower theirs, all eventually benefit.  Market size=important; gives them their entire domestic market to themselves, may drive us out.  Export Subsidies are A payment to a firm or individual that exports goods.  They encourage exports either as a specific or ad valorem tariff.  Effects on prices are essentially the reverse of a tariff.

Countervailing Duty: Tariff granted to U.S. industry hurt by a foreign country’s subsidizing its firms; if industry can prove: subsidies allow foreign firms to sell products at lower prices, countervailing duty seeks to counter the effect of the benefits from a subsidy, Problem: defining a subsidy is subjective, Infrequent: 4-5 times a year

Uruguay Round defined subsidies as: Direct loan or transfer, Preferential tax and treatment, government provided goods/services other than infrastructure; ie-training,  Income and price supports.  Antidumping Duty-tariff levied on an import that is selling at a price below product’s fair value.  Problems: Defining fair value is subjective, source of tension between countries, approximately 21 duties imposed per year.  Ultimately a country can disagree with WTO or other world organizations and get out.  WTO Policy-Dumping occurs when an exporter sells a product at a price below the one it charges in their home country.

To determine whether a good is being dumped: Compare to price in third country markets, Estimate cost of production, Estimate foreign firm’s production costs, Countries will probably be pissed if you accuse them of dumping.  Not only does a country have to prove another country is dumping, also has to prove that it’s hurting them.  Problems: Economic theory and legal definitions are not in agreement.  If a firm is not earning a share of average profits somewhere, it cannot maintain a price somewhere else that is below the cost.  Firms often sell below costs.  May sell at below costs in order to penetrate a market.  May go for extended periods selling at prices that do not cover fixed costs as long as the costs of variable inputs (labor and materials) are covered.  The labor argument for tariffs, argues that it is unfair for a country to face imports from countries that have lower wages.  The problem with this argument is that it ignores the fact that cross-country wage differences reflect productivity differences and ignores the fact that tariffs or quotas are an expensive method of saving jobs

Escape Clause Relief-Temporary tariff of imports to allow a domestic industry to escape the pressure of imports and obtain a period of adjustment.  Refers to a clause in U.S. and GATT trade rules.  Initiated when a firm or industry petitions the VSITC directly for relief.  Not very common.

Section 301-U.S. Trade Representative (USTR) to take action against any nation that persistently engages in unfair trade practices; US defines meaning of unreasonable and unfair trade policies

Nontariff Trade

Labor Standards: formal Trade Barriers have been declining since WWII.  New obstacles have been appearing.  Unintentionally as a result of national laws and regulations for domestic reasons.

Achieving Deeper Levels of Integration:

  1. Harmonization of Standards:Share common standards.  EX: Electric sockets (shape), flash drives
  2. Mutual Recognition of standards: We will honor your law and you will honor ours.  Keep domestic standards and recognize foreign standards.  For example, minimum wage is different in other countries.
  3. Separate Standards: Keep domestic standards.  Refuse to recognize.  For example, China Lead Paint.

No one approach is best.  Some create larger markets and greater efficiency (Ex. Common size electrical outlets).  Some freeze in place inferior technology.  Some less-developed countries have less ability to enforce standards.  Can be probably for less developed countries what works best for situations?

“Race to the Bottom”: Countries with high standards-forced to lower standards or experience a loss of jobs and industry.  Unfair trade practice complaint: failure to enact or to enforce standards gives firms in the countries with lower standards a commercial advantage.  How do you compete?

Ex: We have to lower our minimum wage because it’s hurting our trade

-In order to compete, countries have to lower standards

What are labor standards?

Wide ranging with no universal agreement

Basic rights proposed by international labor organization and OECD:

  • Prohibition of forced labor
  • Freedom of association
  • Right to organize and bargain collectively
  • End to exploitation of child labor
  • Nondiscrimination in Employment

Other potential standards-no agreements-most contentious

Ex: minimum wages, limits on hours worked, health and safety issues

Arguments for Anti-globalization

Transbouundary vs. nontransboundary effects

Pollution havens

Kuznet’s Curve

Pollution Spillovers

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