CHAPTER 6

Tariffs

CHAPTER OUTLINE I. II. Introduction Tariffs: Some Preliminary Details A. Types of Tariffs revenue vs. protective tariffs specific, compound, and ad valorem tariffs free alongside (FAS), free on board (FOB), and cost, insurance, and freight (CIF) Table 6.1 B. Methods of Valuing Imports III. The Welfare Effects of Trade in an Individual Product A. Consumer and Producer Surplus: A Review Figures 6.1 and 6.2 B. The Effects of Free Trade Figure 6.3 IV. The Economic Effects of Tariffs A. The Effects of a Tariff for a Small Country Figure 6.4 B. The Effects of a Tariff for a Large Country Figure 6.5 PASSPORT: Henry George on Free Trade PASSPORT: The Economic Effects of Selected U.S. Import Tariffs Table 6.2 The Effective Rate of Protection Table 6.3 VI. Arguments for Tariffs A. Infant Government B. National Defense Figure 6.6 C. Infant Industries D. Senile Industry Protection E. Tariffs, Trade, and Jobs PASSPORT: Petition of the French Candlemakers TEACHING NOTES AND TIPS I. Introduction

Notes The chapter starts with the idea that we are now relaxing one of our assumptions. What happens if we introduce trade barriers?

120

121 Chapter 6

Teaching Tip Remember the discussion of trade and the distribution of income in Chapter 3. We have already set the stage for the existence of trade barriers. II. Tariffs: Some Preliminary Details

Notes This section introduces revenue vs. protective tariffs; the three types of tariffs (specific, ad valorem, and compound); and the three methods of valuing tariffs (FAS, FOB, and CIF). Teaching Tip The three methods of valuing imports are also extensively used in international business and are not just terms used by customs officials. III. The Welfare Effects of Trade in an Individual Product

Notes The section starts with a quick review of consumer and producer surplus. From there, the effects of imports and exports for an individual product without trade barriers can be shown in terms of the changes in consumer and producer surplus. Teaching Tip Take a little longer to examine the effects of free trade before examining the effects of trade barriers. Weve shown the gains for free trade in a different form in Chapter 2 and this section reenforces the idea that free trade improves the welfare of society. IV. The Economic Effects of Tariffs

Notes The effects of a tariff are shown in Figure 6.4 as the gains to producers and the government and the losses to consumers and the economy as a whole. Figure 6.5 adds the terms of trade effect for a large country. Teaching Tip Take a little longer to examine the effects of tariff for a small country before discussing the effects for a large country. Weve found that students understand large country effects better if they first grasp the associated welfare loses of a tariff in a small country. V. The Effective Rate of Protection

Notes This section shows that the nominal tariff can be deceiving. The first part shows an example of this with DVD players. The formula to calculate the effective rate of protection is given. The final part of the section is a description of the structure of protection in developed countries and how this affects the effective rate of protection and the welfare of developing countries. Teaching Tip

Tariffs 122

Ask the students to consider why they see agricultural products from developing countries in the grocery store but why they rarely see processed foods from these countries. Perhaps the structure of protection in the U.S. might have something to do with that. VI. Arguments for Tariffs

Notes This section discusses the common arguments used by individuals and businesses for imposing tariffs. Along with each argument for tariffs, we also point out the fallacies embodied in each argument. Teaching Tip It is important to note for the students that a policy of subsidizing the domestic industry results in less dead weight loss that an equivalent tariff. BRIEF ANSWERS TO PROBLEMS AND QUESTIONS FOR REVIEW 1. A revenue tariff is imposed by government on a good that is not domestically produced. A specific tariff is a tariff that is measured as a fixed amount of money per unit imported. An ad valorem tariff is a tariff that is measured as a percentage of the value of the imported good. A compound tariff is a tariff that includes a specific tariff and an ad valorem tariff. The three different methods countries use to determine the value of imports are the free alongside price, the free on board price, and the cost, insurance and freight price. The FAS price, defines the price of the imported good as the foreign countrys market price before it is loaded into the ship, train, truck, or airplane for shipment to the importing country. The FOB price defines the imported price of the good as the foreign countrys market price plus the cost of loading the good into the means of conveyance. The CIF price defines the price of the imported good as the foreign countrys market price plus the cost of loading the goods into the means of conveyance plus all intercountry transportation costs up to the importing countrys port of entry. Consumer surplus is the difference between the price a consumer would be willing to pay for the good and the market price. Producer surplus is the difference between the price at which a good is sold and the minimum price that the seller would be willing to accept for it. The economic effects of a tariff are caused by the higher price of imports as consumer surplus declines. Consumers lose as a result of a tariff. Those that gain include the government as it collects tariff revenue and domestic producers as part of the consumer surplus is transferred to domestic producers. However, the net loss to society and loss of consumer welfare is composed of area b + d. This loss to society is referred to as the deadweight loss of a tariff.

2.

3.

4.

123 Chapter 6

5.

The difference between the case of the large country and the small country is that part of the tariff burden falls on consumers of the imported good and part falls on foreign producers of the imported good. In this case, the total government revenue collected from the tariff includes two components. The first component is the amount of the tariff revenue that is shifted from domestic consumers to the government. The second component is the amount of the tariff revenue that is shifted from foreign producers to the government. This second component is called the terms of trade effect and represents a redistribution of income from the foreign country to the domestic country. The terms of this trade improves the welfare of the domestic country at the expense of the foreign country. In the case of a large country, the welfare effects of a tariff are: 1) the loss of consumer surplus, area b + d, and 2) the gain of welfare through the terms of trade affect, area e. a. b. c. $11,000 Before the tariff, domestic value added is $7,500 and after the tariff the domestic value added is $8,375. The ERP is 11.67%.

6.

7.

To determine the actual degree of protection an industry receives, one must not only consider the tariff on the final good but also any tariffs on imported components that the industry uses to produce the final good. This means that we need to consider the impact of tariffs on the value of the product produced domestically. A measure that accounts for the importance of these items is called the effective rate of protection. The general formula for determining the effective rate of protection is: ERP = (Tf - aTc )/(1 - a) Tf is the tariff rate on the imported final product; a is the percentage of imported components used in producing the final product; and Tc is the tariff rate on the imported components used to produce the final product. Since the effective rate of protection is determined by the interaction of three variables, the potential outcomes are infinite, and the effective rate of protection can even be negative. This occurs when the tariff on imported components multiplied by the percentage of imported inputs into the production process is larger than the tariff on the final good. The tariffs on final goods in the U.S. tariff schedule are frequently small. However, a seemingly small nominal tariff coupled with a large percentage of the product coming from imported inputs can yield a large effective rate of protection. This phenomenon is so common that it is referred to as tariff escalation. Any time the tariff escalates with the stage of processing, foreign producers who wish to produce the final product with local inputs are being discriminated against.

8.

The most reasonable case that can be made for a country to impose tariffs is the infant government argument. For a developing country, tariffs can be an attractive form of government taxation. The developing country can design its tariffs so as to collect its revenue in a way that is something like a progressive tax on corporate or individual income. A second argument for tariffs is the national defense argument. Countries have a legitimate need to take steps to ensure that the military forces of a country can operate effectively if necessary. The argument in this case is that certain industries need to be protected from foreign competition to ensure an adequate output of the industry in the case

Tariffs 124

of a conflict. A third argument is the infant industry argument. The argument in this case is that new industries in developing countries initially may need protection to allow them to grow in the face of more established foreign competition. The temporary protection also may allow the industry to become large enough to establish sufficient economies of scale to effectively compete in world markets. Once the industry has become internationally competitive, the protectionism is withdrawn to allow the industry to become even more efficient. The fourth argument is the senile industry argument. The argument for tariffs in this case is that older industries in developed countries that once had a comparative advantage in world markets need protection from lower cost imports. The final and most common argument for tariffs is the creation of jobs in the economy. By imposing a tariff output in the protected industry increases and the amount of employment in the industry likewise will expand. Rather simplistically, the tariff has produced more jobs. 9. A tariff is a costly means of accomplishing an increase in output of an industry as it results in a dead-weight loss. A production subsidy can increase the output of a domestic industry at a lower cost. The effect of a subsidy is to shift the domestic supply downward by the amount of the subsidy and the industry would be willing to produce the larger output. With a subsidy the consumer is still paying the world price for the good and as such the deadweight loss is only the production effect and does not include the consumption effect. No, tariffs increase employment in the protected industry as opposed to the overall level of employment in the economy. A tariff will create jobs in this particular industry but there are fewer jobs in other industries. This is because consumers spend more to goods from the protected industry but less on other goods. The tariff has not increased the total number of jobs, it has just rearranged them. Protected industries have more jobs and other industries have fewer jobs. The overall level of employment hasnt changed. The total number of jobs in the economy is determined by macroeconomic forces such as the rate of economic growth in the long run and the state of fiscal and monetary policy in the long run. Tariffs dont change the total number of jobs, they just put jobs in places that the market would not.

10.

MULTIPLE-CHOICE QUESTIONS 1. A revenue tariff is: a. a tariff on domestically produced products. b. a tariff levied on a product that is produced domestically that is designed to protect domestic industries. c. a tariff levied on a product that is not domestically produced. d. a tariff based on the profits of international firms doing business within a country.

125 Chapter 6

2.

* 3.

The purpose of a protective tariff is: a. to protect domestic consumers from harmful products. b. to protect the international laws of commerce. c. to protect the foreign country from anti-trust actions. d. to protect domestic producers from foreign competition. Specific tariffs are collected: a. only on industrial products. b. only on pharmaceutical products. c. only on products that arrive by train. d. as a fixed amount of money per unit traded. A tariff levied as a certain amount per unit imported is known as: a. a specific tariff. b. a counter tariff. c. a forgone tariff. d. F.A.S. A per unit tax on imported goods is called: a. a specific tariff. b. a per unit tariff. c. an ad valorem tariff. d. a compound tariff. A tariff of 20% on imported goods is called: a. a specific tariff. b. a percentage tariff. c. an ad valorem tariff. d. a compound tariff. Ad valorem tariffs are collected as: a. a percentage of the quantity of imports. b. fixed amounts of money per unit traded. c. a percentage of the price of the product. d. a percentage of the transportation costs. _____ is the barrier to trade that best distinguishes among gradations of a good or service. a. Specific tariff b. Voluntary export restraint c. Ad valorem tariff d. Import quota

* 4. *

5. *

6. * 7. * 8. *

Tariffs 126

9.

* 10.

Product A has an import value of $100. If a tariff of 10 percent of the products value plus $10 per unit were imposed on A, the result would be a(n) ____ of _____ . a. ad valorem; $15 b. combined; $15 c. compound; $15 d. compound; $20 A tariff of 20% plus $1 per unit on imported goods is called: a. a specific tariff. b. a complex tariff. c. an ad valorem tariff. d. a compound tariff. When a tariff is so high that imports are zero, the tariff is said to be: a. effective. b. exclusionary. c. involuntary. d. prohibitive. A compound tariff is a combination of: a. a specific tariff and a F.A.S. tariff. b. a specific tariff and a F.O.B. tariff. c. an ad valorem tariff and a F.A.S. tariff. d. a specific tariff and an ad valorem tariff. A tariff of ($250/import + 15% of the C.I.F. value/import) is known as a(n) _____ tariff. a. nonspecific b. ad valorem c. compound d. specific The Free alongside (FAS) method of valuing imports: a. defines the price of the imported good as the foreign market price before it is loaded into the ship, train, or plane for shipment to the importing country. b. defines the imported price as the price in the foreign market including the cost of loading it onto the ship, train, or plane for shipment to the importing country. c. defines the imported price as the price including all inter-country charges up to the importing countrys port of entry. d. none of the above

* 11.

* 12.

* 13. * 14. *

127 Chapter 6

15. *

The free on board (FOB) method of valuing imports: a. defines the price of the imported good as the foreign market price before it is loaded into the ship, train, or plane for shipment to the importing country. b. defines the imported price as the price in the foreign market including the cost of loading it onto the ship, train, or plane for shipment to the importing country. c. defines the imported price as the price including all inter-country charges up to the importing countrys port of entry. d. none of the above The FOB value of imports includes: a. the value of the product alongside the carrier. b. the expense of loading for shipment. c. all freight and insurance costs to transport the goods to the importing country. d. the sum of a and b. CIF stands for: a. captain in front. b. capital is free. c. cost, insurance, and freight. d. a form of grease payment. The cost, insurance and freight (CIF) method of valuing imports: a. defines the price of the imported good as the foreign market price before it is loaded into the ship, train, or plane for shipment to the importing country. b. defines the imported price as the price in the foreign market including the cost of loading it onto the ship, train, or plane for shipment to the importing country. c. defines the imported price as the price including all inter-country charges up to the importing countrys port of entry. d. none of the above Almost all countries in the world use which of the following definitions to assess the value of an import? a. TTK b. JIT c. CIF d. JMK The availability of alternative definitions of price such as FAS, CIF, and FOB creates complications regarding the administration of the _____ tariff. a. ad valorem b. generic c. export d. specific

16.

* 17. * 18.

19.

* 20. *

Tariffs 128

21.

* 22. *

Which of the following is not a method of valuing imports for tariff purposes? a. Free alongside (FAS) price b. Free on board (FOB) price c. Cost, insurance and freight (CIF) price d. WTO price The difference between the price consumers are willing to pay and the price that they actually pay is known as: a. producer surplus. b. consumer surplus. c. price discrimination. d. government surplus. The difference between the price producers are willing to accept for the product and the price producers actually receive for the product is known as: a. producer surplus. b. consumer surplus. c. price discrimination. d. the firms profit. The difference between what consumers have to pay for a particular product and what they are willing to pay is known as: a. producer surplus. b. tariff revenue. c. the consumption bonus. d. consumers surplus. Consumer surplus is equal to the: a. area under the demand curve and above the supply curve. b. area under the demand curve. c. area under the supply curve. d. area under the demand curve and above the equilibrium price. The triangular area above the supply curve and below the market price is known as: a. consumer surplus. b. producer surplus. c. oligopoly. d. marginal revenue. Consumer surplus will tend to rise if: a. the market price falls. b. the market price rises. c. there are absolutely no imports. d. there are absolutely no exports.

23. *

24.

* 25.

* 26. *

27. *

129 Chapter 6

28. *

A reduction in the price of a commodity due to an increase in supply will: a. increase consumer surplus. b. reduce consumer surplus. c. leave consumer surplus unchanged. d. cause the demand curve to shift to the right. The triangular area below the demand curve and above the market price is known as: a. producer surplus. b. consumer surplus. c. average total cost. d. marginal cost. Producer surplus is equal to the: a. area under the demand curve and above the supply curve. b. area above the supply curve and below the equilibrium price. c. area under the demand curve. d. area under the supply curve. Use the graph below to answer the following questions:
P S

29. *

30. *

P Pt a Pw D Q b c d World Price World Price + Tariff

31.

* 32.

The consumer surplus gained by moving from autarky to free trade is represented by: a. a + b + c + d. b. a + b. c. a + c. d. none of the above The producer surplus lost by moving from autarky to free trade is represented by: a. a. b. b. c. c. d. none of the above

Tariffs 130

33.

* 34. *

According to the graph, imports: a. have caused the price to fall from P to Pw. b. have caused consumer surplus to rise. c. have caused producer surplus to fall. d. all of the above The introduction of a tariff would raise the price from: a. Pw to Pt. b. Pt to P. c. Pw to P. d. none of the above Without a tariff the price of imports would be: a. a + b + c + d. b. b + d. c. P. d. Pw. When a specific tariff is placed on an item, compared to free trade consumers lose: a. a. b. b. c. d. d. a + b + c + d. The loss of consumer surplus due to the tariff is: a. a. b. b. c. d. d. a + b + c + d. A tariff on imports would reduce consumer surplus by: a. a + b. b. b + c. c. a + b + c. d. a + b + c + d. With the tariff, government revenue is: a. a. b. b. c. c. d. d.

35.

* 36.

* 37.

* 38.

* 39. *

131 Chapter 6

40. * 41. *

The imposition of a tariff would yield tariff revenue of: a. a. b. b. c. c. d. d. The increase in producer surplus attributable to the tariff is: a. a. b. b. c. c. d. d. The gain in producers surplus that occurs because of the tariff is: a. a. b. b + c. c. c. d. a + b + c + d. The losses to society because of the inefficient allocation of resources attributable to the tariff is: a. a. b. b. c. c. d. b + c. The dead weight loss of the tariff is: a. a + d. b. b + d. c. c + d. d. b + c. When a tariff is imposed on imported goods or services, the consumer surplus in the domestic market _____ and producer surplus in the domestic market _____ . a. rises; falls b. rises; rises c. falls; falls d. falls; rises When a tariff is imposed on imported goods and services, the _____ in consumer surplus is _____ the ______ in producer surplus. a. increase; less than, increase b. increase; less than, decrease c. decrease; greater than, increase d. decrease; less than, increase

42. *

43. *

44. *

45.

* 46.

Tariffs 132

47. *

When a tariff is imposed on imports, domestic producer surplus: a. falls. b. rises. c. stays the same. d. becomes negative. Tariffs reallocate income from: a. consumers to producers. b. producers to consumers. c. government to producers. d. consumers to foreigners. Tariffs cause a redistribution of income from: a. the government to producers and consumers. b. consumers and the government to producers. c. producers and consumers to the government. d. consumers to producers and the government. If a small country imposes a tariff: a. the imported product price rises by more than the tariff. b. the imported product price rises by exactly the amount of the tariff. c. the imported product price rise by less than the amount of the tariff. d. the imported product price falls by the amount of the tariff.

48. *

49.

* 50. *

The following figure illustrates the demand and supply curves for PCs in a small country. Use this figure to answer the following questions:
P a P b Pt Pw c g d e f World Price D Q1 Q2 Q3 Q4 Q5 Q World Price + Tariff S

51. *

With no trade the amount of domestically produced PCs is: a. Q1. b. Q2. c. Q3. d. Q1 to Q3.

133 Chapter 6

52.

* 53. *

With no trade the countrys producer surplus is: a. area a. b. area b. c. areas b + c. d. areas b + c + g. With no trade the countrys consumer surplus is: a. area a. b. area a + b. c. area b. d. area a + b + c. With free trade the country imports: a. Q1. b. Q2. c. Q3. d. Q1 to Q5. With free trade the countrys producers surplus is: a. area a. b. area b. c. area c. d. area g. With a tariff imposed on PCs, the country imports: a. Q1. b. Q2. c. Q3. d. Q2 to Q4. The loss of consumer surplus due to the tariff is: a. area c. d. area c + d. c. area c + d + e. d. area c + d + e + f. The amount of producer surplus domestic producers gain as a result of the tariff is: a. area c. b. area c + d. c. area d. d. area c + d + e.

54.

* 55.

* 56.

* 57.

* 58. *

Tariffs 134

59. * 60. * 61. * 62.

The amount of revenue the government collects as a result of the tariff is: a. area c. b. area d. c. area e. d. area e + f. The dead-weight loss of the tariff to the country is: a. area c + d + e + f. b. area d + e + f. c. area d + f. d. area d. If a large country imposes a tariff: a. the imported product price rises by more than the tariff. b. the imported product price rises by exactly the amount of the tariff. c. the imported product price rises by less than the amount of the tariff. d. the imported product price falls by the amount of the tariff. The imposition of an import tariff by a large country can cause: a. a decrease in imports. b. an increase in the countrys welfare. c. a decrease in the countrys welfare. d. all of the above Assume that domestic calculators are made with foreign parts that cost $80 and that the calculators retail for $90. If in a small country situation if a tariff of $1 is placed on the foreign parts, then the effective rate of protection is: a. -10%. c. 10%. c. 50%. d. 80%. Assume that U.S.-assembled computers are made with $1,000 of components and sell for $2,000 in the U.S. Now, a $200 tariff is imposed on foreign computers. The nominal tariff is ______ and the effective rate of protection is ________ . a. 10%; 10% b. 5%; 20% c. 20%; 50% d. 10%; 20%

* 63. *

64.

135 Chapter 6

65.

Consider three goods: raw leather, leather wallets, and tanned leather. Assume that an industrial country employs a tariff structure using these ad valorem tariff rates on import of these commodities: 0%, 4.5%, and 7.9%. If this hypothetical industrial country uses a tariff structure similar to most other industrial countries, these rates will be placed on _____, _____, and ____, respectively. a. raw leather, leather wallets, tanned leather b. leather wallets, raw leather, tanned leather c. raw leather, tanned leather, leather wallets d. tanned leather, leather wallets, raw leather

Tariffs 136

66.

* 67.

A domestically produced DVD player sells for $500, including $250 of imported components. A tariff of 20% is imposed on the imported DVD player. What is the effective rate of protection? a. 20% b. 30% c. 40% d. 60% A domestically produced DVD player sells for $500, including $250 of imported components. A tariff of 20% is imposed on the imported DVD player, and a tariff of 10% is imposed on the imported components. What is the effective rate of protection? a. 20% b. 25% c. 30% d. 40% Which of the following components is not necessary to determine the effective rate of protection? a. The tariff on the imported final product b. The tariff on the imported components c. The percentage of imported components used in producing the final product d. The ratio of domestic to imported components used to assemble the final product Tariff escalation encourages: a. final processing of the product in the home country. b. final processing of the product in developing countries. c. final processing of the product and processing of component production in the home country. d. final processing of the product and processing of component production in developing countries.

* 68.

* 69. *

137 Chapter 6

70. *

Tariff escalation results from: a. tariffs increasing as the percent of the value of product imported decreases. b. low tariffs on imported inputs and high tariffs on imported final products. c. tariffs increasing on fuel products whose value is higher than the products produced domestically. d. high tariffs on imported inputs and low tariffs on imported final products. Which of the following is not a common argument for tariffs? a. National defense b. Infant government c. Senile industry d. Senile government Which of the following is not a common argument for tariffs? a. Increase the number of jobs in the economy. b. National defense. c. Infant industry. d. Senile industry. A production subsidy: a. increases domestic output of the industry. b. decreases domestic output of an industry. c. is less efficient than an equivalent tariff. d. is more costly than an equivalent tariff.

71.

* 72. *

73. *

TRUE FALSE QUESTIONS 1. F 2. T 3. T 4. T 5. T 6. T 7. F 8. T A tariff is simply a tax on exported goods. A revenue tariff is a tax on goods that are not domestically produced. In a developing country tariffs may be easier to collect than income or sales taxes. During the nineteenth century, tariffs were the major source of revenue of the U.S. government. Specific tariffs work best on products that essentially are homogeneous. A constant 4-cent tariff on gasoline would be referred to as a specific tariff. Ad valorem tariffs are a regressive form of taxation. A tariff levied as a percentage of the value of the imported item is known as an ad valorem tariff.

Tariffs 138

9. T

Ad valorem tariffs are most useful if the product category is characterized by vertical product differentiation.

10. F A compound tariff is a theoretical possibility that never occurs in practice. 11. F A tariff made up of both an ad valorem component and a specific component is called a pecuniary tariff. 12. F Ad valorem tariffs are a per unit tax on imported goods. 13. F Free on board means that the costs for loading the goods onto the conveyance is not included in the valuation. 14. F The difference between the price producers are willing to sell the product for and the price that they actually receive for the product is called consumer surplus. 15. T Domestic producers always gain from any type of tariff. 16. F The producer surplus gained from an import tariff is always equal to the consumer surplus lost. 17. F As a result of a tariff, producer surplus will increase more than consumers surplus declines. 18. F Consumer surplus is the rectangular area above the demand curve and below the equilibrium price. 19. T If price falls, consumer surplus rises. 20. F If price falls, producer surplus rises. 21. F Tariffs improve the welfare of society because the gain in producer surplus is larger than the loss of consumer surplus. 22. F When a country moves from autarky to free trade, it experiences net gains from exporting goods and net losses from importing goods. 23. T Tariffs tend to raise the prices consumers pay. 24. F Tariffs tend to raise consumer surplus. 25. F Free trade can lead to a significant decline in consumer surplus. 26. T One effect of a tariff is that domestic firms gain additional producer surplus through additional sales and higher prices. 27. F Free trade is worse than protection for a small country.

139 Chapter 6

28. T Free trade is better than no trade for a small country. 29. F The dead-weight loss of a tariff equals the sum of the net changes in consumer and producer surplus. 30. T The effective rate of protection for a product can be negative. 31. T The least expensive way to encourage domestic output of a good is through a production subsidy, not a tariff. 32. F The least expensive way to encourage domestic output of a good is through a tariff, not a production subsidy. 33. T One of the arguments for tariffs is the infant government argument. 34. F Imposing tariffs can increase the overall level of employment for a country. 35. T Imposing a tariff can increase the level employment in the protected industry. SHORT ANSWER ESSAY 1. 2. 3. 4. 5. 6. List and describe the various types of tariffs. Describe the different methods of valuing imports. Describe the concepts of consumer and producer surplus. A tariff tends to decrease consumer surplus and increase producer surplus. Show why this is true. Show how the government benefits from the imposition of a tariff. Suppose that a bottle of beer sells for $1 and contains $.20 of imported inputs. If the tariff on beer is 20 percent and the tariff on imported inputs is 5 percent, what is the effective rate of protection? Explain the various arguments for tariffs. Why is a production subsidy less costly than a tariff in expanding output in a particular industry? Explain why tariffs do not increase the overall level of employment in an economy.

7. 8. 9.

Tariffs 140

BRIEF ANSWERS TO SHORT ANSWER ESSAY 1. A specific tariff is a per unit tax on imported goods. It is expressed as a certain amount of money per unit imported, such as 6 cents per imported liter or $4 per imported ton. An ad valorem tariff is expressed as a percentage of the value of the imported good. A tariff that is comprised of both a specific tariff and an ad valorem tariff is a compound tariff. An example would be $4 per imported ton plus 3 percent of the value. One of the issues a country faces in administering and collecting tariffs is that its customs valuation can be based on one of three different methods of valuing imports. One method of valuing imports is the free alongside (FAS) price. This method defines the price of the imported good as the foreign countrys market price before it is loaded into the ship, train, truck, or airplane for shipment to the importing country. Another method of valuing imports defines the imported price as the free on board (FOB) price. The FOB price defines the price of the imported good as the foreign countrys market price plus the cost of loading the good into the means of conveyance. The third method of valuing imports is the cost, insurance, and freight (CIF) price. This method defines the price of the imported good as the foreign countrys market price plus the cost of loading the goods into the means of conveyance plus all inter-country transportation costs up to the importing countrys port of entry. The difference between the price consumers are willing to pay and the price that they actually pay is known as consumer surplus. Consumer surplus is represented graphically by the triangular area above the equilibrium price and below the demand curve. This area represents the difference between total amount of money consumers were willing to spend on the good and what consumers actually spent purchasing the good. The size of consumer surplus varies inversely with the price. The difference between the price producers are willing to accept and the price that they receive is known as producer surplus. Producer surplus is represented graphically by the triangular area below that equilibrium price and above the supply curve. This area represents the difference between total amount producers were willing to accept for the good and what producers actually receive for selling the good. The size of producer surplus varies directly with the price.

2.

3.

4.
P S

P Pt a Pw D Q b c d World Price World Price + Tariff

141 Chapter 6

The tariff on any imported product decreases consumer surplus be areas a + b+ c+ d, and increases producer surplus by area a. 5. 6. 7. The tariff increases revenue for the government by area c. The Effective Rate of Protection is 23.75%. The first argument for tariff is the infant government argument. For a developing country, tariffs can be an attractive form of government taxation. The developing country can design its tariffs so as to collect its revenue in a way that is something like a progressive tax on corporate or individual income. A second argument for tariffs is the national defense argument. Countries have a legitimate need to take steps to ensure that the military forces of a country can operate effectively if necessary. The argument in this case is that certain industries need to be protected from foreign competition to ensure an adequate output of the industry in the case of a conflict. A third argument is the infant industry argument. The argument in this case is that new industries in developing countries initially may need protection to allow them to grow in the face of more established foreign competition. The temporary protection also may allow the industry to become large enough to establish sufficient economies of scale to effectively compete in world markets. Once the industry has become internationally competitive, the protectionism is withdrawn to allow the industry to become even more efficient. The fourth argument is the senile industry argument. The argument for tariffs in this case is that older industries in developed countries that once had a comparative advantage in world markets needs protection form lower cost imports. The final and most common argument for tariffs is the creation of jobs in the economy. By imposing a tariff output in the protected industry increases and the amount of employment in the industry likewise will expand. Rather simplistically, the tariff has produced more jobs. A production subsidy can increase the output of a domestic industry at a lower cost than a tariff as the effect of a subsidy is to shift the domestic supply downward by the amount of the subsidy and the industry would be willing to produce the larger output. With a subsidy the consumer is still paying the world price for the good and as such the dead-weight loss is only the production effect and does not include the consumption effect. A tariff will create jobs in this particular industry but there are fewer jobs in other industries. This is because consumers spend more on goods from the protected industry but less on other goods. The tariff has not increased the total number of jobs, it has just rearranged them. Protected industries have more jobs and other industries have fewer jobs. The overall level of employment hasnt changed. The total number of jobs in the economy is determined by macroeconomic forces such as the rate of economic growth in the long run and the state of fiscal and monetary policy in the long run. Tariffs dont change the total number of jobs, they just put jobs in places that the market would not.

8.

9.