EC4333Lecture 3Dr Stephen Kinsellastephenkinsella.net

TradeTariffs

Welfare Analysis

LisbonIntegrationTrade Creation

Trade DiversionTariffs

Hecksher-Ohlin

Recap

1/3

1.EU is an economic solution

to a political

problem

2. History of

integration matters, and

reflects current level

of integration

3. There are

welfare effects to

greater integration

From Last Week...

Trade Creation is“The increase in trade volume caused by union with a lower cost (more efficient) supplier within the trade bloc”––Viner, 1950

So what?

All about Customs Unions

European integration involved a sequence preferential liberalisations but all of these were reciprocal

In example, both Home & Partner drop T on each other’s exports

Need to address the 3-nation trade pattern

Why is this important?

Why is this important?

Serious Money Involved

Punion post tax

Pworld post tax

Pworld pre tax

Punion pre tax

Supply Home

Demand Home

P*

C*

P

QB D

Trade Creation (High Cost to Low Cost)

Example

Punion post tax

Pworld post tax

Pworld pre tax

Punion pre tax

Supply Home

Demand Home

P*

C*

P

QB D

Trade Diversion (Low Cost to High Cost)

Example

Tariffs & Welfare

2/3

A tariff is a tax on goods produced abroad and sold

domestically.

{Definition}

Effects of a Tariff

The Effects of a Tariff

Copyright © 2004 South-Western

Priceof Steel

0 Quantityof Steel

Domesticsupply

Domesticdemand

Pricewith tariff Tariff

Importswithout tariff

Equilibriumwithout trade

Pricewithout tariff

WorldpriceImports

with tariff

QSQS QD QD

Copyright © 2004 South-Western

Priceof Steel

0 Quantityof Steel

Domesticsupply

Domesticdemand

Importswithout tariff

Equilibriumwithout trade

Pricewithout tariff

Worldprice

QS QD

Producer surplus

before tariff

Consumer surplusbefore tariff

Figure 6 The Effects of a Tariff

Copyright © 2004 South-Western

A

B

Priceof Steel

0 Quantityof Steel

Domesticsupply

Domesticdemand

Pricewith tariff Tariff

Importswithout tariff

Equilibriumwithout trade

Pricewithout tariff

WorldpriceImports

with tariff

QSQS QD QD

Consumer surpluswith tariff

Figure 6 The Effects of a Tariff

Copyright © 2004 South-Western

C

G

Priceof Steel

0 Quantityof Steel

Domesticsupply

Domesticdemand

Pricewith tariff Tariff

Importswithout tariff

Equilibriumwithout trade

Pricewithout tariff

Worldprice

QS

Importswith tariff

QS QD QD

Producer surplus

after tariff

Figure 6 The Effects of a Tariff

Copyright © 2004 South-Western

E

Priceof Steel

0 Quantityof Steel

Domesticsupply

Domesticdemand

Pricewith tariff Tariff

Importswithout tariff

Pricewithout tariff

Worldprice

QS

Importswith tariff

QS QD QD

Tariff Revenue

DWT Loss: the reduction in

consumer and producer surplus resulting from

restricting output below its efficient level

{Definition}

Figure 6 The Effects of a Tariff

Copyright © 2004 South-Western

C

G

A

ED F

B

Priceof Steel

0 Quantityof Steel

Domesticsupply

Domesticdemand

Pricewith tariff Tariff

Importswithout tariff

Pricewithout tariff

WorldpriceImports

with tariff

QSQS QD QD

Deadweight Loss

Exercise

The Effects of a Tariff

Before Tariff After Tariff Change

CS A+B+C+D+E-F A+B -(C+D+E+F)

PS G C+G +C

Govt. Revenue None E +E

Total Surplus A+B+C+D+E+F+G

A+B+C+E+G -(D+F)

{Story}

The Effects of a Tariff

• A tariff reduces the quantity of imports and moves the domestic market closer to its equilibrium without trade.

• With a tariff, total surplus in the market decreases by an amount referred to as a deadweight loss.

• A tariff reduces the quantity of imports and moves the domestic market closer to its equilibrium without trade.

{The Effects of an Import Quota}

An import quota is a limit on the quantity of a good that can be produced abroad and sold domestically.

Copyright © 2004 South-Western

Priceof Steel

0 Quantityof Steel

Domesticsupply

Domesticsupply

+Import supply

Domesticdemand

Isolandianprice with

quota

Importswithout quota

Equilibriumwith quota

Equilibriumwithout trade

Quota

Importswith quota

QD

Worldprice

Worldprice

Pricewithout

quota=

QS QDQS

{Story}

The Effects of an Import Quota

Because the quota raises the domestic price above the world price, domestic buyers of the good are worse off, and domestic sellers of the good are better off.

License holders are better off because they make a profit from buying at the world price and selling at the higher domestic price.

The Effects of an Import Quota

Figure 7 The Effects of an Import Quota

Copyright © 2004 South-Western

A

E'C

B

G

D E" F

Priceof Steel

0 Quantityof Steel

Domesticsupply

Domesticsupply

+Import supply

Domesticdemand

Isolandianprice with

quota

Importswithout quota

Equilibriumwith quota

Equilibriumwithout trade

Quota

Importswith quota

QD

Worldprice

Worldprice

Pricewithout

quota=

QS QDQS

Exercise

Before Quota After Quota Change

CS A+B+C+D+E’+E’’+F A+B -(C+D

+E’+E”+F)

PS G C+G +C

License Holder None E’+E’’ +(E’+E’’)

Total Surplus A+B+C+D+E’+E’’+F+G

A+B+C+E’+E’’+G -(D+F)

The Effects of an Import Quota

With a quota, total surplus in the market decreases by an amount referred to as a deadweight loss.

The quota can potentially cause an even larger deadweight loss, if a mechanism such as lobbying is employed to allocate the import licenses.

The Lessons for Trade Policy

Lessons for Trade Policy

Both tariffs and import quotas . . .

raise domestic prices

Both tariffs and import quotas . . .

reduce the welfare of domestic consumers.

Both tariffs and import quotas . . .

cause deadweight losses.

Other Benefits of International Trade

Arguments for

Restricting Trade

Arguments for Restricting Trade

1. Jobs

2. National Security

3. Infant Industry

4. Unfair Competition

5. Protection-as-a-Bargaining Chip

Hecksher-Ohlin Samuelson

3/3

Imagine a Pile of Money.

Hecksher Ohlin

Hecksher Ohlin

Samuelson

Example

Summary

Next Week European Monetary Union

Read Wyplosz, C. ‘European Monetary Union: The Dark Sides of a Major Success’, Economic Policy, 2006.

Thanks

EC4333Lecture 3Dr Stephen Kinsellastephenkinsella.net

TradeTariffs

Welfare Analysis