Lecture 8. Trade policy 2

Lecture 8. Trade policy 2 - Tariffs and quotas under...

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Unformatted text preview: Tariffs and quotas under perfect competition Optimal Tariff A large country can gain by imposing a tariff. But what level of tariff maximizes this gain? The optimal tariff. Starting from free trade, a small tariff initially increases welfare because the height and the base of the triangle (b + d ) shrink to zero only the height of the rectangle e shrinks to zero the area of e exceeds (b + d ) For high enough tariff, welfare will fall to its autarky level, wiping out all the gains from trade. Dasgupta (UofT) Trade Policy 18 / 54 Tariffs and quotas under perfect competition Optimal Tariff When the tariff is low, the country still imports a lot. This allows the tariff to have a large impact on the world price. When the tariff is high, the country imports very little - it is no longer a “large” country. Dasgupta (UofT) Trade Policy 19 / 54 Tariffs and quotas under perfect competition Optimal Tariff ∗ Optimal tariff depends on the elasticity of Foreign export supply, EX . If the export supply curve is steep, there is little response of quantity ∗ supplied to a change in price - EX is low. If the export supply curve is ∗ is high. flat, the response is large - EX The optimal tariff is given by optimal tariff = 1 ∗. EX ∗ For a small importing country, EX is infinite, and so the optimal tariff is zero. ∗ If EX is small, a small reduction in quantity leads to a large reduction in price; this generates gains for the importing country. Dasgupta (UofT) Trade Policy 20 / 54 Tariffs and quotas under perfect competition Import Quota An import quota places an upper bound on the amount of a good that can be imported. The effects on price and import quantity of applying a quota and a tariff are similar - for every level of import quota, there is an equivalent import tariff. But a quota and a tariff differ in terms of their effect on welfare; it depends on how the quota rent (area c) is distributed. Dasgupta (UofT) Trade Policy 21 / 54 Tariffs and quotas under perfect competition Import Quota Giving the quota rent to Home firms The Home government could give quota licenses. A license allows a Home firm to purchase a pre-specified amount of the good at the world price P W and sell locally at P2 . The net effect on Home welfare is Fall in consumer surplus: Rise in producer surplus: Quota rents earned at Home: −(a + b + c + d ) +a +c Net effect on Home welfare −(b + d ) Dasgupta (UofT) Trade Policy 22 / 54 Tariffs and quotas under perfect competition Import Quota Rent seeking Firms may engage in inefficient activities to obtain quota rents. Sometimes these activities may use up resources that are greater than the value of the rent. The net effect on Home welfare is Fall in consumer surplus: Rise in producer surplus: −(a + b + c + d ) +a Net effect on Home welfare −(b + c + d ) Dasgupta (UofT) Trade Policy 23 / 54 Tariffs and quotas under perfect competition Import Quota Auctioning the Quota The Home government could auction off quota licenses. In a well-organized, competitive auction, the revenue collected should exactly equal the value of the rents. The net effect on Home welfare is Fall in consumer surplus: Rise in producer surplus: Auction revenue earned at Home: −(a + b + c + d ) +a +c Net effect on Home welfare −(b + d ) Dasgupta (UofT) Trade Policy 24 / 54 Tariffs and quotas under perfect competition Import Quota “Voluntary” Export Restraint Home could give authority for implementing the quota to the government of the exporting country. By giving the quota rents to firms in the exporting country, Home reduces the probability of retaliation. The net effect on Home welfare is Fall in consumer surplus: Rise in producer surplus: −(a + b + c + d ) +a Net effect on Home welfare −(b + c + d ) Dasgupta (UofT) Trade Policy 25 / 54 Tariffs and quotas under imperfect competition Home monopoly We start by looking at a Home monopolist. The effects of a tariff and a quota are different because of the Home monopolist’s market power. Dasgupta (UofT) Trade Policy 26 / 54 Tariffs and quotas under imperfect competition Dasgupta (UofT) Home monopoly Trade Policy 27 / 54 Tariffs and quotas under imperfect competition Dasgupta (UofT) Home monopoly Trade Policy 28 / 54 Tariffs and quotas under imperfect competition Home monopoly Free-trade eliminates the monopoly’s market power and forces it to behave like a perfectly-competitive firm - this is an additional source of gains from trade for Home consumers. The effect is similar to the monopolistic competition model where firms expand after trade, allowing them to move down along their average cost curves. Dasgupta (UofT) Trade Policy 29 / 54 Tariffs and quotas under imperfect competition Home monopoly and Tariff Change in consumer surplus = −(a + b + c + d ) Change in producer surplus = +a Change in government revenue = +c Dasgupta (UofT) Trade Policy 30 / 54 Tariffs and quotas under imperfect competition Home monopoly and Tariff Net effect on Home welfare = −(a + b + c + d ) + a + c = −(b + d ) The tariff still limits the monopoly’s ability to raise price; it can raise the price to P W + t but no higher because otherwise consumers will start importing the product. The deadweight loss under the Home monopoly is the same as that under perfect competition. Dasgupta (UofT) Trade Policy 31 / 54 Tariffs and quotas under imperfect competition Home monopoly and Quota The quota is applied so that the amount of imports M1 is the same as under tariffs. Dasgupta (UofT) Trade Policy 32 / 54 Tariffs and quotas under imperfect competition Home monopoly and Quota Unlike a tariff, a quota allows the monopolist to exercise its market power. The price under a quota is higher than that under a tariff; the equivalence between a tariff and a quota breaks down. The consumers lose due to a quota, while the monopolist gains; net welfare calculations are complex. The output under a quota could actually be lower than that under free trade - workers in the industry getting protection could lose!! Dasgupta (UofT) Trade Policy 33 / 54 Tariffs and quotas under imperfect competition Foreign monopoly and Tariff We assume that the entire Home demand is met by the Foreign exporter - not realistic, but simplifies the analysis. Dasgupta (UofT) Trade Policy 34 / 54 Tariffs and quotas under imperfect competition Foreign monopoly and Tariff If the marginal revenue curve is steeper than the demand curve, the price rise is less than the tariff. As in the perfectly competitive case, there is a terms-of-trade gain. For a small tariff, this gain dominates any deadweight loss. The net effect on Home welfare is Fall in Home consumer surplus: Rise in Home government surplus: −(c + d ) +(c + e ) Net effect on Home welfare +(e − d ) Dasgupta (UofT) Trade Policy 35 / 54 Tariffs and quotas under imperfect competition Dumping With imperfect competition, firms can charge different prices across countries; in particular, they can charge different prices in their domestic and export markets. Price discrimination in international trade is possible only when there are trade costs like transport costs, tariffs, etc. Dumping occurs when a foreign firm sells a product abroad at a price that is either less than the price it charges in the local market, or less than its average cost. Dasgupta (UofT) Trade Policy 36 / 54 Tariffs and quotas under imperfect competition Dumping The equilibrium condition for a discriminating monopolist is MR = MR ∗ = MC ∗ . The Foreign monopolist not only charges different prices in the two markets, its price at Home is lower than average cost. But it still makes profits. Dasgupta (UofT) Trade Policy 37 / 54 Tariffs and quotas under imperfect competition Anti-dumping duty Under the rules of WTO, an importing county is entitled to apply an anti-dumping duty any time a foreign firm is dumping its products. The anti-dumping duty is calculated as the difference between the exporter’s local price and the “dumped” price in the importing country. If the exporter’s local price is not available, the one looks at (i) the price charged by the exporter in a third market, or (ii) the exporter’s average cost of production. A countervailing duty is used when a Foreign government subsidizes its own exporting firms so that they can charge a lower price in the Home market. Dasgupta (UofT) Trade Policy 38 / 54 Tariffs and quotas under imperfect competition Anti-dumping duty The calculation of an anti-dumping duty creates a strong incentive for Foreign firms to raise export prices in order to reduce or avoid duties. The losses for Home are greater than a tariff since no revenue is collected. Just the threat of an anti-dumping duty is enough to cause Foreign firms to raise their prices. Dasgupta (UofT) Trade Policy 39 / 54 Subsidies Export subsidy in a Small country An export subsidy is a payment to firms for every unit exported. Dasgupta (UofT) Trade Policy 40 / 54 Subsidies Export subsidy in a Small country The net effect on Home welfare is Fall in Home consumer surplus: Rise in Home producer surplus: Fall in Home government revenue: −(a + b ) +(a + b + c ) −(b + c + d ) Net effect on Home welfare −(b + d ) There is a deadweight loss from providing export subsidies. The result suggests that the effects of an export subsidy and an import tariff are similar for a small country. Dasgupta (UofT) Trade Policy 41 / 54 Subsidies Export subsidy in a Large country An export subsidy provided by a large country, by increasing world exports substantially, lowers the world price. Dasgupta (UofT) Trade Policy 42 / 54 Subsidies Export subsidy in a Large country The net effect on Home welfare is Fall in Home consumer surplus: Rise in Home producer surplus: Fall in Home government surplus: −(a + b ) +(a + b + c ) −(b + c + d + e ) Net effect on Home welfare −(b + d + e ) A large country loses even more from an export subsidy than a small country because of the reduction in the world price. The Foreign country gains because its terms-of-trade improves. Export subsidy is a way of transferring aid from rich to poor countries; but it is not the most efficient way because the subsidy still involves a deadweight loss for the world as a whole. Dasgupta (UofT) Trade Policy 43 / 54 Subsidies Production subsidy in a Small country An production subsidy is a payment to firms for every unit produced. Dasgupta (UofT) Trade Policy 44 / 54 Subsidies Production subsidy in a Small country The net effect on Home welfare is Fall in Home consumer surplus: Rise in Home producer surplus: Fall in Home government surplus: none +(a + b ) −(a + b + c ) Net effect on Home welfare −c The production subsidy increases the quantity supplied by Home producers, just as an export subsidy does, but the production subsidy does so without raising the price for Home consumers. The deadweight loss in this case consists only of the production inefficiency. Suggests that to achieve some objective, it is best to target that objective directly. Dasgupta (UofT) Trade Policy 45 / 54 ...
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