## Tariffs

Tariffs are taxes levied on goods entering or exiting a country, and have consequences for both domestic consumers and producers.

learning objectives

• Discuss the consequences of a tariff for a domestic economy

One barrier to international trade is a tariff. A tariff is a tax that is imposed by a government on imported or exported goods. They are also known as customs duties.

### Types of Tariffs

Tariffs can be classified based on what is being taxed:

• Import tariffs: Taxes on goods that are imported into a country. They are more common than export tariffs.
• Export tariffs: Taxes on goods that are leaving a country. This may be done to raise tariff revenue or to restrict world supply of a good.

Tariffs may also be classified by their purpose:

• Protective tariffs: Tariffs levied in order to reduce foreign imports of a product and to protect domestic industries.
• Revenue tariffs: Tariffs levied in order to raise revenue for the government.

Tariffs can also be classified on how the duty amount is valued:

• Specific tariffs: Tariffs that levy a flat rate on each item that is imported. For example, a specific tariff would be a fixed $1,000 duty on every car that is imported into a country, regardless of how much the car costs. • Ad valorem tariffs: Tariffs based on a percentage of the value of each item. For example, an ad valorem tariff would be a 20% tax on the value of every car imported into a country. • Compound tariffs: Tariffs that are a combination of specific tariffs and ad valorem tariffs. For example, a compound tariff might consist of a fixed$100 duty plus 10% of the value of every imported car.

### Consequences of Levying a Tariff

To see the effects of levying an import tariff, consider the example shown in. Assume that there is an import tax levied on a good in a domestic country, Home. The domestic supply of the good is represented by the diagonal supply curve, and world supply is perfectly elastic and represented by the horizontal line at $$P_w$$. Before a tariff is levied, the domestic price is at $$P_w$$, and the quantity demanded is at $$D$$ (with quantity $$S$$ provided domestically, and quantity $$D−S$$ imported).

Effects of a Tariff: When a tariff is levied on imported goods, the domestic price of the good rises. This benefits domestic producers by increasing producer surplus, but domestic consumers see a small consumer surplus.

When the tariff is imposed, the domestic price of the good rises to $$P_t$$. Now, more of the good is provided domestically; instead of producing $$S$$, it now produces $$S^*$$. Imports of the good fall, from the quantity $$D−S$$ to the new quantity $$D^*−S^*$$ . With the higher prices, domestic producers experience a gain in producer surplus (shown as area A). In contrast, because of the higher prices, domestic consumers experience a loss in consumer surplus; consumer surplus shrinks from the area above $$P_w$$ to the area above $$P_t$$ (it shrinks by the areas A, B, C, and D).

Because the tariff is a tax, the government gains some revenue. The government charges a tariff amount of $$P_t−P_w$$ on every imported good. The amount of revenue is equal to the tariff amount times the number of imported goods, or $$(P_t−P_w)(D^*−S^*)$$ . This results in a governmental gain of area C.

In this example, domestic producers and the government both gain from the import tariff, and domestic consumers lose. However, if the world price is higher than the domestic price, a tariff will not change the price or quantity consumed of a good.

## Quotas

Quotas are limitations on imported goods, come in an absolute or tariff-rate varieties, and affect supply in the domestic economy.

learning objectives

• Discuss the economic consequences of different kinds of quotas

Barriers to trade exist in many forms. A tariff is a barrier to trade that taxes imports or exports, thus increasing the cost of a good. Another barrier to trade is an import quota, which places a limit on the amount of a good that may enter a country.

### Types of Quotas

There are two main types of import quota: the absolute quota and the tariff-rate quota.

An absolute quota is a limit on the quantity of specific goods that may enter a country during a certain time period. Once the quota has been fulfilled, no other goods may be imported into the country. An absolute quota may be set globally, in which case goods may be imported from any country until the goal has been reached. An absolute quota may also be set selectively for certain countries. As an example, suppose an absolute, global quota for pens is set at 50 million. The government is setting a limit that, in total, only 50 million pens can be imported. If there were a selective, absolute quota, only 50 million pens would be able to be imported, but this total would be divided among exporting countries. Country A might only be able to export 10 million pens, Country B might be able to export 25 million pens, and Country C might be able to export 15 million pens. Collectively, the total imports equal 50 million pens, but the proportions of pens from each country are set.

A tariff-rate quota is a two-tier quota system that combines characteristics of tariffs and quotas. Under a tariff-rate quota system, an initial quota of a good is allowed to enter the country at a lower duty rate. Once the initial quota is surpassed, imports are not stopped; instead, more of the good may be imported, but at a higher tariff rate. For example, under a tariff-rate quota system, a country may allow 50 million pens to be imported at the low tariff rate of $1 each. Any pen that is imported after this first-tier quota has been reached would be charged a higher tariff, say$3 each.

### Reasons to Implement Quotas

Quotas are often implemented for similar reasons as other trade barriers. Often, quotas are instituted to:

• Protect domestic industries and employment: By reducing the number of foreign imports, domestic suppliers must produce more to meet domestic demand. By producing more, the suppliers must hire more domestic workers, increasing employment. Additionally, setting quotas to reduce foreign competition allows domestic “infant industries,” or young, small industries, to grow and mature to a competitive level.
• Protect against unfair trade practices: Setting a quota helps protect a domestic economy from unfair trade practices such as dumping, the pricing of imports below production cost. By restricting imports, quotas minimize the impact of such activities.
• Protect national security: Import quotas discourage imports and encourage domestic production of goods that may be necessary to the security of the country. By protecting and encouraging the growth of these defense-related industries, a country will not have to be dependent on foreign imports in the event of a war.

### Consequences of Quotas

Like other trade barriers, quotas restrict international trade, and thus, have consequences for the domestic market. In particular, quotas restrict competition for domestic commodities, which raises prices and reduces selection. This hurts the domestic consumer, who experiences a loss in consumer surplus. On the other hand, this very action benefits the domestic producer, who sees an increase in producer surplus. Often, the increase in producer surplus is not enough to offset the loss in consumer surplus, so the economy experiences a loss in total surplus.

Quotas may also foster negative economic activities. Import quotas may promote administrative corruption, especially in countries where import quotas are given to selected importers. There are incentives to give the quotas to importers who can provide the most favors or the largest bribes to officials. Quotas may also encourage smuggling. As quotas raise the price of domestic goods, it becomes profitable to try and circumvent the quota by bringing in goods illegally, or in excess of the quota.

## Other Barriers

Barriers to trade include specific limitations to trade, customs procedures, governmental participation, and technical barriers to trade.

learning objectives

• Distinguish different barriers to trade

In addition to tariffs and quotas, other barriers to trade exist. They can be divided into four separate categories: specific limitations to trade, customs and administrative procedures, government participation, and technical barriers to trade.

This category of trade barriers stems from regulations on international trade. Some examples include:

• Local content requirements, or domestic content requirements, are rules that mandate how much of a product must be produced domestically in order to qualify for lowered tariffs or other preferential treatment.
• Embargoes are prohibitions on trade ban imports or exports, and may apply to certain categories of products, or strictly to goods supplied by certain countries.

This category of trade barriers refers to trade impediments that stem from governmental procedures and controls. Some examples include:

• Bureaucratic delays: Delays at ports or other country entrances caused by administrative or bureaucratic red-tape increase uncertainty and the cost of maintaining inventory.
• Anti-dumping duties: In international trade, dumping refers to a form of predatory pricing in which exported products are priced below the cost of production or below the price charged in the home market. Anti-dumping duties are usually extra taxes levied on the product to neutralize the predatory pricing and bring the price closer to the “normal value. “

### Government Participation

This category of trade barriers represents direct governmental involvement in international trade. Some examples include:

• Government procurement programs: Public authorities, such as government agencies, are much like private interests in that they must also buy goods and services. Unlike private interests, governments are more likely to buy domestically produced goods and services, rather than the lowest-cost commodities. Because government procurement often represent a significant portion of a country’s GDP, foreign suppliers are at a disadvantage to domestic ones when it comes to these programs.
• Export subsidies: Export subsidies are production subsidies granted to exported products, usually by a government. With export subsidies, domestic producers can sell their commodities in foreign markets below cost, which makes them more competitive.
• Countervailing duties: Countervailing duties, or anti-subsidy duties, are extra duties levied on imports in order to neutralize an export subsidy. If a country discovers that a foreign country subsidizes its exports, and domestic producers are injured as a result, a countervailing duty can be imposed in order to reduce the export subsidy advantage. In that respect, countervailing duties are similar to anti-dumping duties in that they both bring a imported product’s value closer to the “normal value. “

Technical barriers to trade are non-tariff barriers to trade that refer to standards implemented by countries. Because these standards must be met before goods are allowed to enter or leave a country, they represent international trade barriers. Some examples include:

• Sanitary and phytosanitary measures: These are health standards for plants, animals, and other products, and are designed to protect humans, animals, and plants from pests or diseases.
• Rules for product weights, sizes, or packaging.
• Standards for labeling and testing products.
• Ingredient or identity standards.

## Key Points

• Tariffs can be levied on goods being imported in a country ( import tariff), or exported from a country ( export tariff). They may be levied in order to protect domestic producers (protective tariff), or to raise revenue for the government (revenue tariff).
• Specific tariffs levy a fixed duty on a good. Ad valorem tariffs are based on a percentage of the good’s value. Compound tariffs are a combination of specific and ad valorem tariffs.
• Tariffs often increase domestic producer surplus and the quantity of a good supplied domestically, but hurt domestic consumer surplus.
• There are two types of quotas: absolute and tariff -rate. Absolute quotas are quotas that limit the amount of a specific good that may enter a country. Tariff-rate quotas allow a quantity of a good to be imported under a lower duty rate; any amount above this is subject to a higher duty.
• Justifications for the use of quotas include protection for domestic employment and infant industries, protection against unfair foreign trade practices, and protection of national security.
• Quotas often hurt domestic consumers and benefit domestic producers. Quotas may also provide incentives for administrative corruption and smuggling.
• Specific limitations to trade barriers include local content requirements and embargoes. This category of barriers comes from trade regulations.
• Customs and administrative procedure barriers include bureaucratic red tape and anti- dumping practices. This category of barriers comes from government procedures.
• Governmental participation barriers include government procurement programs, export subsidies, and countervailing duties. This category of barriers involves the direct participation of government in trade.
• Technical barriers to trade include sanitary regulations, measurement and labeling standards, and ingredient standards. This category of barriers involves health, safety, and measurement standards.

## Key Terms

• tariff: A system of government-imposed duties levied on imported or exported goods; a list of such duties, or the duties themselves.
• absolute quota: A limitation of the quantity of certain goods that may enter commerce during a specific period.
• quota: A restriction on the import of something to a specific quantity.
• tariff-rate quota: Allows a specified quantity of imported goods to be entered at a reduced rate of duty during the quota period, with quantities entered in excess of the quota limit subject to a higher duty rate.
• Dumping: Selling goods at less than their normal price, especially in the export market.
• countervailing duty: A tax levied on an imported article to offset the unfair price advantage it holds due to a subsidy paid to producers or exporters by the government of the exporting country if such imports cause or threaten injury to a domestic industry.
• embargo: A ban on trade with another country.