Tariffs

Tariffs (AO3, AO4)

Tariffs are a specific tax on imported goods and services. 

• On this diagram, the economy is importing goods and services as the world price (Pw) is much lower than the domestic equilibrium (Pe). 

• This means domestic producers are losing out as they now have to compete with international firms. 

• As a way to support domestic firms, the government could put a tariff in place: Raise the cost of foreign products by taxing them.

• This makes foreign goods more expensive than before (Pw -> Pwt), and more people will consume domestic products. 

• Results: 

  • • Imports decrease (from between Qs1 and Qd1, to between Qs2 and Qd2)

    • Price increases (from Pw to Pwt)

    • Quantity supplied by domestic firms increases (from Qs1 to Qs2)

    • Quantity demanded by consumers decreases (from Qd1 to Qd2)

    • The government earns itself some nice extra tax revenue :)

Effect on Consumers

• Surplus is lost as prices increase

• In the long run, foreign companies may choose to stop selling as the price is too high, which decreases competition, decreasing consumer choice

• The effects depend on the price elasticity of the product

Effect on Producers

• Surplus is gained (by domestic producers) as prices increase

• Foreign companies will lose out, as their goods are marked up and look less attractive 

• In the long run, other governments may do similar things in response, which will negatively affect these producers

• The effects depend on the price elasticity of the product

Effect on the Market (Consumers+Producers)

• The gained surplus for producers is smaller than the lost surplus for consumers

• Hence, tariffs make markets less efficient, as they reduce the social/community surplus

Effect on the Government

• The government will receive increased tax revenue as a result of tariffs

• The government will also be protecting domestic producers, strengthening a national industry

• However, it will have to spend money administrating and regulating the tariff

• Other countries might say it is unfair and complain

• The World Trade Organization may step in and fine/sanction the country

Calculating the Effect of Tariffs (HL Only) (AO4)

If you are an HL student, you also need to know how to calculate changes in consumer expenditure/surplus, producer revenue/surplus, government tax revenue, and welfare loss. 

• In this example, the government of a country, let's say San Marino, has imposed a tariff of $5,000 on imports of sedans (a class of cars). 

• This raises prices of sedans from $20K to $25K

• This means domestic firms are more competitive, and they produce 15K sedans instead of 10K.

• This also means market equilibrium is higher, decreasing consumer demand from 30K to 25K.

• Now, let's calculate the changes!