protectionist-policies-tariffs

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How a Tariff Works

A tariff is a tax on imported goods/services (customs duty)
Domestic producers/retailers have to pay the tariff when the good/service crosses the border into the country
- This raises the cost of production for domestic firms
- Firms often pass on the increased costs to consumers in the form of higher prices
- These higher prices allow some domestic firms to increase their output (law of supply)
Due to the tariff, more inefficient domestic firms are now producing more at the expense of more efficient foreign firms, which reduce their output due to the tariff
- With increased domestic output, employment may increase

Diagram: Tariff Imposed on Imports

Supply and demand graph showing tariff effect on imports. Labels: price, quantity, supply, demand. Tariff increases price from Pw to Pw + tariff. — **A tariff raises the price of world supply from PW to PW + Tariff. This reduces the quantity of imports from Q1Q2 to Q3Q4**

Diagram analysis

World supply (W_s) is considered to be infinite, and this supply curve is added to the domestic demand (DD) and supply (SD) curves

The pre-tariff market equilibrium is seen at P_wQ₂
- Domestic firms supply up to Q₁ at a price of P_w
- Foreign firms supply the difference equal to Q₁Q₂(the level of imports), at a price of P_w

After the tariff is imposed, the world price increases from P_w to P_w + Tariff
- Following the law of demand, the quantity demanded contracts from Q₂ to Q₄
- Following the law of supply, the quantity supplied by domestic firms extends from Q₁ to Q₃
- The new market equilibrium is seen at P_w+tariff Q₄
- The level of imports is reduced from Q₁Q₂ to Q₃Q₄
  - Domestic producer surplus has increased by area 2
  - Domestic consumer surplus has decreased by areas 1, 2, 3 & 4
  - The government receives tax revenue equal to ((P_w+tariff) – P_w) x (Q₄-Q₃)
    - This is equivalent to area 3 on the diagram

The Impact of a Tariff

The best way to consider the impact of a tariff on stakeholders is to explain it using a diagram

Diagram: The Impact of Tariffs on Stakeholders

The Impact of Tariffs on Stakeholders

Stakeholder	Impact on Stakeholder
Domestic producers	Before the tariff domestic producers produced output equal to 0Q₁ and their revenue was equal to P_w x Q₁ After the tariff was imposed domestic producers produced 0Q₃ and their revenue was equal to P_w+tariff x Q₃ Domestic producer surplus has increased by area 1
Foreign producers	Before the tariff foreign producers sold output equal to Q₁Q₂ and their revenue was equal to P_w x (Q₂ – Q₁) After the tariff was imposed foreign producers sold output equal to Q₃Q₄and their revenue was equal to P_w x (Q₄-Q₃) Foreign producer surplus has decreased by the areas underneath 2 and 4
Domestic consumers	Before the tariff domestic consumers consumed Q₂ products at a price of P_w After the tariff domestic consumers consumed fewer products (Q₄) at a higher price of P_w+tariff Domestic consumer surplus has decreased by areas 1,2 3 and 4 Some consumers have been priced out of the market (contraction of quantity demanded from Q₂ → Q₄
The government	After the tariff is imposed the government receives tax revenue equal to ((P_w+tariff) – Pw) x (Q₄-Q₃) This is equal to area 3
Downstream producers	Other producers who rely on the imported product as a raw material in their own production process, now have to pay more for it as prices are higher This increases their costs of production They may have to reduce output which could impact unemployment levels and government tax receipts in their industry
Society (welfare loss)	Less efficient domestic firms are now producing at the expense of more efficient foreign producers – there is a welfare loss equal to area 2 Consumers are frustrated with the higher prices and there is no longer allocative efficiency – there is a welfare loss equal to area 4 The net welfare loss is equal to areas 2 and 4

Impact on standards of living

The standards of living for consumers worsen as the value of their income is eroded as they are paying higher prices
Domestic firms that benefit from increased production may increase employees’ wages
- This would increase the standard of living for employees

Impact on equality

Workers in industries that have been experiencing structural unemployment due to foreign competition will feel that the tariff results in them being treated more fairly

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protectionist-policies-tariffs

How a Tariff Works

Diagram: Tariff Imposed on Imports

Diagram analysis

The Impact of a Tariff

Diagram: The Impact of Tariffs on Stakeholders

Impact on standards of living

Impact on equality

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