Welfare Effects of a Tariff Essay Example for Free

Welfare Effects of a Tariff Essay Free trade necessarily works to the advantage of domestic consumers boosting their choice of goods and services, the quality as well as reduced prices while protectionism is considered by some to be disruptive and harmful to the efficiency of international trade besides harming consumer interests, but even so, trade has never been and may never be free. While free trade has various advantages; protectionism too has a few if not helpful, necessary benefits to a country, Feenstra Taylor (2007). These benefits are hardly set in stone and depend on manifold factors which are equally variable and thus determining the true effect of a tariff requires a case by case assessment of the effects. This essay will asses the common reasons for the use of tariffs and presents the general welfare implications of the tariff on both small countries as well as large countries. Background Tariffs are the most commonly applied ways of protectionism in trade so much so that the WTO was founded in part to create a frame work to allow countries to negotiate a reduction in tariffs in trade. A tariff refers to customs, tributes, tolls or duties, or a schedule of them, imposed by governments on merchandise imported or exported as it crosses international borders. As such every country has a separate system of tariffs as well as regulations and tariffs may take one or more of the following forms; revenue tariff, specific tariffs, protective, ad valorem tariffs as well as protective tariffs each, according to their nature or differing objectives, Pugel Peter Lindert ( 2000). Revenue tariffs are imposed by governments not to bar importation but raise revenues and are mostly imposed on goods or services with inelastic import demand. On the contrary, protective tariffs are imposed by governments to keep out imports and thusly they are set as high as can be possible to render their domestic prices uncompetitive while protective tariffs aim at reducing imports enabling local production to compete with imports. Other classifications of tariffs are based on the nature of taxes and their administration and these in clued ad valorem tariffs which are imposed as a proportion of the value of imports while specific tariffs are simply imposed on imported goods and services according to their amounts in volume, weight or number and not their values. Intuitively, the reasons for the imposition of tariffs vary from protection of infant industries in less developed countries so they can mature and compete favorably with others to other protection of jobs in developed countries, Kraus (2000). In protection of fledge ling industries commonly touted as import substitution practiced by developing countries, tariffs are imposed on goods or services with local production that the country wishes to encourage growth. This would effectively raise the domestic prices of imports thusly rendering domestic products competitive on price terms and shields them from being edged out of the market through predatory pricing which will foster maturity of those industries and facilitate the transformation of less developed economies from agricultural to industrial economies. Tariffs are as well imposed to protect domestic jobs by shielding domestic industries from foreign competition. Lack of regulations, cheap labor, deplorable working conditions and export subsidies in foreign countries would make their exports more competitive price wise and to the disadvantage of local industries who must cut costs by laying off staff. This is well evidenced with the Chinese exports to the United States and European Union and the attendant controversy. Consumer protection is often another motive for imposition of tariffs aimed at stopping goods and services that the government deems harmful to its population. In addition, countries impose tariffs on goods and services that are seen as crucial to the national security. In this, regard defense industries enjoy special treatment as they are deemed important for the interests of a nation; a good example of this includes the protection of aircraft manufacturing industries Boeing and Air Bus in the United States and Europe respectively, Yarbrough Yarbrough (1991). Tariffs have as well been used as political instruments from the days of Alexander Hamilton in protecting infant industries which used tariffs on the back of which a new nation to the 21st century America imposing tariffs on imports from politically incorrect countries. Tariffs may as well be imposed on a country’s goods if their trading partners consider them as employing unfair practices for instance export subsidies. Retaliation can as well be used to achieve a number of political ends by countries. Welfare effects of a Tariff Small Country The welfare analysis begins with the case with a small country, not geographically but one whose import policies have no considerable impact on the international terms of trade, Bowen et al (1998). The analysis is a partial equilibrium analysis considering the market for a single good or service, this assumes that the market is relatively small to have a considerable effect on other markets and thusly it is safe to ignore those interactions. In addition, the model assumes that the tariff is in fact the only one imposed or one of only a few and thusly would not be appropriate in the analysis of welfare impacts involving the implementation of numerous tariffs as would be the case in a trade round. Consider the diagram below. Fig A The diagram shows the respective demand as well as supply curves of an imported good inside a country. The world prices represented as PW are assumed to be below the domestic prices shown in the diagram as by the direction arrow. Under autarky the quantity demanded from domestic production of good X is equal to the quantity indicated by the direction arrow between Stm and Dtm. When an autarky opens up to international trade, the domestic prices tumble to Pw so that there is an excess demand of good X in the country represented by Dft of which on Sft would be supplied by domestic producers at the prevailing world prices and as per the demand and supply curves. The consumer surplus in the country is given by the area above the world supply curve Pw but below the domestic demand curve, Pugel Peter Lindert (2000). . When a specific tariff t is imposed on good X, the world prices Pw would not be affected since a country’s imports are relatively small to have any considerable effect on the world prices and demanded quantity, instead, a tariff would have the impact of raising domestic prices by the amount of the tariff to reach Pw+t. The rise in domestic prices would induce local producers to step up their production to Stm since below this level domestic production is more efficient than foreign production. Thusly the producer surplus would rise by the area shown in the diagram by A, thus this represents a gain by domestic producers due to increased prices and a rise in production resulting from the imposition.