Trade Policy

Global Trade and Finance

Prof. Bryson, Marriott School
Part I. Tariffs
 A tariff is a tax, usually ad valorem
(“on the value” or some percentage
of the estimated market value of a
commodity).

 It is imposed as a commodity crosses

the frontier of the importing country.
 The Two Functions of Tariffs

First, they create revenues

Second, they hinder foreign competition.
 Trade Before Tariffs
Because the
world price is
below the
domestic price,
Sd imports are equal
to the shortage
World Price
between Dd and
Dd Sd at the world
price.
Imports
 Tariffs
 Now, this country imposes a tariff,

Pw plus tariff

World Price

and the price rises from Pw to Pw + Tariff.

 Tariffs
 We get the famous areas a,b,c, and d.

Wp plus tariff
a b c d
World Price

Imports after tariff

Imports before tariff
Consumers lose areas a+b+c+d in consumer’s
surplus as the tariff raises the price.

Wp plus tariff
a b c d
World Price

Producers gain Area A

Smaller than what consumers lost
 Government collects area c as tariff revenues

Net national loss from the quota: areas b and d.

These are losses in consumer surplus not offset by
gains made elsewhere.

Wp plus tariff
a b c d
World Price
b is the “Production effect.” This is a deadweight loss. Consumers
purchases are shifted to the more expensive, less-efficient
domestically produced product.

Wp plus tariff
a b c d
World Price

d is the “consumption effect,” also deadweight loss, resulting

from the reduction in consumption due to the higher price.
So the net national welfare loss is b + d.

Wp plus tariff
a b c d
World Price
 More about b and d

 The net losses, b and d, don’t appear very

large, but
 1% of US GNP is still well over $100 billion
 Net national loss is substantially less than
consumer loss.
 More about b and d
 There is also an administrative cost to a tariff
(part of c must be added to b and d).
 Protection has dynamic (technological
effects).
 Stagnation.
Part II. Quotas
 Import Quotas
 Historically, as tariffs decrease through the
efforts of GATT/WTO, other barriers
replace them. This has gone on since the
early 1950s.

 Import Quotas, a most popular substitute

for tariffs, are limits on the total Q of
imports permitted.
 Import Quotas

 With quotas, importing countries have

absolute assurance about import
quantities.
 With tariffs, countries have less control
over import volumes, since foreign
exporters can cut prices to increase sales
when they face tariffs.
 Quotas
 Analytically speaking, quotas are not better and
are usually worse than tariffs.
 Total market supply is the domestic supply curve
plus the fixed quota at all prices above the world
price. Sd

Sd + Quota

Imports, limited to the Quota,

simply shift the S curve out.
Pw
Quantities are determined
Imports after by the Intersection of D
Dd
and Sd + Quota.

Imports before quota

But stop!
Let’s compare this to a tariff and we will
notice they are almost identical analyses.
 Tariffs and Quotas Compared
 This country has imposed a tariff. How
would a quota look?
Sd Sd + Quota

Wp plus tariff

World Price

Just add the quota to the supply curve

 Quotas
 Once again, we have the same net
economic welfare situation illustrated by
the areas in the strip abcd diagram
Sd

Sd + Quota

a b c d
Pw

Dd
Consumers lose areas a+b+c+d in consumer’s
surplus,

Sd
Sd + quota

Equilibrium price with

quota where
Dd = Sd + quota
a b c d
World Price
Producers gain area a.

Sd
Sd + quota

a b c d
Government could collect area c
auctioning import licenses.

Sd
Sd + quota

Equilibrium price with

quota where
Dd = Sd + quota
a b c d
World Price
Net national loss from the quota:
at least areas b and d.

Sd
Sd + quota

Equilibrium price with

quota where
Dd = Sd + quota
a b c d
World Price
b is the “Production effect.” This is a deadweight loss. Consumers
purchases are shifted to the more expensive, less-efficient
domestically produced product.

Sd
Sd + quota

a b c d

d is the “consumption effect,” also deadweight loss, resulting from

the reduction in consumption due to the higher price.
Additional Quota Problems

 First, the quota can create domestic and

foreign monopoly power.

 The domestic firm may have very high

prices, and limited competing imports
don’t force prices down.
Additional Quota Problems

 The foreign producers can tacitly

collude and charge the domestic
monopoly price.
 Additional Quota Problems

Second, efficiency depends on how the

rights to import are distributed. Import
licenses can be allocated as follows:

1. by competing auctions (generates

same as tariff revenues.

2. by sales (or bribes) by corrupt customs

officials
 Additional Quota Problems

3. by fixed favoritism – some arbitrary

method, e.g., on the basis of pre-quota
sales proportions

4. by resource-using application
procedures. Use the bureaucratic
method, viz., queues.
 Part III.
Voluntary Export
Restraints
 Voluntary Export Restraints

 Here, a major exporting partner is warned

to restrict its sales in your country
voluntarily.
 Voluntary Export Restraints

 The importing country says:

“As you invade our market, you had
better restrain yourself voluntarily, or our
parliament will cream you with tariffs or
quotas.”
 Voluntary Export Restraints

 President Reagan did this with Japanese

auto exporters.

 Unwittingly, this is like saying,

“You had better behave like a monopolist
in our market!” (Restrict your output and
do what you will with your price.)
 VER’s, Quotas, and Free Trade,
See Figure 8.2 in the text

 A VER is, in effect, like a quota.

 Let’s compare the VER, quota, and free

trade.
 VER’s, Quotas, and Free Trade,

 Free Trade
Fs= foreign supply of Ms

Fs

Dm Dm = demand for imports

Small Country Large country (w/monopsony power)

With free trade, both countries enjoy same consumers surplus
With free trade, both cases enjoy the same producers surplus.
 VER’s, Quotas, and Free Trade
With a quota, the small country loses consumer surplus, but can get
the yellow area by auctioning import licenses.
 Using a Quota

Fs= foreign supply of Ms

Fs

Dm Dm = demand for imports

Small Country Large country (with monopsony power)

With a quota, the large country gains the larger yellow box.
 VER’s, Quotas, and Free Trade

 Using a Quota

Fs= foreign supply of Ms

Fs

Dm Dm = demand for imports

Small Country Large country (with monopsony power)

With a quota, the exporter loses the larger green area of

producer surplus.
 VER’s, Quotas, and Free Trade

 A VER is, in effect, like a quota.

 Let’s compare the three types of

protection
 VER,

 quota, and

 free trade.
 With a VER, the large country is like the small one, except
it gives its larger yellow box to the foreign monopolist.

 Using a VER

Fs= foreign supply of M

Fs

Dm Dm = demand for imports

Small Country Large country (with monopsony power)

With a VER, the small country loses consumer surplus. It gives
the yellow box to the foreign monopolist.
 Trade and Historical Societies
 Contrast the cases of the USSR and China

 The case of the Lamanites and Nephites

THE BOOK OF HELAMAN, CHAPTER 6
The righteous Lamanites preach to the wicked Nephites—Both peoples
prosper during an era of peace and plenty—
7 And behold, there was peace in all the land, insomuch that the
Nephites did go into whatsoever part of the land they would,
whether among the Nephites or the Lamanites.
8 And it came to pass that the Lamanites did also go whithersoever
they would, whether it were among the Lamanites or among the
Nephites; and thus they did have free intercourse one with another,
to buy• and to sell, and to get gain, according to their desire.
9 And it came to pass that they became exceedingly rich, both the
Lamanites and the Nephites; and they did have an exceeding plenty
of gold•, and of silver, and of all manner of precious metals, both in
the land south and in the land north.
10 Now the land south was called Lehi• and the land north was
called Mulek•, which was after the son• of Zedekiah; for the Lord
did bring Mulek into the land north, and Lehi into the land south.

11 And behold, there was all manner of gold in both these lands,
and of silver, and of precious ore of every kind; and there were also
curious workmen, who did work all kinds of ore and did refine it;
and thus they did become rich.

12 They did raise grain in abundance, both in the north and in the
south; and they did flourish exceedingly, both in the north and in
the south. And they did multiply and wax exceedingly strong in the
land. And they did raise many flocks and herds, yea, many fatlings.
 13 Behold their women did toil and spin, and did make all manner of
cloth•, of fine-twined linen and cloth of every kind, to clothe their
nakedness. And thus the sixty and fourth year did pass away in
peace.

14 And in the *sixty and fifth year they did also have great joy and
peace, yea, much preaching and many prophecies concerning that
which was to come. And thus passed away the sixty and fifth year.

And what was the result?

How well did the Nephites handle
their wealth?

17 For behold, the Lord had blessed them so long with the riches of
the world that they had not been stirred up to anger, to wars, nor to
bloodshed; therefore they began to set their hearts upon their
riches; yea, they began to seek to get gain that they might be lifted
up one above another; therefore they began to commit secret•
murders, and to rob and to plunder, that they might get gain.

18 And now behold, those murderers and plunderers were a band

who had been formed by Kishkumen and Gadianton•.