SECTION 10

MONEY, BANKING AND

INTERNATIONAL
TRADE
ALAA SHARAF
HAIDY GABER

Part Three:
Global Economic System
and Issues
Tariff policy and Welfare
 Tariff System

Imported Tax Exported Tax

Tariff is a tax is imposed on imports or exports products.

Import tax is a large common Export tax is a less common policy
policy which means all imports are which means all Exports are exempted
subjected to taxes except some from taxes except some cases.
cases.
Customs tax on imports can be
classified to three types based on
the target of imposing tax:

Protective Tariff Revenue Tariff Preventive Tariff

To protect the local industries To maximize To prevent some imports to
from foreign competition. government revenue. enter the domestic market.

all types of tariffs in application can be classified to three

categories

Specific Tariff Compound Tariff Ad Valorem Tariff

is a fixed amount of tax per The tariff includes both two Is imposed as a certain
unit of imported or exported types of tariffs, specific and percentage of the value of
products regardless their ad - valorem tariff. imports or exports. It could apply
value. with different rates to achieve
many economic and social
targets.

Specific Tariff Ad Valorem Tariff

To neutralize the cost Grants to protect
disadvantages of the finished goods.
domestic products from
raw material.
 Advantages Disadvantages
Relatively easy to apply and easy to It is inelastic during fluctuation times
administrate especially for especially during increasing imports
standardized commodities and food price and inflation.
Products.
Losses some protective effect in case
inflation.

Causes high protection to domestic

Specific tax
product during recession and less
protection in case inflation.

For example, a specific tariff of $1,000

on autos will discourage imports priced
at $20,000 per auto to a greater degree
than those priced at $25,000.

This tariff system is elastic and In application it has many problems

responds more with changes of the related to custom valuation such as:
imports price, for this reason it has
constant relative protection for In most cases the customs appraisers
domestic producers with economic don`t accept the product values in
fluctuations. documents for tax purpose.

For example, If the tariff rate is a 20 Import prices tend to fluctuate over
percent ad valorem and the imported time which makes the valuation process
Ad Valorem product price is $200, the duty is $40. very difficult, this problem doesn`t
tax If the product’s price increases, say, to appear if the tariffs are specific.
$300, the duty collected rises to $60; if
the product price falls to $100, the There are many valuation methods can
duty drops to $20. be used to determine the value of the
products for customs purposes. (FOB –
CIF) each method has different impacts
on the economic and social variables.
Example:
There is a compound duty on woven fabrics in USA (48.5 cent per kilogram
+ 38% of its value). The specific portion of the duty 48.5 cents compensates
USA fabric manufacturers for the tariff protection granted to USA cotton
producers. While the ad valorem portion of the duty provides protection
for the woven fabric.

According to the free trade agreement, open markets based on comparative

advantage and specialization result in the most efficient use of economic
resources at the global level. Each nation will achieve gains and welfare
from international trade more than its welfare in case isolation.

Although all of this, why do the tendencies towards protectionist policies

have grown?
1- As a response to import dumping which means the practice of selling
goods in another country at a price lower than their cost of
production, often to gain market share.
2- As a response to chronic trade deficit which means occurs when a
country consistently imports more goods and services than it exports
over a long period of time.
3- For employment protection.
4- To protect infant (fledgling) sectors.
5- To protect politically strategic (key) industries as rise in Egypt.
6- Raise extra revenues for governments with budget deficits.
7- As a response to a recession (stagnant) domestic demand.
 Tariff effect: Producer and Consumer Surplus

P
S
Consumer surplus
measure the difference
between the amount that the
buyers would be willing and P*
able to pay for certain goods
and the actual amount they
are paying.
D
Any increase of market price Q
with other things being equal Q*
will lead to decrease consumer Producer surplus
surplus. is the difference between the amount of revenue
received by producer and the total variable cost
The area under the demand curve ( marginal cost) that reflects the minimum amount
and above the price level of return is accepted by producer to supply their
product at each price.
Any increase of market price with other things
being equal will lead to increase producer surplus.

The area under the price

level and above the
supply curve.

What is the impact of the 3 types of tariffs on consumer surplus,

producer surplus, imports size and government?
In other words,
What is the welfare effect of tariff (revenue effect, redistribution effect,
consumption effect and protective effect)?
 .
P
i
Sd

h
PA
f g
PW+t SW+t

b d e c
PW SW

a Dd
Q
Qs1 Qs2 QA Qd2 Qd1

Imports after tariff

Imports before tariff

Assumption:
PA: autarky price (isolation)
A nation whose imports from autos
QA: autarky quantity (isolation)
considered as a very small portion of the
PW: world price after free trade world market supply which means the
SW: supply of the world after free trade nation hasn`t influence the world market
price (Price Taker).
PW+t: world price after tariff (free trade)
The imported autos could be produced
SW+t: world supply after tariff (free trade)
internally.
Sd: domestic supply
The price of the domestic production is
Dd: domestic demand determined through free market.
Qs: quantity supplied (produced)
Compare between the position before trade
Qd: quantity demanded (consumed) (autarky) and after trade with and without
tariff:
 Protective and Revenue Tariff

Before trade (autarky):

Whatever produced in this nation
is consumed at PA and QA.
Consumer surplus was represented
by the triangle area (i PA h).
Producer surplus was represented
by the triangle area (PA h a).

After free trade (without tariff)

The market price decreased from
PA to Pw which leads to:
• Less production by domestic
producers from QA to Qs1
• More demand from domestic
consumers from QA to Qd1
The gap between the quantity
demanded Qd1 and the quantity
supplies Qs1 filled by imports.
As a result, consumer surplus
increase from triangle (i PA h) to
Imports before tariff
triangle (i Pw c).
Producer surplus decrease from triangle (PA h a) to triangle (Pw a b).

Therefore, free trade has a negative impact on the producer

welfare and positive impact on the consumer welfare
 After free trade (with tariff)
The market price increased from
Pw to Pw+t shifting world supply
from Sw to Sw+t which is because of
imposing tariff (the diff between
Pw and Pw+t) leads to:
• More production by domestic
producers from Qs1 to Qs2
• Less consumption by domestic d e
consumers from Qd1 to Qd2

The gap between the quantity

demanded and the supplied decrease
from (Qs1 Qd1) to (Qs2 Qd2) which Imports after tariff
means decrease the size of imports. Imports before tariff

As a result, consumer surplus decrease

from triangle (i Pw c) to triangle (i Pw+t g)
Producer surplus increase from triangle (Pw a b) to triangle (a Pw+t f).

The revenue effect:

The tariff is combined with increasing of government tax revenue because
of imposing tariff.
The revenue of tariff =
quantity of imports (Qs2 Qd2) x tariff
reflected in rectangle area (f g d e).
(Part of the consumer losses went to
the government in a form of tax
revenue)

Tariff has positive effect on d e

government
The redistributive effect:
As a result of imposing tariff, some groups will benefit (Producers), other
will lose (Consumers). It means the increasing of producer surplus is
combined with decreasing of consumer welfare.

In other words, after imposing tariff producers took part from the consumer
surplus (part of consumer losses went to the in producer as more profit)

Protective and Revenue tariff

has positive effect on producer
welfare and negative effect on d e
consumer welfare

The protective effect of tarrif:

This effect is generated because of the increasing of domestic production
from protected products achieved with increasing cost of production. It
means the cost of production will increase and more inefficiency will be
achieved at least in the short run.

In other words, foreign production (Imports) is substituted by less efficient

domestic production leads to lose in production efficiency appears in
triangle (b d f).
negative protective effect

Before tariff: After tariff:

The domestic cost of production The domestic cost of production
equals the cost of production for increased by the tariff, but the cost of
imported goods producing imported products still the
same in the origin country
The Consumption effect of tariff:
Most of losses in consumer welfare went partially to government as
revenue and partially to producers as more revenue, but the losses of
consumers will be greater than gains for both government and domestic
producers. (Net losses for economy because of decreasing domestic
production)

The trapezium distance (Pw c g Pw+t)

reflects the total loss of consumers
welfare.

Part of this losses went to d e

government as revenues
reflected in rectangle (f g e d)

Part of this losses went to

domestic producers as more revenues
reflected in trapezium (Pw b f Pw+t)

The dead weight loss reflects the net losses to

the economy reflects a real cost to the society,
not transferred to any sector in the
economy.
It appears in both triangles (f b d) and (g e c),
which reflects the losses in consumer surplus
that don’t get covered or transferred to any
other party.
 Preventive Tariff

After trade After trade

(without imposing preventive tariff): (with imposing preventive tariff):
The market price decreased from PA to The market price increased from
Pw which leads to: Pw to Pw+t shifting world supply
from Sw to Sw+t which is because of
Less production by domestic producers imposing tariff (the diff between
from QA to Qs1 Pw and Pw+t) leads to:
More demand from domestic consumers
from QA to Qd1 More production by domestic producers
from Qs1 to Q
The gap between the quantity Less demand from domestic consumers from
demanded Qd1 and the quantity Qd1 to Q
supplies Qs1 filled by imports.
The gap between the quantity
As a result, consumer surplus demanded and the quantity
increase from triangle (i PA h) to supplies disappeared because the tariff
triangle (i Pw c). imposed make it impossible to import this
Producer surplus decrease from triangle good (No imports).
(PA h a) to triangle (Pw a b).
As a result, consumer surplus
Preventive tariff has decrease from triangle (i Pw c) to
positive effect on producer triangle (i Pw+t h).
welfare and negative effect Producer surplus increase from triangle
on consumer welfare (Pw a b) to triangle (Pw+t a h).
 Effective Rate of Protection
In analysing tariffs, economists distinguish between
the nominal tariff rates and the effective tariff rates.

published and declared Takes in its calculation not only the nominal
(known) tariff rate on finished products but also
tariff rate that is applied on the imported
inputs that are using in producing the
finished products.

N–ab E: refers to effective tariff rate

E=
1–a (effective rate of protection).

N: refers to nominal tariff rate of

the final products.

a: refers to the ratio

between the value of imported inputs
and the value of the finished product

Let’s take a numerical

b: refers to the nominal tariff on the
example to make it clearer imported inputs.
😊
Example:
Suppose the nominal tariff on clothes is 50% of its value, tariff on
the imported components of clothes is 20%, the value of the
imported inputs equals 60% of the domestic output of clothes,
Determine the effective rate of tariff on clothes …
The answer

50% – (60% x 20%)

E= = 95%
1 – 60%

This result means the effective rate of protection to the domestic

clothes approximately 95% not equal the nominal rate of
protection 50% for local clothes industry.