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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
                                                       Equot;
  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

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Ec4333 Lecture 3 2007 Slideshare

  • 1. Lecture 4 Stephen Kinsella stephenkinsella.net Recap Tariffs Welfare Analysis
  • 3. EU is an 1. economic solution to a political problem
  • 4. History of integration 2. matters, and reflects current level of integration
  • 5. There are 3. welfare effects to greater integration
  • 7. Trade Creation is “The increase in trade volume caused by union with a lower cost (more efficient) supplier within the trade bloc”––Viner, 1950
  • 8. 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
  • 9. 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
  • 11. {Definition} A tariff is a tax on goods produced abroad and sold domestically.
  • 12. Effects of a Tariff
  • 13. 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
  • 14. 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
  • 15. 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
  • 16. 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
  • 17. 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
  • 18. {Definition} DWT Loss: the reduction in consumer and producer surplus resulting from restricting output below its efficient level
  • 19. 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
  • 21. 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
  • 23. 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.
  • 24. {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.
  • 25. 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
  • 27. 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.
  • 28. The Effects of an Import Quota
  • 29. 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 Equot; 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
  • 31. 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
  • 32. 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.
  • 33. The Lessons for Trade Policy
  • 36. CASE STUDY: Trade Agreements and the World Trade Organization
  • 37. CASE STUDY: Trade Agreements and the World Trade Organization
  • 38. CASE STUDY: Trade Agreements and the World Trade Organization
  • 40. Next Week • European Monetary Union • Read Wyplosz, C. ‘European Monetary Union: The Dark Sides of a Major Success’, Economic Policy, 2006.