Lecture 4Stephen Kinsella
stephenkinsella.net
RecapTariffs
Welfare Analysis
{Story}
1.EU is an economic solution
to a political
problem
2. History of
integration matters, and
reflects current level
of integration
3. There are
welfare effects to
greater integration
Recap
Trade Creation is“The increase in trade volume caused by union with a lower cost (more efficient) supplier within the trade bloc”––Viner, 1950
Punion post tax
Pworld post tax
Pworld pre tax
Punion pre tax
Supply Home
Demand Home
P*
C*
P
QB D
Trade Creation (High Cost to Low Cost)
Punion post tax
Pworld post tax
Pworld pre tax
Punion pre tax
Supply Home
Demand Home
P*
C*
P
QB D
Trade Diversion (Low Cost to High Cost)
Beach on the Enlargement
A tariff is a tax on goods produced abroad and sold
domestically.
{Definition}
Effects of a Tariff
The Effects of a Tariff
Copyright © 2004 South-Western
Priceof Steel
0 Quantityof Steel
Domesticsupply
Domesticdemand
Pricewith tariff Tariff
Importswithout tariff
Equilibriumwithout trade
Pricewithout tariff
WorldpriceImports
with tariff
QSQS QD QD
Copyright © 2004 South-Western
Priceof Steel
0 Quantityof Steel
Domesticsupply
Domesticdemand
Importswithout tariff
Equilibriumwithout trade
Pricewithout tariff
Worldprice
QS QD
Producer surplus
before tariff
Consumer surplusbefore tariff
Figure 6 The Effects of a Tariff
Copyright © 2004 South-Western
A
B
Priceof Steel
0 Quantityof Steel
Domesticsupply
Domesticdemand
Pricewith tariff Tariff
Importswithout tariff
Equilibriumwithout trade
Pricewithout tariff
WorldpriceImports
with tariff
QSQS QD QD
Consumer surpluswith tariff
Figure 6 The Effects of a Tariff
Copyright © 2004 South-Western
C
G
Priceof Steel
0 Quantityof Steel
Domesticsupply
Domesticdemand
Pricewith tariff Tariff
Importswithout tariff
Equilibriumwithout trade
Pricewithout tariff
Worldprice
QS
Importswith tariff
QS QD QD
Producer surplus
after tariff
Figure 6 The Effects of a Tariff
Copyright © 2004 South-Western
E
Priceof Steel
0 Quantityof Steel
Domesticsupply
Domesticdemand
Pricewith tariff Tariff
Importswithout tariff
Pricewithout tariff
Worldprice
QS
Importswith tariff
QS QD QD
Tariff Revenue
DWT Loss: the reduction in
consumer and producer surplus resulting from
restricting output below its efficient level
{Definition}
Figure 6 The Effects of a Tariff
Copyright © 2004 South-Western
C
G
A
ED F
B
Priceof Steel
0 Quantityof Steel
Domesticsupply
Domesticdemand
Pricewith tariff Tariff
Importswithout tariff
Pricewithout tariff
WorldpriceImports
with tariff
QSQS QD QD
Deadweight Loss
Exercise
The Effects of a Tariff
Before Tariff After Tariff Change
CS A+B+C+D+E-F A+B -(C+D+E+F)
PS G C+G +C
Govt. Revenue None E +E
Total Surplus A+B+C+D+E+F+G
A+B+C+E+G -(D+F)
{Story}
The Effects of a Tariff
• A tariff reduces the quantity of imports and moves the domestic market closer to its equilibrium without trade.
• With a tariff, total surplus in the market decreases by an amount referred to as a deadweight loss.
{The Effects of an Import Quota}
An import quota is a limit on the quantity of a good that can be produced abroad and sold domestically.
Copyright © 2004 South-Western
Priceof Steel
0 Quantityof Steel
Domesticsupply
Domesticsupply
+Import supply
Domesticdemand
Isolandianprice with
quota
Importswithout quota
Equilibriumwith quota
Equilibriumwithout trade
Quota
Importswith quota
QD
Worldprice
Worldprice
Pricewithout
quota=
QS QDQS
{Story}
The Effects of an Import Quota
Because the quota raises the domestic price above the world price, domestic buyers of the good are worse off, and domestic sellers of the good are better off.
License holders are better off because they make a profit from buying at the world price and selling at the higher domestic price.
The Effects of an Import Quota
Figure 7 The Effects of an Import Quota
Copyright © 2004 South-Western
A
E'C
B
G
D E" F
Priceof Steel
0 Quantityof Steel
Domesticsupply
Domesticsupply
+Import supply
Domesticdemand
Isolandianprice with
quota
Importswithout quota
Equilibriumwith quota
Equilibriumwithout trade
Quota
Importswith quota
QD
Worldprice
Worldprice
Pricewithout
quota=
QS QDQS
Exercise
Before Quota After Quota Change
CS A+B+C+D+E’+E’’+F A+B -(C+D
+E’+E”+F)
PS G C+G +C
License Holder None E’+E’’ +(E’+E’’)
Total Surplus A+B+C+D+E’+E’’+F+G
A+B+C+E’+E’’+G -(D+F)
The Effects of an Import Quota
With a quota, total surplus in the market decreases by an amount referred to as a deadweight loss.
The quota can potentially cause an even larger deadweight loss, if a mechanism such as lobbying is employed to allocate the import licenses.
The Lessons for Trade Policy
Other Benefits of International Trade
Arguments for Restricting Trade
CASE STUDY: Trade Agreements and the World Trade Organization
CASE STUDY: Trade Agreements and the World Trade Organization
CASE STUDY: Trade Agreements and the World Trade Organization
Summary
Next Week
• European Monetary Union
• Read Wyplosz, C. ‘European Monetary Union: The Dark Sides of a Major Success’, Economic Policy, 2006.
Thanks