Taxes, Subsidies, and Tariffs:
“Small” Country
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Taxes, Subsidies - International Economics - Lecture Slides, Slides of Economics
Topics include in International Economics trade theory, tariffs and other protectionist policies, trade agreements between nations, the World Trade Organization, balance of payments, exchange rates, and the European Monetary Union. Key points for this lecture are: Taxes, Subsidies, Tariffs, Effects of a Tariff, Effects of a Tariff on Prices and Quantities, Welfare Under Free Trade, Consumer Surplus, Producer Surplus, Government's Revenue from Tariff, Production Subsidy, Consumption Tax
Typology: Slides
2012/2013
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Taxes, Subsidies, and Tariffs:
“Small” Country
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The Effects of a Tariff
• A tariff is a tax on imported goods
• Tariffs raise the price of imported goods above
the world price by the amount of the tariff.
• This
– Reduces consumption, …
– Increases production, and thereby …
– Reduces the amount imported
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Price
of Steel
0 Quantity
of Steel
Domestic
supply
Domestic
demand
Imports
under free trade
Equilibrium
without trade
Price
before tariff
World
price
Q
S
Q
D
Producer
surplus
before tariff
Consumer surplus
before tariff
Welfare under free trade
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A
B
Price
of Steel
0 Quantity
of Steel
Domestic
supply
Domestic
demand
Price
after tariff Tariff
Imports
under free trade
Equilibrium
without trade
Price
before tariff
World
price Imports
with tariff
Q
S
Q
S
Q
D
Q
D
Consumer surplus
after tariff
Consumer Surplus after Tariff
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E
Price
of Steel
0 Quantity
of Steel
Domestic
supply
Domestic
demand
Price
after tariff Tariff
Imports
under free trade
Price
before tariff
World
price
Q
S
Imports
after tariff
Q
S
Q
D
Q
D
Tariff Revenue
Government’s Revenue from Tariff
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Effects of Tariff on Social Welfare
C
G
A
D E F
B
Price
of Steel
0 Quantity
of Steel
Domestic
supply
Domestic
demand
Price
with tariff Tariff
Imports
without tariff
Price
without tariff
World
price Imports
after tariff
Q
S
Q
S
Q
D
Q
D
Deadweight Loss
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Tariffs are “third best”
• The tariff can be thought of as the
combination of a production subsidy and a
consumption tax
• The only rationale for a tariff is that it helps
producers
• But even that goal can be better achieved by
using only a production subsidy
• That way, the bad effects of the consumption
tax can be avoided
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CONSUMPTION TAX
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Price
of Steel
0 Quantity
of Steel
Consumption Tax
Imports
under free trade
Imports
after tax
= Q
S
Q
D
Consumption Tax
Purchase price
before tax
D
C
G
A
E F
B
Domestic
demand
Purchase price
after tax
Q
D
World
price
Domestic
supply
Equilibrium
without trade
Deadweight loss of
the consumption tax
Free Trade Consumption Tax
Consumers’ Surplus ABCDEF AB
Producers’ Surplus G G
Government CDE
Total Surplus ABCDE F G ABCDEG
Q
S
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Consumption Tax
Free Trade Consumption Tax
Consumers’
Surplus
ABCDEF AB
Producers’
Surplus
G G
Government CDE
Total Surplus ABCDE F G ABCDEG
The deadweight loss of the consumption tax is F ,
less than D + F , the deadweight loss of the tariff.
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PRODUCTION SUBSIDY
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Price
of Steel
0 Quantity
of Steel
Domestic
supply
Domestic
demand
Production Subsidy
Imports
under free trade
World Price
Imports
after subsidy
Q
S
Q
S
Q
D
Q
D
Production Subsidy
Price sellers get
after subsidy
Price sellers get
before subsidy
price buyers pay, with
or without the subsidy
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Production Subsidy
Free Trade Production
Subsidy
Consumers’
Surplus
ABCDEF ABCDEF
Producers’
Surplus
G CG
Government -CD
Total Surplus ABC D EFG ABCEFG
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Production Subsidy
• When a small country gives a subsidy to
domestic producers of an imported good
– Consumers are unaffected
– Producers gain (C), same as under the tariff
– Taxpayers have to pay for the subsidy (CD)
– Overall, the country is worse off (D).
– Recall that under the tariff, the country suffered
even more (DF)
– Tariffs are “third best”
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