Chapter The Theory of Tariffs and Quotas Copyright © 2011 Pearson Addison-Wesley All rights reserved Analysis of a Tariff • Quotas: direct limit on imports: regulate the quantity of imports • Tariffs: indirect limit on imports: impose a tax on imports • Both cause consumers to switch to relatively cheaper domestic good Copyright © 2011 Pearson Addison-Wesley All rights reserved 6-2 Consumer and Producer Surplus • Consumer surplus: value received by consumers in excess of the price they pay • Producer surplus: value received by producers in excess of the minimum price at which they are willing to produce Copyright © 2011 Pearson Addison-Wesley All rights reserved 6-3 Prices, Output, and Consumption • Assume: There is only one price for a good (world price Pw) Foreign producers are willing to supply us with all of the units of the good we want at that price It’s a small country Copyright © 2011 Pearson Addison-Wesley All rights reserved 6-4 TABLE 6.1 Economic Effects of the Tariff in Figure 6.3 Copyright © 2011 Pearson Addison-Wesley All rights reserved 6-5 A Comparison of Tariff Rates • Until Doha round, developing countries have been left out • Since mid-90s tariff rates in most countries have fallen • Tariff rates in developing nations are higher • Developed nations often have highest tariffs in laborintensive products • Prevents developing countries from gaining comparative advantage Copyright © 2011 Pearson Addison-Wesley All rights reserved 6-6 FIGURE 6.4 Average Tariff Rates, 1986-2007 Copyright © 2011 Pearson Addison-Wesley All rights reserved 6-7 Other Potential Costs of a Tariff • Retaliation adds to net loss of tariff • Innovation diminishes from less competition • Rent seeking occurs with protected firms who hire lobbyists to keep protection Copyright © 2011 Pearson Addison-Wesley All rights reserved 6-8 The Large Country Case • Large country: Tariff will actually decrease the world price of the good • Can improve their national welfare by imposing a tariff as long as there’s no retaliation Copyright © 2011 Pearson Addison-Wesley All rights reserved 6-9 Effective versus Nominal Rates of Protection • Amount of protection for one product depends on the tariff rate but also on tariffs on the inputs used to produce the good – Nominal rate of protection: tariff rate levied on a given product – Effective rate of protection: nominal rate + tariffs on intermediate inputs – Value added: price of a good minus the costs of intermediate goods used to produce it Copyright © 2011 Pearson Addison-Wesley All rights reserved 6-10 Effective vs Nominal Rates of Protection (cont.) • In sum, effective rate of protection = (VA* - VA) / VA • Negative tariff rates aren’t uncommon • Tariffs aren’t planned in coherent way Copyright © 2011 Pearson Addison-Wesley All rights reserved 6-11 TABLE 6.2 Nominal and Effective Rates of Protection Copyright © 2011 Pearson Addison-Wesley All rights reserved 6-12 Analysis of Quotas • Quota: Restriction that specifies a limit on the quantity of imports • Same impact as tariffs, but no government revenue for domestic country • Net loss often bigger than with tariffs Copyright © 2011 Pearson Addison-Wesley All rights reserved 6-13 Types of Quotas 1) Limitation on the quantity of imports 2) Import licensing requirement: importers must obtain government licenses 3) Voluntary export restraint (VER) : the exporting country “voluntarily” agrees to limit its exports for a period Copyright © 2011 Pearson Addison-Wesley All rights reserved 6-14 Types of Quotas: VERs • VERs have similar effects as quotas, but (1) not require domestic legislative action (2) Politicians appear as proponents of free trade • The use of VERs increased with the decline in tariffs Copyright © 2011 Pearson Addison-Wesley All rights reserved 6-15 The Effect on the Profits of Foreign Producers • Domestic firms prefer quotas over tariffs because increase in demand increases price • Two circumstances that can limit quota rents – If there is a large number of foreign producers, competition may limit their ability to increase prices – The government can extract the extra profits from foreign producers through an auction for import licenses Copyright © 2011 Pearson Addison-Wesley All rights reserved 6-16 Hidden Forms of Protection • Non-tariff measures are hidden, nontransparent forms of protection, such as: - excessively complicated customs procedures, - environmental and consumer health and safety precautions, - technical standards, - government procurement rules Copyright © 2011 Pearson Addison-Wesley All rights reserved 6-17 Intellectual Property Rights and Trade • There are rules for respecting intellectual property rights as they relate to trade • These rules were negotiated during the Uruguay Round (1986-1994) with the Trade Related Aspects Intellectual Property Rights (TRIPS) agreement Copyright © 2011 Pearson Addison-Wesley All rights reserved 6-18 ... and Producer Surplus • Consumer surplus: value received by consumers in excess of the price they pay • Producer surplus: value received by producers in excess of the minimum price at which they... Innovation diminishes from less competition • Rent seeking occurs with protected firms who hire lobbyists to keep protection Copyright © 2011 Pearson Addison-Wesley All rights reserved 6-8 The Large... Tariff will actually decrease the world price of the good • Can improve their national welfare by imposing a tariff as long as there’s no retaliation Copyright © 2011 Pearson Addison-Wesley All