Friday, August 28, 2009

Types of Tarrifs

Tarrifs have a variety of effects which depend upon their power to reduce imports. The effects of the tarrifs may be analysed from the stand point of the economy as a whole which is known as the general equilibrium analysis. Or, they may be discussed from the point of view of a particular good or market which is known as the partial equilibrium analysis. A tarrif is likely to alter trade prices, output and consumption and to reallocate resources, change factor proportions, redistribution income, change employment and alter the balance of payments.

Accordingly Prof. Kindle Berger has listed eight effects of tarrifs: (1) Protective Effect (2) Consumption Effect (3) Revenue Effect (4) Redistributive Effect (5) Terms of Trade Effect (6) Competitive Effect (7) Income Effect and (8) Balance of Payments Effect. All these effects are the result of the Price Effect.

Effects of a Tarrif under Partial Equilibrium:

The analysis of the effects of a tarrif under the partial equilibrium analysis is based on the following assumptions.

1. The demand and supply curves of a commodity relate to the country which levies an import duty.

2. These curves are assumed as given and constant.

3. On the demand side, consumer’s tastes, income and prices of other commodities are assumed to be fixed.

4. On the supply side, change sin cost conditions such as externalities, technological innovations etc do not take place.

5. There are no transport costs.

6. The foreign price of the commodity remains unchanged.

Here D and S are the domestic demand and supply curves of a commodity. OP represents the constant world price at which the foreign producers are prepared to sell their commodity in the domestic market. Thus the horizontal line PB is the supply curve of imports which is perfectly elastic at OP price. Thus under free trade (before the imposition of tarrif). The equilibrium market position is given by point B where the domestic demand curve D intersects the world supply curve PB at the price OP. The total demand for commodity is OQ3. The domestic supply is OQ. The difference between domestic demand and domestic supply is met by importing QQ3 quantity at OP price. Suppose a tarrif of PP1 is imposed on the imports of the commodity. Given a constant foreign price, the domestic price of the commodity rises by the full amount of the tarrif OP1. Thus the rise in the price of the commodity by PP1 is the price effect of tarrif. As a result the new equilibrium market position is given by point N. So that the total demand for the commodity is OQ2 which is partly met by domestic supply OQ1 and partly by importing Q1Q2.

The protective, consumption, revenue and redistribution effects of tarrif can also be illustrated by the help of above diagram.

1. Protective Effect: The protective effect shows how the domestic industry can be protected from foreign competition by imposing an import duty. In above diagram under free trade, OQ3 quantity of the commodity is imported at OP price. With the imposition of the import duty of PP1 imports are reduced to Q1Q2. While the domestic production (supply) of the commodity increases from OQ to OQ1. Thus increase in the domestic production of the commodity by QQ1 as a result of the tarrif is the protective or production effect.

2. Consumption Effect: The consumption effect of the tarrif is to reduce consumption of the commodity on which the tarrif is imposed, as also to reduce consumer’s net satisfaction. These are illustrated in above diagram. Before the imposition of tarrif, consumers were consuming OQ3 quantity of the commodity at OP price, with the levying of an import duty of PP1 the price of the commodity rises to OP1. Now imports are reduced by Q3Q2 and the total consumption of the commodity is also reduced from OQ3 to OQ2. Thus Q3Q2 is the consumption effect of the tarrif. This in turn leads to a net loss of consumer’s satisfaction equal to the PP1NB. Prof. Kindle Berger calls the combined protective and consumption effects as trade effect. The imposition of PP1 tarrif has the effect of reducing the total volume of trade of the country equivalent to QQ3-QQ2.

3. Revenue Effect: The revenue effect is the change in government receipts as a result of the tarrif. In the case illustrated in above diagram, initially the tarrif is assumed zero at price OP. So when PP1 import duty is levied, the revenue to the government is equal to the amount of the import duty multiplied by the quantity of imports. The revenue effect is therefore PP1 × Q1Q2 or the rectangular shaded area R.

4. Redistributive Effect: The redistribution effect results from producers receiving a higher price for their commodity after the imposition of the tarrif. This is show in the above diagram by the area PP1MA. This amount is surplus over production costs and is an economic rent which goes to producers. According to Kindle Berger the redistribution effect “is an addition to producer’s surplus derived by subtraction from consumer’s surplus”. In this sense the net loss to consumer’s satisfaction as measured by the consumption effect is PP1NB. Out of this amount show by the area R is taken away by the government as revenue, and the loss of consumer’s surplus is represented by the triangles a and to is neither transferable to the producers nor to the government and is called by Kindle Berger as the “dead weight loss of the quadrilateral PP1MA measures the redistributive effect of the tarrif which goes to the domestic producers of the commodity.


1 Responses to “Types of Tarrifs”

Anonymous said...
August 28, 2013 at 10:14 PM

incomplete information without graphs

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