The Effects of Trade Policy: A Summary

The Effects of Trade Policy: A Summary
The effects of the major instruments of trade policy are usefully summarized by Table 9-1,
which compares the effect of four major kinds of trade policy on the welfare of consumers.
This table certainly does not look like an advertisement for interventionist trade policy.
All four trade policies benefit producers and hurt consumers. The effects of the policies on
economic welfare are at best ambiguous; two of the policies definitely hurt the nation as a
whole, while tariffs and import quotas are potentially beneficial only for large countries
that can drive down world prices.
Why, then, do governments so often act to limit imports or promote exports? We turn to
this question in Chapter 10.
SUMMARY
1. In contrast to our earlier analysis, which stressed the general equilibrium interaction of
markets, for analysis of trade policy it is usually sufficient to use a partial equilibrium
approach.
2. A tariff drives a wedge between foreign and domestic prices, raising the domestic
price but by less than the tariff rate. An important and relevant special case, however,
is that of a “small” country that cannot have any substantial influence on foreign
prices. In the small country case, a tariff is fully reflected in domestic prices.
3. The costs and benefits of a tariff or other trade policy may be measured using the concepts
of consumer surplus and producer surplus. Using these concepts, we can show
that the domestic producers of a good gain because a tariff raises the price they
receive; the domestic consumers lose, for the same reason. There is also a gain in
government revenue.
TABLE 9-1 Effects of Alternative Trade Policies
Tariff
Export
Subsidy
Import
Quota
Voluntary
Export Restraint
Producer surplus Increases Increases Increases Increases
Consumer surplus Falls Falls Falls Falls
Government
revenue
Increases Falls
(government
spending rises)
No change
(rents to
license holders)
No change
(rents to
foreigners)
Overall national
welfare
Ambiguous
(falls for
small country)
Falls Ambiguous
(falls for
small country)
Falls
212 PART TWO International Trade Policy
4. If we add together the gains and losses from a tariff, we find that the net effect on national
welfare can be separated into two parts: On one hand is an efficiency loss, which
results from the distortion in the incentives facing domestic producers and consumers.
On the other hand is a terms of trade gain, reflecting the tendency of a tariff to drive
down foreign export prices. In the case of a small country that cannot affect foreign
prices, the second effect is zero, so that there is an unambiguous loss.
5. The analysis of a tariff can be readily adapted to analyze other trade policy measures,
such as export subsidies, import quotas, and voluntary export restraints. An export
subsidy causes efficiency losses similar to those of a tariff but compounds these
losses by causing a deterioration of the terms of trade. Import quotas and voluntary
export restraints differ from tariffs in that the government gets no revenue. Instead,
what would have been government revenue accrues as rents to the recipients of import
licenses (in the case of a quota) and to foreigners (in the case of a voluntary
export restraint).
KEY TERMS
ad valorem tariff, p. 192
consumer surplus, p. 198
consumption distortion
loss, p. 202
effective rate of protection,
p. 197
efficiency loss, p. 201
export restraint, p. 193
export subsidy, p. 203
export supply curve, p. 193
import demand curve, p. 193
import quota, p. 193
local content requirement,
p. 209
nontariff barriers, p. 193
producer surplus, p. 199
production distortion
loss, p. 202
quota rent, p. 206
specific tariff, p. 192
terms of trade gain, p. 201
voluntary export restraint
(VER), p. 208
PROBLEMS
1. Home’s demand curve for wheat is
Its supply curve is
Derive and graph Home’s import demand schedule. What would the price of wheat be
in the absence of trade?
2. Now add Foreign, which has a demand curve
and a supply curve
a. Derive and graph Foreign’s export supply curve and find the price of wheat that
would prevail in Foreign in the absence of trade.
b. Now allow Foreign and Home to trade with each other, at zero transportation cost.
Find and graph the equilibrium under free trade. What is the world price? What is
the volume of trade?
S* = 40 + 20P.
D* = 80 - 20P
S = 20 + 20P.
D = 100 - 20P.
CHAPTER 9 The Instruments of Trade Policy 213
3. Home imposes a specific tariff of 0.5 on wheat imports.
a. Determine and graph the effects of the tariff on the following: (1) the price of
wheat in each country; (2) the quantity of wheat supplied and demanded in each
country; (3) the volume of trade.
b. Determine the effect of the tariff on the welfare of each of the following groups:
(1) Home import-competing producers; (2) Home consumers; (3) the Home
government.
c. Show graphically and calculate the terms of trade gain, the efficiency loss, and the
total effect on welfare of the tariff.
4. Suppose that Foreign had been a much larger country, with domestic demand
(Notice that this implies that the Foreign price of wheat in the absence of trade would
have been the same as in problem 2.)
Recalculate the free trade equilibrium and the effects of a 0.5 specific tariff by Home.
Relate the difference in results to the discussion of the small country case in the text.
5. What would be the effective rate of protection on bicycles in China if China places a
50 percent tariff on bicycles, which have a world price of $200, and no tariff on bike
components, which together have a world price of $100?
6. The United States simultaneously limits imports of ethanol for fuel purposes and provides
incentives for the use of ethanol in gasoline, which raise the price of ethanol by
about 15 percent relative to what it would be otherwise. We do, however, have free
trade in corn, which is fermented and distilled to make ethanol, and accounts for
approximately 55 percent of its cost. What is the effective rate of protection on the
process of turning corn into ethanol?
7. Return to the example of problem 2. Starting from free trade, assume that Foreign offers
exporters a subsidy of 0.5 per unit. Calculate the effects on the price in each
country and on welfare, both of individual groups and of the economy as a whole, in
both countries.
8. Use your knowledge about trade policy to evaluate each of the following statements:
a. “An excellent way to reduce unemployment is to enact tariffs on imported goods.”
b. “Tariffs have a more negative effect on welfare in large countries than in small
countries.”
c. “Automobile manufacturing jobs are heading to Mexico because wages are so
much lower there than they are in the United States. As a result, we should implement
tariffs on automobiles equal to the difference between U.S. and Mexican
wage rates.”
9. The nation of Acirema is “small” and unable to affect world prices. It imports peanuts
at the price of $10 per bag. The demand curve is
The supply curve is
Determine the free trade equilibrium. Then calculate and graph the following effects
of an import quota that limits imports to 50 bags.
a. The increase in the domestic price.
b. The quota rents.
c. The consumption distortion loss.
d. The production distortion loss.
S = 50 + 5P.
D = 400 - 10P.
D* = 800 - 200P, S* = 400 + 200P.
214 PART TWO International Trade Policy
10. If tariffs, quotas, and subsidies each cause net welfare losses, why are they so common,
especially in agriculture, among the industrialized countries such as the United
States and the members of the European Union?
11. Suppose that workers involved in manufacturing are paid less than all other workers
in the economy. What would be the effect on the real income distribution within the
economy if there were a substantial tariff levied on manufactured goods?