What this lesson teaches
I can weigh the benefits and costs of protectionism.
Syllabus 9570, 3.3.1(d). Globalisation, International Trade and Economic Co-operation: Benefits and costs of protectionism
Make a guess
A small country puts a tariff on imported shoes. What happens to the number of shoes made at home?
- It rises, because local firms can sell at a higher price.
- It falls, because shoes become more expensive.
- It stays the same, because the tariff is charged on imports, not local shoes.
Show the answer
It rises, because local firms can sell at a higher price.
The tariff raises the domestic price to Pw + t. Local producers move up their supply curve and make more.
A tariff raises the domestic price, so domestic producers supply more, consumers buy less, and imports fall.
A tariff is a tax on imports. For a small country, the world price (Pw) is fixed, and it can import as much as it wants at that price.
Under free trade, the domestic price equals Pw. Domestic producers supply Q1, consumers buy Q2, and imports fill the gap, Q1 to Q2.
A tariff raises the domestic price to Pw + t. Domestic producers expand output to Q3, consumers cut purchases to Q4, and imports shrink to Q3 to Q4.
The government collects the tariff on each unit still imported.
- Tariff
- Price rises from Pw to Pw + t.
- Effect
- Domestic supply up, demand down, imports down.
Worked example: A $1 tariff
Suppose the world price is $4. At $4, domestic firms supply 40 units a day and consumers buy 120, so 80 are imported. A $1 tariff raises the price to $5.
- Domestic supply rises from 40 to 60.
- Consumption falls from 120 to 100.
- Imports fall from 80 to 40.
- Tariff revenue = $1 x 40 = $40 a day.
Watch out for this
Tariff revenue is the tariff times total consumption.
The tariff is paid only on imports, so revenue is the tariff times the quantity still imported.
Check your understanding
The world price is $40, the tariff is $10 a pair, and imports fall to 2,000 pairs. How much revenue does the government collect?
- $100,000: the new domestic price times the pairs imported.
- $80,000: the world price times the pairs imported.
- $20,000: the tariff times the pairs still imported.
Show the answer
$20,000: the tariff times the pairs still imported.
Right. Revenue is the tariff on each imported pair, $10 x 2,000. On the diagram it is the rectangle between Pw and Pw + t over the imports.