Tariffs are a tax placed by the government on imports. They raise the price for consumers, lead to a decline in imports, and can lead to retaliation by other countries.
- They could be a specific amount (e.g. £1 per unit.)
- Or they could be an ad valorem tax (e.g. 10% of the price)
Tariffs are an important barrier to free trade; they are often imposed to protect domestic industry from cheap imports. However, it often leads to retaliation with other countries placing tariffs on their exports.
- In this case, the tariff is P1-P2.
- The tariff leads to a decline in imports. Imports were Q4-Q1. After the tariff, imports fall to Q3-Q2.
- Consumer surplus falls by 1+2+3+4
- Government raises tariff revenue of area 3
- Domestic suppliers gain an increase in producer surplus of area 1
- The net welfare loss is (1+2+3+4) – (1+3) = 2+4
Effect of tariffs
- Without any trade, the equilibrium price is £1.80 and a quantity of 40 million
- With a tariff of £0.40, the price of imports will be £1.60.
- The quantity of imports at £1.60 is (50-30) = 20 million.
- With free trade (no tariffs) the price would be £1.20 and quantity bought 60 million.
Government tariff revenue
- Tariff revenue = tariff × q. of imports (£0.40 × 20 million) = £ 8 million
This is the difference between the price consumers pay and the price they are willing to pay; therefore we find the area of the triangle between demand curve and price
- With no trade = (£3.20 – £1.80 × 40) /2 = (£1.40 ×40)/2 = £28 million
- After tariff – (£3.20 – £1.60) × 50)/2 = £40 million
- With no tariff (free trade)- £3.20 – £1.20 × 60)/2 = £60 million
- Tariffs reduce consumer surplus by £20 million
Diagram showing the effect of tariffs on consumer surplus
Tariffs lead to a decline in consumer surplus of 1+2+3+4.
- With no trade (£1.80 – £0.5) × 40)/2 = £24 million
- With tariff (£1.60-0.50) × 30)/2 = £16.5 million
- With free trade and no tariff (£1.20-0.50 × 20)/2 = £6 million.
- Tariffs increase producer surplus by £10.5 million
Welfare effect of tariffs = gain in producer surplus (£9 m) + gain in tariff revenue (£8m) – loss of consumer surplus £20m)
- Therefore net welfare loss = £3 million
Reasons for imposing tariffs
- Raise revenue. If a country produces no oil, levying a tax on oil imports will raise money as people have no alternative put to pay the import tariff.
- Environmental. A tariff could be placed on goods who may have negative externalities. e.g.
- Protectionism. The most common reason for a tariff. Imposing import tariffs makes domestic firms more competitive.
Reasons for removing tariffs
- Trade liberalisation involves removing barriers to trade such as tariffs on imports.
- Free trade areas will have no tariffs between member states, though they may have a common external tariff if it is a customs union.
- Lower prices for consumers
- Increase specialisation and benefits from economies of scale.
- Theory of comparative advantage states net welfare gain from free trade.
- The reduction of tariffs leads to trade creation.
Winners and losers of tariffs
Examples of tariffs
The US has tariffs on many imports, such as:
- Most vegetables 20% tariff.
- Asparagus and sweetcorn – 21.5%. See: UTSC for more
- EU has tariffs on many food imports.
- See: Examples of protectionism