Trade policy under perfect competition Sources: Feenstra Taylor; Mucchielli Mayer
Eleni ILIOPULOS Paris 1
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Aim of this lecture
Understand the impact of trade barriers on walfare, consumption, production and the equilibirum. Apply the standard model of trade so as to understant the impact of trade barriers. Understand how import tari¤s act (both in a small and a large open economy) Understand how import quotas act References: Feenstra Taylor (2008), Mucchielli Mayer (2005).
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Small open economy with free trade Back to consumer and producer surplus (see class 4!)
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Import tari¤ for the small economy
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Import tari¤ for the small economy A small country is one where its imports does not have any e¤ect on the world price.
! the price charged to Home consumers will increase by the amount of the tari¤. With an import tari¤ of t dollars, the export supply curve facing Home shifts up to X + t ! P w + t , import quantity of M2 because of higher price. Also,the quantity supplied at Home rises from S1 to S2 . . However, as …rms increase the quantity produced, the marginal costs of production rise. The domestic price will equal the import price. Foreign exporters still receive the “net of tari¤” price, PW. These changes a¤ect producer and consumer surplus, and overall Home welfare. E. ILIOPULOS (Paris 1)
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Consumer surplus
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Producer surplus
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The gain of the Government
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Net e¤ect and deadweight loss
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Consumption Loss
The triangle d also has a precise de…nition. Due to the tari¤, the price increase from, PW to PW+t reduces quantity consumed at Home from D1 to D2. The area of the triangle can be interpreted as the drop in consumer surplus for those individuals who are no longer able to consume the units from D1 to D2 because of the higher price. We refer to this drop in consumer surplus as the consumption loss for the economy.
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Production loss
The base of b is the net increase in Home supply due to the tari¤, from S1 to S2. The height of this triangle is the increase in marginal costs due to the increase in supply. The fact that marginal costs are greater than world price means that this country is producing the extra supply ine¢ ciently. Fewer resources would be used if imported rather than produced at home. The area of b is the production loss or e¢ ciency loss— due to producing at marginal costs above world price.
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Net e¤ect and deadweight loss
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Why are then tari¤s widely used? Tari¤s always lead to deadweight losses for small countries !most economists are opposed to them. Why then do so many countries use tari¤s? One idea is that developing countries do not have any other source of revenue. Import tari¤s are “easy-to-collect” (customs agents at major ports checking the goods crossing the borders). However, to the extent that developing countries recognize that tari¤s have a higher deadweight loss, we would expect that over time they will shift away from such “easy-to-collect” taxes. However, If the government cares more about producer surplus than consumer surplus, it might decide to use the tari¤ despite the deadweight loss it incurs. E. ILIOPULOS (Paris 1)
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General equilibrium, small open economy
Remember: the tarif modi…es the domestic price, p = international one p =
px py
, but not the
px py
Suppose small country H has a comparative advantage in producing Y. Imports X, exports Y. Tari¤ implies: p = (1 + T ) p Optimality conditions: consumption: MRS=p production: MRT=p trade balance: px (Xc Xp ) + py (Yc
ToT= ppx = y
Yp ). World prices!!
(Y c Y p ) (X p X c )
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General equilibrium, small open economy
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Equilibrium with tari¤
Uf > Ut > Ua In the tari¤ equilibrium, imports decreased but also exports (see triangles of trade). Focus on graph 13.1 Mucchielli Mayer. VZ are imports at domestic prices. It represents country H imports IF country H does not redistribute govt revenues arising from the tari¤. ZCt are tari¤ govt revenues evaluated in terms of good X. VCt are imports at world prices. NB: in Z trade is not balanced.
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Equivalance of tari¤ with consumption tax + subsidy
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Equivalance of tari¤ with consumption tax + subsidy
Suppose we are in the free trade eq Govt introduces subsidy for producers of X! (px /py ) " for producers!
Producers produce at a new relative price (Qt ), but consumers still face world price p (Cs ) loss of specialization gains: the productive structure changes Consumption decreases becuse trade must be balanced
Govt introduces consumption tax on X! (px /py ) " for consumers also! Cx #
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Export tax on Y
Py = (1
T ) Py , Px = Px !
p = p / (1
T) > p
Remember, with a tari¤: Px = (1 + T ) Px , PY = Py ! p = (1 + T ) p > p , same qualitative e¤ect
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Export subsidy
Subsidy on exports: Py = (1 + s ) Py , Px = Px ! p = p / (1 + s ) < p
In equilibrium:MRS=MRT=p =
p 1 +s
< p + trade balance Opposite and symmetric e¤ect wrt a tari¤: more specialization. But welfare decreases: consumption is on a lower indi¤ curve.
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Large country
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E¤ect of import tari¤s
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Terms of trade
Terms of trade is the ratio of export prices to import prices. In order to measure terms of trade, we want to use the net-of-tari¤ import price, P*. Since P* is lower than PW , it follows that the Home terms of trade has increased/improved. We might expect, therefore, that the Home country gains from the tari¤
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The deadweight loss at Home is (b + d), and the terms-of-trade gain is area e.
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Welfare at Home The higher Home price makes consumers worse o¤, lowering consumer surplus (a+b+c+d). Home …rms are better o¤ with the higher price and increased surplus, a. Revenue collected from the tari¤ equals the amount of the tari¤, t, times the new amount of imports, M2 , giving total revenue of (c + e ). Fall in consumer surplus Rise in producer surplus Rise in government revenue Net e¤ect on Home welfare
-(a+b+c+d) +a +(c + e) = – (b+d) + (e)
!
The triangle (b+d) is the deadweight loss due to the tari¤. But notice, there is a source of gain, e, that o¤sets part of the loss. If e > (b + d ), then Home is better o¤. If e < (b + d ), then Home is worse o¤. E. ILIOPULOS (Paris 1)
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World Welfare and Foreign
The Foreign loss, (e + f ) is the loss in Foreign producer surplus from selling fewer goods to Home at a lower price. The area e is the terms-of-trade gain for Home (equivalent terms-of-trade loss for Foreign). Extra deadweight loss in Foreign of f , giving a combined total greater than the bene…ts to Home. Adding together the net loss to world welfare of (b+d+f). World deadweight loss ! most economists oppose the use of tari¤s.
Moreover, in a general eq. perspective, countries specialize in most protected sectors.."ine¢ cient specialization"!! You loose the e¢ ciency gains arising from specialization.
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The optimal tari¤
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Import quotas
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Import quotas
The import quota of M2 < M1 is imposed: quantity imported cannot exceed this amount.! Vertical supply curve, X: …xes the import quantity at M2 . Demand at point C ! Home price P2 .
P2 leads …rms to increase the quantity supplied to S2 and consumers to decrease their quantity demanded to D2 . For every level of import quota, there is an equivalent import tari¤!! The equivalent tari¤, would be: t = P2
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E¤ect on Welfare
The rise in price from the quota ! fall in consumer surplus:(a + b + c + d ). The increase in price ! gain in producer surplus: a.
What changes with the quota is the area c which was government revenue under the tari¤. With a quota, whoever is actually importing the good will be able to earn c, the di¤erence between the world price and the higher Home price times the imports sold in the Home market. The di¤erence between these two prices is the rent associated with the quota. Area c represents the total quota rents. How to allocate the rent?
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How to allocate the rent?
1
Giving the Quota to Home (import) Firms. This is the same loss we saw with a tari¤.
2
Rent Seeking: the waste of resources devoted to rent seeking could be as large as the value of the rents themselves, c. ! loss: -(b+c+d) – larger thean with tari¤s.
3
Auctioning the Quota. The revenue collected should equal the value of the rents!same loss as the tari¤.
4
“Voluntary” Export Restraint: the importing country can give authority for implementing the quota to the exporting government!quota rents are earned by foreign producers!higher loss than with a tari¤.
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