Effects of Tariffs and Quotas

Effects of Tariffs –

Tariffs are used as a trade barrier to protect the domestic industries from foreign competition.

We use partial equilibrium approach represented by supply and demand analysis to exam in the effects of tariffs.

Let’s take a product, smartphones, in which a country-A has a comparative disadvantage.

Fig. 37.1

In above fig. We have drawn domestic demand (D_d) and supply (S_d) curves respectively of smartphones in country-A.

In the absence of foreign trade, domestic price OP_d is determined at which OQ quantity of smartphones are demanded and sold.

Now assume that the country-A is now opened to trade with country-B which has a comparative advantage in the production of smartphones.

Suppose OP_w represents the world price at which country-B sells smartphones. We assume that when the country-A is opened to trade, it can import smartphones from country-B at the world price OP_w.

In other words, free trade price is OP_w, at free trade OP_w, the domestic demand (consumption) for smartphones is OH and the domestic producers are supplying ON quantity. So, with the free trade out of OH quantity, domestic production is ON. The quantity NH is being imported.

Now suppose that in order to protect the domestic smartphone industries country-A imposes a tariff of P_wP_t per smartphone. As a result price of smartphone in country-A will rise to OP_t. Due to the imposition of tariff and consequently rise in the price of smartphones in country-A will have alot of effects.

Consumption Effect –

First, at a higher price OP_t, the consumption of smartphones in country-A will decline to OL, as the higher price causes buyers of smartphones to move up the demand curve D_d. This is called Consumption Effect of the Tariffs.

The imposition of tariffs on smartphones have adversely affected the consumers of smartphones of country-A. As a result of tariff, the prices of smartphones have increased and the consumers have to pay P_wP_t more per smartphone, which induces them to buy fewer smartphones and look for other less desired substitute products.

Production Effect –

Second, Due to tariffs, country-A’s producers of smartphones will now be able to sell their products at a higher price OP_t instead of free trade price or world price OP_w.

At a higher price OP_t, they will produce and sell more by moving up the domestic supply curve S_d. At price OP_t, domestic producers of smartphones raise domestic production and quantity supplied from ON to OM. This is called Production Effect of Tariffs.

This increase in the domestic production of smartphones by NM will be done by transferring some scarce resources from other presumably more efficient industries to smartphone manufacturing industries.

Trade Effect –

Revenue Effect –

Effects of Quotas –