Lecture 4
Stephen Kinsella
stephenkinsella.net
Recap
Tariffs
Welfare Analysis

{Story}

EU is an
1.
economic
solution
to a
political
problem

History of
integration
2.
matters, and
reflects
current level
of
integration

There are
3.
welfare
effects to
greater
integration

Recap

Trade Creation is
“The increase in trade
volume caused by union
with a lower cost (more
efficient) supplier within
the trade bloc”––Viner, 1950

Trade Creation (High Cost to Low Cost)
P
Supply Home
Punion post tax
Pworld post tax
P*
Punion pre tax
Pworld pre tax
Demand Home
Q
B C* D

Trade Diversion (Low Cost to High Cost)
P
Supply Home
P*
Punion post tax
Pworld post tax
Punion pre tax
Pworld pre tax
Demand Home
Q
B C* D

Beach on the
Enlargement

{Definition}
A tariff is a tax on
goods produced
abroad and sold
domestically.

Effects of a Tariff

The Effects of a Tariff
Price
of Steel
Domestic
supply
Equilibrium
without trade
Price
Tariff
with tariff
Price World
without tariff price
Imports
Domestic
with tariff
demand
S S D D
Quantity
0 Q Q Q Q
of Steel
Imports
without tariff Copyright © 2004 South-Western

Price
of Steel
Consumer surplus
before tariff Domestic
supply
Producer
surplus Equilibrium
before tariff without trade
Price World
without tariff price
Domestic
demand
S D
Quantity
0 Q Q
of Steel
Imports
without tariff Copyright © 2004 South-Western

Figure 6 The Effects of a Tariff
Price
of Steel
Consumer surplus
with tariff Domestic
supply
A
Equilibrium
without trade
B
Price
Tariff
with tariff
Price World
without tariff price
Imports
Domestic
with tariff
demand
S S D D
Quantity
0 Q Q Q Q
of Steel
Imports
without tariff Copyright © 2004 South-Western

Figure 6 The Effects of a Tariff
Price
of Steel
Domestic
supply
Producer
surplus
Equilibrium
after tariff without trade
Price
Tariff
with tariff C
Price World
without tariff G price
Imports
Domestic
with tariff
demand
S S D D
Quantity
0 Q Q Q Q
of Steel
Imports
without tariff Copyright © 2004 South-Western

Figure 6 The Effects of a Tariff
Price
of Steel
Domestic
supply
Tariff Revenue
Price
Tariff
with tariff
E
Price World
without tariff price
Imports
Domestic
with tariff
demand
S S D D
Quantity
0 Q Q Q Q
of Steel
Imports
without tariff Copyright © 2004 South-Western

{Definition}
DWT Loss:
the reduction in
consumer and producer
surplus resulting from
restricting output below
its efficient level

Figure 6 The Effects of a Tariff
Price
of Steel
Domestic
supply
A
Deadweight Loss
B
Price
Tariff
with tariff C
D E F
Price World
without tariff G price
Imports
Domestic
with tariff
demand
S S D D
Quantity
0 Q Q Q Q
of Steel
Imports
without tariff Copyright © 2004 South-Western

Exercise

The Effects of a Tariff
Before Tariff After Tariff Change
A+B+C+D
CS A+B -(C+D+E+F)
+E-F
PS G C+G +C
Govt.
None E +E
Revenue
A+B+C+D A+B+C+E
Total Surplus -(D+F)
+E+F+G +G

{Story}

The Effects of a Tariff
• A tariff reduces the quantity of imports and
moves the domestic market closer to its
equilibrium without trade.
• With a tariff, total surplus in the market
decreases by an amount referred to as a
deadweight loss.

{The Effects of an Import Quota}
An import quota is a
limit on the quantity of
a good that can be
produced abroad and
sold domestically.

Price
of Steel
Domestic
supply
Equilibrium
without trade
Domestic
Quota
supply
+
Import supply
Isolandian
price with
Equilibrium
quota
with quota
Price
World World
without =
price price
Imports
quota Domestic
with quota
demand
S S D D
Quantity
0 Q Q Q Q
of Steel
Imports
without quota Copyright © 2004 South-Western

{Story}

The Effects of an Import Quota
Because the quota raises the domestic price
above the world price, domestic buyers of the
good are worse off, and domestic sellers of
the good are better off.
License holders are better off because they
make a profit from buying at the world price
and selling at the higher domestic price.

The Effects of an Import
Quota

Figure 7 The Effects of an Import Quota
Price
of Steel
Domestic
supply
Equilibrium
without trade
Domestic
Quota
supply
A
+
Import supply
Isolandian
B
price with
Equilibrium
quota
with quota
E'
C D F
E\"
Price
World World
without = G
price price
Imports
quota Domestic
with quota
demand
S S D D
Quantity
0 Q Q Q Q
of Steel
Imports
without quota Copyright © 2004 South-Western

Exercise

Before
After Quota Change
Quota
A+B+C+D -(C+D
CS A+B
+E’+E’’+F +E’+E”+F)
PS G C+G +C
License
None E’+E’’ +(E’+E’’)
Holder
A+B+C+D A+B+C
Total Surplus -(D+F)
+E’+E’’+F+G +E’+E’’+G

The Effects of an Import Quota
With a quota, total surplus in the market
decreases by an amount referred to as a
deadweight loss.
The quota can potentially cause an even
larger deadweight loss, if a mechanism such as
lobbying is employed to allocate the import
licenses.

The Lessons for Trade
Policy

Other Benefits of
International Trade

Arguments for
Restricting Trade

CASE STUDY: Trade Agreements and
the World Trade Organization

CASE STUDY: Trade Agreements and
the World Trade Organization

CASE STUDY: Trade Agreements and
the World Trade Organization

Summary

Next Week
• European Monetary Union
• Read Wyplosz, C. ‘European Monetary
Union: The Dark Sides of a Major Success’,
Economic Policy, 2006.

Thanks