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Tariff, partial equilibrium Countries may restrict trade in several ways. For example, they may Impose a 100 Euro tax per imported computer (tariff) Impose a 12% tax per imported computer (ad valorem tariff)
Tariff, partial equilibrium p D We start with a basic partial equilibrium setup; quantity demanded increases and quantity supplied falls as the price falls. In autarky, the equilibrium S price is p0, with quantity q0 The price in the world market, however, is equal to p1
p0
p1 imports
q1
q0
q2
At that price the domestically supplied quantity equals q1, and the domestically demanded quantity equals q2. The difference between these two quantities is imported q from abroad.
Tariff, partial equilibrium p D Suppose the government wants to help the domestic suppliers who face a lower price with trade than in autarky. One way to do this is by S imposing a tariff equal to T If this is a small country in the world markets this raises the domestic price to p1+T As a result the domestically produced quantity rises to q3, and the domestically demanded quantity falls to q4. The quantity imported from abroad thus falls q
p1+T p1 imports
q1 q3
q4
q2
Tariff, partial equilibrium p D We note that the price level has risen from p1 to p1+T, which has increased the quantity of domestically produced goods S from q1 to q3. Thus, the domestic producers support this policy; indeed their profits have increased by the area: The government turns out to be pleased as well; not only has domestic production and profitability increased, they earn a revenue as well equal to:
p1+T p1
q1 q3
q4
q2
Tariff, partial equilibrium p D The only party not in support of this policy are the consumers. They see the price level rise from p1 to p1+T.
This reduces the consumer surplus considerably, by the area equal to: Indeed, the loss in consumer surplus is so considerable that the total welfare change is negative, equal to the deadweight loss triangles:
p1+T p1
q1 q3
q4
q2
Tariff, partial equilibrium p D Is it possible in this analysis that the total welfare change is positive, rather than negative? Yes, it is. Remember that imposing
p2+T p1 p2 T
a tariff reduces the quantity imported from abroad. If this fall in demand has a substantial impact on the rest of the world it will reduce the world price of this good, say from p1 to p2 (large country) This does not mean that domestic prices will be lower than p1, since the tariff T has to be paid for imports (price wedge). q2 q
q1 q3
q4
Tariff, partial equilibrium The producers gain the area: p D The government gains the area:
The total welfare change is equal to: An omniscient government would set tariffs to maximize this welfare gain, the optimal tariff argument, see the sequel.
p2+T p1 p2
q1 q3
q4
q2