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Lecture 3

POLI 441 Lecture Notes - Lecture 3: Big Country, Solarworld, Landfill Gas

Political Science
Course Code
POLI 441
Krzysztof Pelc

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the effect of a tariff
canonical example
relevant concepts:
consumer and producer surplus
(see graph on slides)
the higher the price, the lower demand is, the higher supply is
consumer surplus
the money you were willing to pay but don’t have to pay in the
end, because the price was lower
market clearing
market clearing price is the one where demand meets supply
where D and S curves intersect
trade changes equilibrium production and consumption: domestic consumption rises,
domestic production falls, and imports fill the difference
when you’ve gone up in price, the blue zone on the graph corresponds to lost
consumer surplus (some of which gets transferred to producer surplus)
tariff revenue (rectangle in the middle)
the quantity of imports x the tariff
deadweight loss
consumption distortion loss, and production distortion loss, both at the
cost of the consumer (domestic underconsumption and domestic
terms of trade
Torrens usually credited for the initial insight, and was ridiculed for it
ToT: the purchasing power of a country's exports in terms of the imports it can
under specific circumstances, ToT may justify protection as benefiting the state
it is most important exception to free trade every conceived
only applies to big countries as price setters
if I am a big country and impose a tariff, then domestic demand decreases
as a big country and price setter, this has a global impact
the global price will fall
gives certain assumptions about flexibility curve
those big countries that can impose a tariff while other countries don’t (those
that keep free trade free), it reduces the global price
that country will have to send fewer exports in exchange of imports
by the sheer weight of their economy in the global system, able to manipulate
prices in such a way that we’re better off overall
John Stuart Mill and ToT
JS Mill settled the debate over ToT, conceding that there were circumstances in which
Torrens was right
“the circumstances are of a nature so imperfectly ascertainable, that it must be
almost impossible to decide, after the tax has been imposed, whether we have
been gainers by it or losers” (1844)
When can a tariff improve ToT?
if a country is large, i.e. it can influence world prices
then the tariff burden can be shifted onto foreigners, just as in the case of a tax that
is shifted onto consumers with price inelastic goods
doesn’t make us all better off; only makes me better off (conditional on those
foreigners not retaliating, not doing the same)
an optimal tariff
a tariff that decreases domestic demand, and thus reduces the world price
the country imposing the tariff obtains more imports for its exports
the higher price paid by consumers is compensated by the tariff windfall to the
and the deadweight loss (of consumer surplus) is outweighed by ToT improvement at
the expense of foreign producers
ToT effects are “beggar-thy-neighbour"
exploiting ToT effects makes the pie smaller
the country imposing the optimal tariff gains, but by a lesser amount than the exporting
country loses (no compensation possible)
such strategies offer incentives for retaliation, leading to possible trade wars
makes us both worse off
think of prisoner’s dilemma
Tit-for-tate in trade
trade agreements are meant to defuse PD games, yet retaliation and TFT remain
retaliation is the legal last resort in WTO dispute settlement
filings of remedies and disputes follows retaliatory pattern
direct retaliation: China goes after US following safeguards on tires in Sept. 2009.
Does the same for the EU
Infant industry doctrine
associated with Alexander Hamilton
popularized by JS Mill
“The only case in which, on mere principles of political economy, protecting
duties can be defensible, is when they are imposed temporarily, in hopes of
naturalizing a foreign industry, in itself perfectly suitable to the circumstances of
the country”
current example?
“As a long-standing and still-expanding American manufacturers of solar
technology, SolarWorld is heartened that the US government and military
clearly grasp the critical role of domestically produced solar technology in the
country’s national-security future” —NYTimes, Jan. 9th, 2011
Ontario feed-in tariff program
“The Ontario Power Authority (OPA) has developed the Feed-In Tariff (FIT) program
for the Province of Ontario to encourage and promote greater use of renewable
energy sources including on-shore wind, waterpower, renewable biomass, biogas,
landfill gas, and solar photovoltaic (PV) for electricity generating projects in Ontario"
guarantee of a minimum floor price
debate over infant industry
Hamilton favoured a subside over tariffs
all proponents also agreed that such subsidies had to be temporary
opponents claimed such actions created a vested interest, that subsidies were
impossible for young nations, and that supporting education was a better alternative
should gov’ts be in the business of private equity?
in 1955, Meade showed that all eligible infant industries should turn to capital
markets (think of venture capitalists and green energy)
in the absences of efficient capital markets, gov’t should remedy that inefficiency first
int’l capital and trade opening often go together
at the very moment where trade would endanger an infant industry, int’l capital
could help
possible exception: if there is market failure because of free-riding on technological
Krugman’s Common Misconceptions
“We need a new paradigm”: trade is one economic activity among many. And the
level of exchange is not unprecedented
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