Chapter 4 Summary

LO 4.1 Meaning, Importance, and Types of Tariff

• An import tariff is a tax imposed on an imported product that is collected by customs officials before the shipment is allowed to enter the country.
• There are several types of tariff: a specific tariff represents a fixed amount of money per unit of the imported product; an ad valorem tariff is a fixed percent of the value of the imported product; and a compound tariff is a combination of a specific tariff and ad valorem tariff.
• With a specific tariff, the degree of protection increases with a fall in the price of the import and decreases with a rise in its price.
• An ad valorem tariff keeps the level of protection from imports steady.
• A compound tariff is used when both the final product and input are subject to tariff protection.
• The effective tariff rate often differs from the nominal tariff rate when the import-competing industry uses imported inputs.

LO 4.2 Economic Effects of a Tariff in a Small Importing Country

• A tariff reduces consumer surplus because it raises the domestic price and lowers the quantity consumed – consumers pay a higher price and receive a smaller quantity of the product.
• A tariff increases producer surplus as the increase in price enables domestic producers to boost production – domestic producers produce more and get a higher price.
• The loss of consumer surplus is greater than the increase in producer surplus – while consumers must pay the price mark-up on both imports and domestic production, domestic producers receive the mark-up only on the latter.
• The importing country’s government collects tax revenue as a result of the tariff. The tariff revenue represents a transfer of economic surplus from consumers to the government and is, therefore, not a loss of surplus for the importing country.
• The increase in producer surplus also represents a redistribution of surplus from consumers to producers and is, therefore, not a loss of national well-being.
• However, not all of the loss in consumer surplus is transferred to other groups within the nation. Some of what consumers lose – indicated by the production and consumption effects – are deadweight losses.
• The production effect reflects inefficient use of global resources as higher-cost domestic consumption is substituted for lower-cost imports.
• The consumption effect reflects the reduction in purchases of the product by domestic consumers even though they value this additional supply relatively highly.
• As a result of the production effect and the consumption effect, there is an overall loss of economic wellbeing for a small importing nation.

LO 4.3 Economic Effects of a Tariff in a Large Importing Country

• If the importing country is large, meaning that it is able to influence the price for the imported product, a tariff on imports can improve its terms of trade.
• If the improvement of the terms of trade is significant enough, it can more than offset the usual deadweight losses of the production and consumption effects, leading to an overall improvement in national economic well-being.
• While an import tariff might benefit a large country, it is still bad for the world, as foreign exporters lose from not being able to supply a larger quantity even though buyers in the importing country would welcome the additional supplies. Moreover, in the real world, the exporting country is likely to retaliate, which would cause global trade to decline.

LO 4.5 The Terms-of-Trade Effect and a Nationally Optimal Tariff

• The terms-of-trade effect reflects the portion of the tariff revenue collected from foreign producers who reduce their export price in an attempt to maintain sales to the importing country.
• A nationally optimal tariff maximizes the difference between the terms-of-trade effect and the sum of the production and consumption effects.

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