Lecture 7. Trade policy 1

Lecture 7. Trade policy 1 - ECO 364 - Topic 6 Trade Policy...

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Unformatted text preview: ECO 364 - Topic 6 Trade Policy Kunal Dasgupta Dasgupta (UofT) Trade Policy 1 / 43 Road map 1 Motivation 2 Tariffs and quotas under perfect competition 3 Tariffs and quotas under imperfect competition 4 Export subsidy 5 World Trade Organization (WTO) Dasgupta (UofT) Trade Policy 2 / 43 Motivation Why do countries use trade policy? We have seen that trade creates winners and losers. The losers (industries, labor unions, etc.) might ask the government for protection in the form of tariffs, quotas or subsidies. Although inefficient in most cases (there are exceptions), trade policy is usually used by governments for political economy reasons. Even a country like the U.S., where policymakers generally agree that free trade is good, had average tariff rates of over 30% during the first half of the 20th century. Dasgupta (UofT) Trade Policy 3 / 43 Tariffs and quotas under perfect competition Consumer and Producer surplus In previous chapters, we had demonstrated the gains from trade using PPF and indifference curves. In this chapter, we revisit the gains from trade using demand and supply curves of the Home country. We introduce the concepts of consumer surplus and producer surplus. Dasgupta (UofT) Trade Policy 4 / 43 Tariffs and quotas under perfect competition Dasgupta (UofT) Consumer and Producer surplus Trade Policy 5 / 43 Tariffs and quotas under perfect competition Gains from Trade Home is a small country =⇒ Home takes world price P W as given. Assume that P A > P W =⇒ Home is an importer. Dasgupta (UofT) Trade Policy 6 / 43 Tariffs and quotas under perfect competition Gains from Trade Change in consumer surplus = +(b + d ). Change producer surplus = −b . Net effect on Home welfare = +d . The gains from trade are measured as the area of the triangle denoted by d . 1 d = · (P A − P W ) · M1 2 The gains are higher, the bigger is the difference between the two prices and greater is the volume of imports. With many goods, we must add up the areas of the triangles for all goods. Dasgupta (UofT) Trade Policy 7 / 43 Tariffs and quotas under perfect competition Import Tariff for a small country Home Import Demand Curve Dasgupta (UofT) Trade Policy 8 / 43 Tariffs and quotas under perfect competition Import Tariff for a small country An import tariff of t is applied on the good. Since the Home country is small, the world price P W remains unaffected. Dasgupta (UofT) Trade Policy 9 / 43 Tariffs and quotas under perfect competition Import Tariff for a small country Change in consumer surplus = −(a + b + c + d ) Change in producer surplus = +a Change in government revenue = +c Dasgupta (UofT) Trade Policy 10 / 43 Tariffs and quotas under perfect competition Import Tariff for a small country Net effect on Home welfare = −(a + b + c + d ) + a + c = −(b + d ) These losses from trade are referred to as the Deadweight Loss. The deadweight losses are measured as the areas of the triangle denoted by b and d . 1 1 · t · (S2 − S1 ) + · t · (D1 − D2 ) 2 2 1 = · t · [(D1 − S1 ) − (D2 − S2 )] 2 1 = · t · (M1 − M2 ). 2 b+d = Dasgupta (UofT) Trade Policy 11 / 43 Tariffs and quotas under perfect competition Import Tariff for a small country The deadweight loss has two components: Production Loss: An inefficiency that arises because the Home is producing at a marginal cost that is above the world price. It would be cheaper to import rather than produce the extra quantity at Home. Consumption Loss: An inefficiency that arises because the tariff distorts consumer choice; consumers consume less than they would under free trade. Dasgupta (UofT) Trade Policy 12 / 43 Tariffs and quotas under perfect competition Import Tariff for a small country Why does a small country impose tariffs? Import tariffs are easier to collect Import tariffs can be collected by putting customs agents at any port of entry. Taxes which have lower deadweight loss like income tax require individuals to truthfully reveal their income. Over time, as a country develops, there should be a shift from easy-to-collect to hard-to-collect taxes. Political reasons Imposition of an import tariff leads to re-distribution of income within a country. The producers who benefit are concentrated and can lobby more effectively; the consumers who lose are typically dispersed. Dasgupta (UofT) Trade Policy 13 / 43 Tariffs and quotas under perfect competition Import Tariff for a large country If Home is a large country, it does not take world price as given; rather, it faces an upward-sloping supply curve. Dasgupta (UofT) Trade Policy 14 / 43 Tariffs and quotas under perfect competition Import Tariff for a large country Change in consumer surplus = −(a + b + c + d ) Change in producer surplus = +a Change in government revenue = +(c + e ) Dasgupta (UofT) Trade Policy 15 / 43 Tariffs and quotas under perfect competition Import Tariff for a large country Net effect on Home welfare = −(a + b + c + d ) + a + (c + e ) = e − (b + d ) A large country still has a deadweight loss. But there is a new source of gain - a Terms-of-Trade gain. The Home term-of-trade improves because the tariff drives down the net-of-tariff import price P ∗ . The Home has to pay less per unit of import. If terms-of-trade improve significantly, Home could actually gain by imposing a tariff. Dasgupta (UofT) Trade Policy 16 / 43 Tariffs and quotas under perfect competition Import Tariff for a large country Change in Foreign producer surplus = −(e + f ) Net effect on World welfare = (e − b − d ) − (e + f ) = −(b + d + f ). The Home country’s gain comes at the loss of the Foreign country =⇒ Tariff imposition by a large country is a “beggar thy neighbor” policy. Furthermore, the Home country’s gain is outweighed by the loss of the Foreign country. There is a deadweight loss for the world as a whole. Dasgupta (UofT) Trade Policy 17 / 43 ...
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This note was uploaded on 03/23/2012 for the course ECO 364 taught by Professor Petermorrow during the Spring '10 term at University of Toronto- Toronto.

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