Chapter 8 Notes

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Economics for Management Studies
Garth Frazer

Chapter 8 The Instruments of Trade Policy Notes Basic Tariff Analysis • a tariff, the simplest of trade policies, is a tax levied when a good is imported • specific tariffs are levied as a fixed charge for each unit of goods imported • ad valorem tariffs are tariffs that are levied as a fraction of the value of the imported goods • tariffs are the oldest form of trade policy and have traditionally been used as a source of government income • their true purpose, however, has usually been not only to provide revenue but to protect particular domestic sectors • the importance of tariffs has declined in modern times, because modern governments usually prefer to protect domestic industries through a variety of nontariff barriers, such as import quotas (limitations on the quantity of imports) and export restraints (limitations on the quantity of exports—usually imposed by the exporting country at the importing country’s request) Supply, Demand, and Trade in a Single Industry • home demand – home supply = foreign supply – foreign demand • home demand + foreign demand = home supply + foreign supply  world demand = world supply Costs and Benefits of a Tariff • a tariff raises the price of a good in the importing country and lowers it in the exporting country • as a result of these price changes, consumers lose in the importing country and gain in the exporting country; producers gain in the importing country and lose in the exporting country; and the government imposing the tariff gains revenue Consumer and Producer Surplus • consumer surplus measures the amount a consumer gains from a purchase by the difference between the price they actually pay and the price they would have been willing to pay; it can be derived from the market demand curve • if P is the price of a good and Q the quantity demanded at that price, then consumer surplus is calculated by subtracting P times Q from the area under the demand curve up to Q • if P is the price and Q the quantity supplied at that price, then producer is P times Q minus the area under the supply curve up to Q Other Instruments of Trade Policy Export Subsidies: Theory • an export subsidy is a payment to a firm or individual that ships a good abroad • like a tariff, an export subsidy can be either specific (a fixed sum per unit) or ad valorem (a proportion of the value exported) • when the government offers an export subsidy, shippers will export the good up to the point where the domestic price equals the foreign price by the amount of the subsidy • the effects of an export subsidy on prices are exactly the reverse of those of a tariff Import Quotas: Theory • an import quota is a direct restriction on the quantity of some good that may be imported • the restriction is usually enforced by issuing licenses to some groups of individuals or firms • an import quota always raises the domestic price of the imported good • when imports are limited, immediate result is that at the initial price the demand for the good exceeds domestic supply plus imports • in the end, an import quota will raise domestic prices by the same amount as a tariff that limits imports to the same level (except in the case of domestic monopoly, when the quota raises prices more than this) • when quota instead of tariff is used to restrict imports, sum of money that would have appeared as government revenue with tariff is collected by whoever receives import licenses as they are able to buy imports and resell them at higher price in domestic market • the profits received by the holders of import licenses are known as quota rents Voluntary Export Restraints • a variant on the import quota is the voluntary export restraint (VER), also known as a voluntary restraint agreement (VRA) • a VER is a quota on trade imposed from the exporting country’s side instead of the importer’s • VERs are generally imposed at the request of the importer and are agreed to buy the exporter to forestall other trade restrictions • from an economic point of view, however, a voluntary export restraint is exactly like an import quota where the licenses are assigned to foreign governments and is therefore very costly to the importing country • a VER is always mor
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