Quiz 8: Analysis of a Tariff
A tariff is an import duty or tax that is imposed on the imported goods in order to give protection to the domestic producer of those imported goods. Moreover, a tariff earns government some amount of revenue. Higher the amount of tariff, higher will be protection. The amount of tariff that wipes out all the imports is called a prohibitive tariff. A country will take part in trade when it finds some prices lower that the domestic equilibrium price. But as a result domestic producers get affected. The producer surplus due to imports reduces and consumer surplus increases abruptly. A government imposes tariff, the world price becomes higher by the amount of tariff. As a result, now while importing consumers have to pay much higher than before to import and even higher to obtain the same domestically. However, producers receives a much higher price and there by revenue due to imposition of tariff domestically. Hence, it can be said that a tariff hurts a consumer more than it benefits the domestic producers.
The consumption effect of a tariff is the loss of consumer surplus for the units that consumers would consume with free trade but do not consume when the tariff increases the domestic price. The tariff "artificially" raises the domestic price and causes some consumers to buy less of the product. On a diagram like Figure 8.3 or 8.4A, it is the triangular area d.
For a small country the world price of $400 will not be affected by the tariff. The size of the net national loss from imposing a $40 tariff will depend on the shapes of the domestic supply and demand curves. The graph shows several possible domestic supply and demand curves. (We will assume that supply and demand are straight lines.) The maximum net national loss occurs when the two triangles of deadweight loss are as large as possible. The maximum loss occurs when the $40 tariff just eliminates all imports, so that the country shifts to no trade with a domestic price of $440. The tariff imposes a full $40 price distortion on the full amount of free-trade imports of 0.4 million per year. In the graph, any curves like S1 and D1 , which have free-trade at A and B and intersect each other at a price of $440, will cause a net national loss shown by the shaded triangle. The size of the loss is (½)•(1.4 - 1.0)•($40) = $8 million. The minimum net national loss is zero. This can occur in any of several extreme cases. First, if both the supply curve and the demand curve are vertical (S0 and D0 ), then the domestic price increases to $440, but there are no changes of quantities. With no distortion of domestic producer and consumer decisions, there are no triangles of inefficiency. Second, if the domestic demand curve is flat (D 3 ), then domestic consumers receive no consumer surplus at the price of $400, and they will not pay more than $400 per bike. When the tariff is imposed, imports fall to zero, domestic price remains at $400, and domestic production remains aT1.0 million bikes. There are no triangles of loss. Third, if the domestic supply curve is flat (S 3 ), then domestic producers receive no producer surplus at the price of $400, and they can supply more bikes at the same price. When the tariff is imposed, imports fall to zero, domestic price remains at $400, and domestic production increases to match domestic consumption aT1.4 million bikes. There are no triangles of loss.