The document discusses the effects of tariffs on the terms of trade between countries, indicating that their impact depends on the reciprocal demand and potential retaliation by trading partners. It highlights that while a tariff may improve the terms of trade for the imposing country, it can also lead to a contraction in trade volume. In cases of foreign retaliation, both countries may experience a significant reduction in trade volume and overall welfare without an improvement in terms of trade.

1. Dr. Jayasree T O
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2. TOT EFFECT-LARGE COUNTRY CASE
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3. • The tariff is likely to improve the terms of trade
• But the extent to which tariff can ensure the
improvement in terms of trade is determined by the
reciprocal demand of the two trading countries or their
respective offer curves
•whether the terms of trade will become favourable or not
for the tariff-imposing home country, depends upon
whether the other countries retaliate or not to tariff
restrictions imposed by the home country against their
products.
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4. Terms of Trade Effect in the Absence of Retaliation:
• Two types of effects can follow.
• Firstly, there is an improvement in the terms of
trade of the tariff- imposing country.
• Secondly, the tariffs result in the contraction in
the volume of trade.

5. The terms of trade for the home
country A at P = (QM/QX) =
(PQ/OQ) = Slope of Line OP =
Tan α.
If the home country imposes
tariff on steel, its offer curve shifts
to the left,
Now exchange takes place at
P1 where the given offer curve of
country B intersects the offer
curve OA1 of country A.
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6.  At this point, country A imports P1Q1 quantity of
steel and exports OQ1 quantity of cloth.
 The terms of trade for country A at P1 = (QM/QX) =
(P1Q1/OQ1) = Slope of Line OP1 = Tan α1.
Since Tan α1 > Tan α, there is an improvement in the
terms of trade for the tariff-imposing home country A,
subsequent upon the imposition of tariff.
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7.  The volume of trade – fall in the volume of
trade after tariff is imposed.
Before trade
 OQ exports of cloth + PQ imports of steel.
 After the imposition of tariff both exports
and imports stand reduced to OQ1 and
P1Q1 respectively.
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8.  No improvement in the
terms of trade.
 Only effect tariff will
have in such a situation is the
reduction in the volume of
international trade.
 The terms of trade at P1 =
(QM/QX) = (P1Q1/OQ1) =
Slope of Line OP1 = Tan α.
Since the terms of trade at
both P1 and P are measured by
the constant Tan α,
offer curve of the foreign country is
perfectly elastic,
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9. offer curve of the foreign
country is highly inelastic
 tariff can cause
improvement in the TOT for
the home country.
 Imports may get enlarged
but the contraction in exports
being relatively greater,
 There is still a net
reduction in the volume of
international trade.
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10. TOT Effect in the event of Foreign Retaliation
 There is no improvement
in the terms of trade -Since
the terms of trade at the
original position P and the
final position (post-
retaliation) P2 are measured
by constant Tan α, it signifies
that for country A.
 volume of trade slumps
down very significantly
resulting in loss in welfare for
both the trading countries.
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