ECON231 Lecture Notes - Lecture 5: Government Procurement, Demand Curve, Final Good

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9 Aug 2016
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Fact: Free trade can maximize world output and benefit all countries
 Practically all nations impose some restrictions on the free flow of international
trade.
Trade policy consists of:
-Tariff
-Import quotas
-Export subsidies
-Voluntary export restraints
-local content requirements
There are 2 types of tariffs:
1. Specific Tariffs: a specific tariff is expressed as a fixed sum per physical unit
of imported good(s)
2. Ad-valorem Tariffs: is levied as a specific percentage of the value of
imported goods
There are also compound specific and ad-valorem tariffs. U.S. uses both specific
and ad-valorem tariffs about half the time each one, while the EU relies mainly
on ad-valorem tariffs
Tariff in a small country
When a SMALL COUNTRY imposes a tariffs, it has NO EFFECT on the
foreign (world) price of a good (because its demand for the good is
insignificant compared to world demand)
However, the domestic PRICE of the imported good will RISE by the full
amount of the tariff for producers and consumers
Therefore the foreign price remains at Px, while the price in the domestic
market rises to Px’ = Px + t
Tariffs bring 3 effects:
1. Reduction in consumption
2. Increase in production
3. Revenue from tariff
Costs of a tariff:
-Since price is higher when tariff is imposed, consumers consume less
-Less consumption and higher price leads to lower consumer surplus
-The cost of the tariff is the loss of consumer surplus
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Benefit of a tariff:
-Increase in producer surplus
-Since price is higher, domestic producers are willing to produce more
-Tariff revenue to the government
Result: result of a tariff imposed on imports in a small country is total welfare is
decreasing (negative welfare effect)
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