Slide 8-2,Copyright 2003 Pearson Education, Inc.,Introduction Basic Tariff Analysis Costs and Benefits of a Tariff Other Instruments of Trade Policy The Effects of Trade Policy: A Summary Summary Appendix I: Tariff Analysis in General Equilibrium Appendix II: Tariffs and Import Quotas in the Presence of Monopoly,Chapter Organization,Slide 8-3,Copyright 2003 Pearson Education, Inc.,Introduction,This chapter is focused on the following questions: What are the effects of various trade policy instruments? Who will benefit and who will lose from these trade policy instruments? What are the costs and benefits of protection? Will the benefits outweigh the costs? What should a nations trade policy be? For example, should the United States use a tariff or an import quota to protect its automobile industry against competition from Japan and South Korea?,Slide 8-4,Copyright 2003 Pearson Education, Inc.,Classification of Commercial Policy Instruments,Introduction,Commercial Policy Instruments,Slide 8-5,Copyright 2003 Pearson Education, Inc.,Basic Tariff Analysis,Tariffs can be classified as: Specific tariffs Taxes that are levied as a fixed charge for each unit of goods imported Example: A specific tariff of $10 on each imported bicycle with an international price of $100 means that customs officials collect the fixed sum of $10. Ad valorem tariffs Taxes that are levied as a fraction of the value of the imported goods Example: A 20% ad valorem tariff on bicycles generates a $20 payment on each $100 imported bicycle.,Slide 8-6,Copyright 2003 Pearson Education, Inc.,A compound duty (tariff) is a combination of an ad valorem and a specific tariff. Modern governments usually prefer to protect domestic industries through a variety of nontariff barriers, such as: Import quotas Limit the quantity of imports Export restraints Limit the quantity of exports,Basic Tariff Analysis,Slide 8-7,Copyright 2003 Pearson Education, Inc.,Supply, Demand, and Trade in a Single Industry Suppose that there are two countries (Home and Foreign). Both countries consume and produce wheat, which can be costless transported between the countries. In each country, wheat is a competitive industry. Suppose that in the absence of trade the price of wheat at Home exceeds the corresponding price at Foreign. This implies that shippers begin to move wheat from Foreign to Home. The export of wheat raises its price in Foreign and lowers its price in Home until the initial difference in prices has been eliminated.,Basic Tariff Analysis,Slide 8-8,Copyright 2003 Pearson Education, Inc.,To determine the world price (Pw) and the quantity trade (Qw), two curves are defined: Home import demand curve Shows the maximum quantity of imports the Home country would like to consume at each price of the imported good. That is, the excess of what Home consumers demand over what Home producers supply: MD = D(P) S(P) Foreign export supply curve Shows the maximum quantity of exports Foreign would like to provide the rest of the world at each price. That is, the excess of what Foreign producers supply over what foreign consumers demand: XS = S*(P*) D*(P*),Basic Tariff Analysis,Slide 8-9,Copyright 2003 Pearson Education, Inc.,PA,P2,P1,Figure 8-1: Deriving Homes Import Demand Curve,Basic Tariff Analysis,Slide 8-10,Copyright 2003 Pearson Education, Inc.,Properties of the import demand curve: It intersects the vertical axis at the closed economy price of the importing country. It is downward sloping. It is flatter than the domestic demand curve in the importing country.,Basic Tariff Analysis,Slide 8-11,Copyright 2003 Pearson Education, Inc.,P2,P*A,P1,Figure 8-2: Deriving Foreigns Export Supply Curve,Basic Tariff Analysis,Slide 8-12,Copyright 2003 Pearson Education, Inc.,Properties of the export supply curve: It intersects the vertical axis at the closed economy price of the exporting country. It is upward sloping. It is flatter that the domestic supply curve in the exporting country.,Basic Tariff Analysis,Slide 8-13,Copyright 2003 Pearson Education, Inc.,Figure 8-3: World Equilibrium,MD,Basic Tariff Analysis,Slide 8-14,Copyright 2003 Pearson Education, Inc.,Useful definitions: The terms of trade is the relative price of the exportable good expressed in units of the importable good. A small country is a country that cannot affect its terms of trade no matter how much it trades with the rest of the world. The analytical framework will be based on either of the following: Two large countries trading with each other A small country trading with the rest of the world,Basic Tariff Analysis,Slide 8-15,Copyright 2003 Pearson Education, Inc.,Effects of a Tariff Assume that two large countries trade with each other. Suppose Home imposes a tax of $2 on every bushel of wheat imported. Then shippers will be unwilling to move the wheat unless the price difference between the two markets is at least $2. Figure 8-4 illustrates the effects of a specific tariff of