Chapter8TheInstrumentsofTradePolicyPreparedbyIordanisPetsasToAccompany

InternationalEconomics:TheoryandPolicy,SixthEditionbyPaulR.KrugmanandMauriceObstfeld1Chapter8PreparedbyIordanisIntroductionBasicTariffAnalysisCostsandBenefitsofaTariffOtherInstrumentsofTradePolicyTheEffectsofTradePolicy:ASummarySummaryAppendixI:TariffAnalysisinGeneralEquilibriumAppendixII:TariffsandImportQuotasinthePresenceofMonopolyChapterOrganization2IntroductionChapterOrganizatiIntroductionThischapterisfocusedonthefollowingquestions:Whataretheeffectsofvarioustradepolicyinstruments?Whowillbenefitandwhowilllosefromthesetradepolicyinstruments?Whatarethecostsandbenefitsofprotection?Willthebenefitsoutweighthecosts?Whatshouldanation’stradepolicybe?Forexample,shouldtheUnitedStatesuseatarifforanimportquotatoprotectitsautomobileindustryagainstcompetitionfromJapanandSouthKorea?3IntroductionThischapterisfoClassificationofCommercialPolicyInstrumentsIntroductionCommercialPolicyInstrumentsTradeContractionTradeExpansionTariffExporttaxImportquotaVoluntaryExportRestraint(VER)ImportsubsidyExportsubsidyVoluntaryImportExpansion(VIE)PriceQuantityPriceQuantity4ClassificationofCommercialPBasicTariffAnalysisTariffscanbeclassifiedas:SpecifictariffsTaxesthatareleviedasafixedchargeforeachunitofgoodsimportedExample:Aspecifictariffof$10oneachimportedbicyclewithaninternationalpriceof$100meansthatcustomsofficialscollectthefixedsumof$10.AdvaloremtariffsTaxesthatareleviedasafractionofthevalueoftheimportedgoodsExample:A20%advaloremtariffonbicyclesgeneratesa$20paymentoneach$100importedbicycle.5BasicTariffAnalysisTariffscAcompoundduty(tariff)isacombinationofanadvaloremandaspecifictariff.

Moderngovernmentsusuallyprefertoprotectdomesticindustriesthroughavarietyofnontariffbarriers,suchas:ImportquotasLimitthequantityofimportsExportrestraintsLimitthequantityofexportsBasicTariffAnalysis6Acompoundduty(tariff)isaSupply,Demand,andTradeinaSingleIndustrySupposethattherearetwocountries(HomeandForeign).Bothcountriesconsumeandproducewheat,whichcanbecostlesstransportedbetweenthecountries.Ineachcountry,wheatisacompetitiveindustry.SupposethatintheabsenceoftradethepriceofwheatatHomeexceedsthecorrespondingpriceatForeign.ThisimpliesthatshippersbegintomovewheatfromForeigntoHome.TheexportofwheatraisesitspriceinForeignandlowersitspriceinHomeuntiltheinitialdifferenceinpriceshasbeeneliminated.BasicTariffAnalysis7Supply,Demand,andTradeinaTodeterminetheworldprice(Pw)andthequantitytrade(Qw),twocurvesaredefined:HomeimportdemandcurveShowsthemaximumquantityofimportstheHomecountrywouldliketoconsumeateachpriceoftheimportedgood.Thatis,theexcessofwhatHomeconsumersdemandoverwhatHomeproducerssupply:MD=D(P)–S(P)ForeignexportsupplycurveShowsthemaximumquantityofexportsForeignwouldliketoprovidetherestoftheworldateachprice.Thatis,theexcessofwhatForeignproducerssupplyoverwhatforeignconsumersdemand:XS=S*(P*)–D*(P*)BasicTariffAnalysis8Todeterminetheworldprice(Quantity,QPrice,PPrice,PQuantity,QMDDSAPAP2P1S2D2D2–S22S1D1D1–S11Figure8-1:DerivingHome’sImportDemandCurveBasicTariffAnalysis9Quantity,QPrice,PPrice,PQuaPropertiesoftheimportdemandcurve:Itintersectstheverticalaxisattheclosedeconomypriceoftheimportingcountry.Itisdownwardsloping.Itisflatterthanthedomesticdemandcurveintheimportingcountry.BasicTariffAnalysis10PropertiesoftheimportdemanP2P*AD*S*P1XSPrice,PPrice,PQuantity,QQuantity,QS*2–D*2S*2D*2Figure8-2:DerivingForeign’sExportSupplyCurveBasicTariffAnalysisD*1S*1S*1–D*111P2P*AD*S*P1XSPrice,PPrice,PQPropertiesoftheexportsupplycurve:Itintersectstheverticalaxisattheclosedeconomypriceoftheexportingcountry.Itisupwardsloping.Itisflatterthatthedomesticsupplycurveintheexportingcountry.BasicTariffAnalysis12PropertiesoftheexportsupplFigure8-3:WorldEquilibriumXSPrice,PQuantity,QMDPWQW1BasicTariffAnalysis13Figure8-3:WorldEquilibriumXUsefuldefinitions:Thetermsoftradeistherelativepriceoftheexportablegoodexpressedinunitsoftheimportablegood.Asmallcountryisacountrythatcannotaffectitstermsoftradenomatterhowmuchittradeswiththerestoftheworld.Theanalyticalframeworkwillbebasedoneitherofthefollowing:TwolargecountriestradingwitheachotherAsmallcountrytradingwiththerestoftheworldBasicTariffAnalysis14Usefuldefinitions:BasicTarifEffectsofaTariffAssumethattwolargecountriestradewitheachother.SupposeHomeimposesataxof$2oneverybushelofwheatimported.Thenshipperswillbeunwillingtomovethewheatunlessthepricedifferencebetweenthetwomarketsisatleast$2.Figure8-4illustratestheeffectsofaspecifictariffof$tperunitofwheat.BasicTariffAnalysis15EffectsofaTariffBasicTarifXSPTMDD*S*DSPW2QT1QWBasicTariffAnalysisFigure8-4:EffectsofaTariffP*T3tPrice,PQuantity,QPrice,PQuantity,QPrice,PQuantity,QHomemarketWorldmarketForeignmarketHomemarketWorldmarketForeignmarket16XSPTMDD*S*DSPW2QT1QWBasicTariIntheabsenceoftariff,theworldpriceofwheat(Pw)wouldbeequalizedinbothcountries.Withthetariffinplace,thepriceofwheatrisestoPTatHomeandfallstoP*T

(=PT

–t)atForeignuntilthepricedifferenceis$t.InHome:producerssupplymoreandconsumersdemandless

duetothehigherprice,sothatfewerimportsaredemanded.InForeign:producerssupplylessandconsumersdemandmoreduetothelowerprice,sothatfewerexportsaresupplied.Thus,thevolumeofwheattradeddeclinesduetotheimpositionofthetariff.BasicTariffAnalysis17Intheabsenceoftariff,theTheincreaseinthedomesticHomepriceislessthanthetariff,becausepartofthetariffisreflectedinadeclineinForeign’sexportprice.IfHomeisasmallcountryandimposesatariff,theforeignexportpricesareunaffectedandthedomesticpriceatHome(theimportingcountry)risesbythefullamountofthetariff.BasicTariffAnalysis18TheincreaseinthedomesticHFigure8-5:ATariffinaSmallCountrySPrice,PQuantity,QDPW

+tPWImportsaftertariffS1D1ImportsbeforetariffD2S2BasicTariffAnalysis19Figure8-5:ATariffinaSmalMeasuringtheAmountofProtectionInanalyzingtradepolicyinpractice,itisimportanttoknowhowmuchprotectionatradepolicyactuallyprovides.Onecanexpresstheamountofprotectionasapercentageofthepricethatwouldprevailunderfreetrade.Twoproblemsarisefromthismethodofmeasurement:Inthelargecountrycase,thetariffwilllowertheforeignexportprice.Tariffsmayhavedifferenteffectsondifferentstagesofproductionofagood.BasicTariffAnalysis20MeasuringtheAmountofProtecEffectiverateofprotection

Onemustconsiderboththeeffectsoftariffsonthefinalpriceofagood,andtheeffectsoftariffsonthecostsofinputsusedinproduction.Theactualprotectionprovidedbyatariffwillnotequalthetariffrateifimportedintermediategoodsareusedintheproductionoftheprotectedgood.Example:AEuropeanairplanethatsellsfor$50millionhascost$60milliontoproduce.Halfofthepurchasepriceoftheaircraftrepresentsthecostofcomponentspurchasedfromothercountries.Asubsidyof$10millionfromtheEuropeangovernmentcutsthecostofthevalueaddedtopurchasersoftheairplanefrom$30to$20million.Thus,theeffectiverateofprotectionis(30-20)/20=50%.BasicTariffAnalysis21EffectiverateofprotectionBCostsandBenefitsofaTariffAtariffraisesthepriceofagoodintheimportingcountryandlowersitintheexportingcountry.Asaresultofthesepricechanges:ConsumersloseintheimportingcountryandgainintheexportingcountryProducersgainintheimportingcountryandloseintheexportingcountryGovernmentimposingthetariffgainsrevenueTomeasureandcomparethesecostsandbenefits,weneedtodefineconsumer

and

producersurplus.22CostsandBenefitsofaTariffConsumerandProducerSurplusConsumersurplusItmeasurestheamountaconsumergainsfromapurchasebythedifferencebetweenthepriceheactuallypaysandthepricehewouldhavebeenwillingtopay.Itcanbederivedfromthemarketdemandcurve.Graphically,itisequaltotheareaunderthedemandcurveandabovetheprice.Example:Supposeapersoniswillingtopay$20perpacketofpills,butthepriceisonly$5.Then,theconsumersurplusgainedbythepurchaseofapacketofpillsis$15.CostsandBenefitsofaTariff23ConsumerandProducerSurplusC8$129$1010$911DFigure8-6:DerivingConsumerSurplusfromtheDemandCurveCostsandBenefitsofaTariffPrice,PQuantity,Q248$129$1010$911DFigure8-6:DerFigure8-7:GeometryofConsumerSurplusCostsandBenefitsofaTariffabP1P2DPrice,PQuantity,QQ2Q125Figure8-7:GeometryofConsumProducersurplusItmeasurestheamountaproducergainsfromasalebythedifferencebetweenthepriceheactuallyreceivesandthepriceatwhichhewouldhavebeenwillingtosell.Itcanbederivedfromthemarketsupplycurve.Graphically,itisequaltotheareaabovethesupplycurveandbelowtheprice.Example:Aproducerwillingtosellagoodfor$2butreceivingapriceof$5gainsaproducersurplusof$3.CostsandBenefitsofaTariff26ProducersurplusCostsandBeneFigure8-8:GeometryofProducerSurplusCostsandBenefitsofaTariffdcP2P1SPrice,PQuantity,QQ2Q127Figure8-8:GeometryofProducCostsandBenefitsofaTariffMeasuringtheCostandBenefitsIsitpossibletoaddconsumerandproducersurplus?Wecan(algebraically)addconsumerandproducersurplusbecauseanychangeinpriceaffectseachindividualintwoways:AsaconsumerAsaworkerWeassumethatatthemarginadollar’sworthofgainorlosstoeachgroupisofthesamesocialworth.28CostsandBenefitsofaTariffFigure8-9:CostsandBenefitsofaTarifffortheImportingCountryCostsandBenefitsofaTariffPTPWP*TbcdeDa=consumerloss(a+b+c+d)=producergain(a)=governmentrevenuegain(c+e)QTD2S2SS1D1Price,PQuantity,Q29Figure8-9:CostsandBenefitsTheareasofthetwotrianglesbanddmeasurethelosstothenationasawhole(efficiencyloss)andtheareaoftherectangleemeasuresanoffsettinggain(termsoftradegain).Theefficiencylossarisesbecauseatariffdistortsincentivestoconsumeandproduce.Producersandconsumersactasifimportsweremoreexpensivethantheyactuallyare.Trianglebistheproductiondistortionlossandtriangledistheconsumptiondistortionloss.Thetermsoftradegainarisesbecauseatarifflowersforeignexportprices.CostsandBenefitsofaTariff30TheareasofthetwotrianglesIfthetermsoftradegainisgreaterthantheefficiencyloss,thetariffincreaseswelfarefortheimportingcountry.Inthecaseofasmallcountry,thetariffreduceswelfarefortheimportingcountry.CostsandBenefitsofaTariff31IfthetermsoftradegainisFigure8-10:NetWelfareEffectsofaTariffPTPWP*TbdeD=efficiencyloss(b+d)=termsoftradegain(e)ImportsSPrice,PQuantity,QCostsandBenefitsofaTariff32Figure8-10:NetWelfareEffecExportSubsidies:TheoryExportsubsidyApaymentbythegovernmenttoafirmorindividualthatshipsagoodabroadWhenthegovernmentoffersanexportsubsidy,shipperswillexportthegooduptothepointwherethedomesticpriceexceedstheforeignpricebytheamountofthesubsidy.Itcanbeeitherspecificoradvalorem.OtherInstrumentsofTradePolicy33ExportSubsidies:TheoryOtherbaFigure8-11:EffectsofanExportSubsidyOtherInstrumentsofTradePolicyPSPWP*SPrice,PQuantity,QExportsgfeSubsidydc=producergain(a+b+c)=consumerloss(a+b)=costofgovernmentsubsidy(b+c+d+e+f+g)DS34baFigure8-11:EffectsofanEAnexportsubsidyraisespricesintheexportingcountrywhileloweringthemintheimportingcountry.Inaddition,andincontrasttoatariff,theexportsubsidyworsensthetermsoftrade.Anexportsubsidyunambiguouslyleadstocoststhatexceeditsbenefits.OtherInstrumentsofTradePolicy35AnexportsubsidyraisespriceFigure8-12:Europe’sCommonAgriculturalProgramOtherInstrumentsofTradePolicyPrice,PQuantity,QSDEUpricewithoutimportsWorldprice=costofgovernmentsubsidySupportpriceExports36Figure8-12:Europe’sCommonAImportQuotas:TheoryAnimportquotaisadirectrestrictiononthequantityofagoodthatisimported.Example:TheUnitedStateshasaquotaonimportsofforeigncheese.Therestrictionisusuallyenforcedbyissuinglicensestosomegroupofindividualsorfirms.Example:Theonlyfirmsallowedtoimportcheesearecertaintradingcompanies.Insomecases(e.g.sugarandapparel),therighttosellintheUnitedStatesisgivendirectlytothegovernmentsofexportingcountries.OtherInstrumentsofTradePolicy37ImportQuotas:TheoryOtherInsAnimportquotaalwaysraisesthedomesticpriceoftheimportedgood.Licenseholdersareabletobuyimportsandresellthematahigherpriceinthedomesticmarket.Theprofitsreceivedbytheholdersofimportlicensesareknownasquotarents.OtherInstrumentsofTradePolicy38AnimportquotaalwaysraisesWelfareanalysisofimportquotasversusofthatoftariffsThedifferencebetweenaquotaandatariffisthatwithaquotathegovernmentreceivesnorevenue.Inassessingthecostsandbenefitsofanimportquota,itiscrucialtodeterminewhogetstherents.Whentherightstosellinthedomesticmarketareassignedtogovernmentsofexportingcountries,thetransferofrentsabroadmakesthecostsofaquotasubstantiallyhigherthantheequivalenttariff.OtherInstrumentsofTradePolicy39WelfareanalysisofimportquoPriceinU.S.Market466WorldPrice280bcdDemanda8.456.32Supply5.149.26Price,$/tonQuantityofsugar,milliontonsFigure8-13:EffectsoftheU.S.ImportQuotaonSugarOtherInstrumentsofTradePolicyImportquota:2.13milliontons=consumerloss(a+b+c+d)=producergain(a)=quotarents(c)40PriceinU.S.Market466WorldVoluntaryExportRestraintsAvoluntaryexportrestraint(VER)isanexportquotaadministeredbytheexportingcountry.Itisalsoknownasavoluntaryrestraintagreement(VRA).VERsareimposedattherequestoftheimporterandareagreedtobytheexportertoforestallothertraderestrictions.OtherInstrumentsofTradePolicy41VoluntaryExportRestraintsOthAVERisexactlylikeanimportquotawherethelicensesareassignedtoforeigngovernmentsandisthereforeverycostlytotheimportingcountry.AVERisalwaysmorecostlytotheimportingcountrythanatariffthatlimitsimportsbythesameamount.ThetariffequivalentrevenuebecomesrentsearnedbyforeignersundertheVER.Example:About2/3ofthecosttoconsumersofthethreemajorU.S.voluntaryrestraintsintextilesandapparel,steel,andautomobilesisaccountedforbytherentsearnedbyforeigners.AVERproducesalossfortheimportingcountry.OtherInstrumentsofTradePolicy42AVERisexactlylikeanimporLocalContentRequirementsAlocalcontentrequirementisaregulationthatrequiresthatsomespecifiedfractionofafinalgoodbeproduceddomestically.Thisfractioncanbespecifiedinphysicalunitsorinvalueterms.Localcontentlawshavebeenwidelyusedbydevelopingcountriestryingtoshifttheirmanufacturingbasefromassemblybackintointermediategoods.OtherInstrumentsofTradePolicy43LocalContentRequirementsOtheLocalcontentlawsdonotproduceeithergovernmentrevenueorquotarents.

Instead,thedifferencebetweenthepricesofimportsanddomesticgoodsgetsaveragedinthefinalpriceandispassedontoconsumers.Example:Supposethatautoassemblyfirmsarerequiredtouse50%domesticparts.Thecostofimportedpartsis$6000andthecostofthesamepartsdomesticallyis$10,000.Thentheaveragecostofpartsis$8000(0.5x$6000+0.5x$10,000).Firmsareallowedtosatisfytheirlocalcontentrequirementbyexportinginsteadofusingpartsdomestically.OtherInstrumentsofTradePolicy44LocalcontentlawsdonotprodOtherTradePolicyInstruments

ExportcreditsubsidiesAformofasubsidizedloantothebuyerofexports.Theyhavethesameeffectasregularexportsubsidies.NationalprocurementPurchasesbythegovernment(orpublicfirms)canbedirectedtowardsdomesticgoods,eveniftheyaremoreexpensivethanimports.Red-tapebarriersSometimesgovernmentsplacesubstantialbarriersbasedonhealth,safetyandcustomsprocedures.OtherInstrumentsofTradePolicy45OtherTradePolicyInstrumentsTheEffectsofTradePolicy:

ASummaryTable8-1:EffectsofAlternativeTradePolicies46TheEffectsofTradePolicy:

SummaryAtariffdrivesawedgebetweenforeignanddomesticprices,raisingthedomesticpricebutbylessthanthetariffrate(exceptinthe“small”countrycase).Inthesmallcountrycase,atariffisfullyreflectedindomesticprices.Thecostsandbenefitsofatarifforothertradepolicyinstrumentsmaybemeasuredusingtheconceptsofconsumerandproducersurplus.ThedomesticproducersofagoodgainThedomesticconsumersloseThegovernmentcollectstariffrevenue47SummaryAtariffdrivesawedgeSummaryThenetwelfareeffectofatariffcanbeseparatedintotwoparts:Efficiency(consumptionandproduction)lossTermsoftradegain(iszerointhecaseofasmallcountry)Anexportsubsidycausesefficiencylossessimilartoatariffbutcompoundstheselossesbycausingadeteriorationofthetermsoftrade.Underimportquotasandvoluntaryexportrestraintsthegovernmentoftheimportingcountryreceivesnorevenue.48SummaryThenetwelfareeffectTable8AI-1:FreeTradeEquilibriumforaSmallCountryAppendixI:TariffAnalysisinGeneralEquilibriumSlope=-P*M/P*FManufacturesproductionandconsumption,QM,DMFoodproductionandconsumption,QF,DFD1Q149Table8AI-1:FreeTradeEquiliQF,DFQM,DMQ2D2Slope=-P*M/P*F(1+t)Table8AI-2:ATariffinaSmallCountryAppendixI:TariffAnalysisinGeneralEquilibrium50QF,DFQM,DMQ2D2Slope=-P*M/Table8AI-3:EffectofaTariffontheTermsofTradeAppendixI:TariffAnalysisinGeneralEquilibriumFM1Slope=(P*M/P*F)11Slope=(P*M/P*F)2M223Homeexportsofmanufactures,QM

-

DMForeignimportsofmanufactures,D*M-

Q*MHomeimportsoffood,DF-QFForeignexportsoffood,Q*F

-D*FO51Table8AI-3:EffectofaTarifDAppendixII:TariffsandImportQuotasinthePresenceofMonopolyTable8AII-1:AMonopolistUnderFreeTradePrice,PQuality,QPWPMMCMRDfQMQf52DAppendixII:TariffsandImpoDAppendixII:TariffsandImportQuotasinthePresenceofMonopolyTable8AII-2:AMonopolistProtectedbyaTariffPrice,PQuality,QPWPMMCMRDfQMQfDtQtPW+t53DAppendixII:TariffsandImpoPrice,PQuality,QPWPqAppendixII:TariffsandImportQuotasinthePresenceofMonopolyTable8AII-3:AMonopolistProtectedbyanImportQuotaMCMRqDqDQq54Price,PQuality,QPWPqAppendixPrice,PQuality,QPWPqPW+tAppendixII:TariffsandImportQuotasinthePresenceofMonopolyTable8AII-4:ComparingaTariffandaQuotaMCMRqDqDQtQq55Price,PQuality,QPWPqPW+tApChapter8TheInstrumentsofTradePolicyPreparedbyIordanisPetsasToAccompany

InternationalEconomics:TheoryandPolicy,SixthEditionbyPaulR.KrugmanandMauriceObstfeld56Chapter8PreparedbyIordanisIntroductionBasicTariffAnalysisCostsandBenefitsofaTariffOtherInstrumentsofTradePolicyTheEffectsofTradePolicy:ASummarySummaryAppendixI:TariffAnalysisinGeneralEquilibriumAppendixII:TariffsandImportQuotasinthePresenceofMonopolyChapterOrganization57IntroductionChapterOrganizatiIntroductionThischapterisfocusedonthefollowingquestions:Whataretheeffectsofvarioustradepolicyinstruments?Whowillbenefitandwhowilllosefromthesetradepolicyinstruments?Whatarethecostsandbenefitsofprotection?Willthebenefitsoutweighthecosts?Whatshouldanation’stradepolicybe?Forexample,shouldtheUnitedStatesuseatarifforanimportquotatoprotectitsautomobileindustryagainstcompetitionfromJapanandSouthKorea?58IntroductionThischapterisfoClassificationofCommercialPolicyInstrumentsIntroductionCommercialPolicyInstrumentsTradeContractionTradeExpansionTariffExporttaxImportquotaVoluntaryExportRestraint(VER)ImportsubsidyExportsubsidyVoluntaryImportExpansion(VIE)PriceQuantityPriceQuantity59ClassificationofCommercialPBasicTariffAnalysisTariffscanbeclassifiedas:SpecifictariffsTaxesthatareleviedasafixedchargeforeachunitofgoodsimportedExample:Aspecifictariffof$10oneachimportedbicyclewithaninternationalpriceof$100meansthatcustomsofficialscollectthefixedsumof$10.AdvaloremtariffsTaxesthatareleviedasafractionofthevalueoftheimportedgoodsExample:A20%advaloremtariffonbicyclesgeneratesa$20paymentoneach$100importedbicycle.60BasicTariffAnalysisTariffscAcompoundduty(tariff)isacombinationofanadvaloremandaspecifictariff.

Moderngovernmentsusuallyprefertoprotectdomesticindustriesthroughavarietyofnontariffbarriers,suchas:ImportquotasLimitthequantityofimportsExportrestraintsLimitthequantityofexportsBasicTariffAnalysis61Acompoundduty(tariff)isaSupply,Demand,andTradeinaSingleIndustrySupposethattherearetwocountries(HomeandForeign).Bothcountriesconsumeandproducewheat,whichcanbecostlesstransportedbetweenthecountries.Ineachcountry,wheatisacompetitiveindustry.SupposethatintheabsenceoftradethepriceofwheatatHomeexceedsthecorrespondingpriceatForeign.ThisimpliesthatshippersbegintomovewheatfromForeigntoHome.TheexportofwheatraisesitspriceinForeignandlowersitspriceinHomeuntiltheinitialdifferenceinpriceshasbeeneliminated.BasicTariffAnalysis62Supply,Demand,andTradeinaTodeterminetheworldprice(Pw)andthequantitytrade(Qw),twocurvesaredefined:HomeimportdemandcurveShowsthemaximumquantityofimportstheHomecountrywouldliketoconsumeateachpriceoftheimportedgood.Thatis,theexcessofwhatHomeconsumersdemandoverwhatHomeproducerssupply:MD=D(P)–S(P)ForeignexportsupplycurveShowsthemaximumquantityofexportsForeignwouldliketoprovidetherestoftheworldateachprice.Thatis,theexcessofwhatForeignproducerssupplyoverwhatforeignconsumersdemand:XS=S*(P*)–D*(P*)BasicTariffAnalysis63Todeterminetheworldprice(Quantity,QPrice,PPrice,PQuantity,QMDDSAPAP2P1S2D2D2–S22S1D1D1–S11Figure8-1:DerivingHome’sImportDemandCurveBasicTariffAnalysis64Quantity,QPrice,PPrice,PQuaPropertiesoftheimportdemandcurve:Itintersectstheverticalaxisattheclosedeconomypriceoftheimportingcountry.Itisdownwardsloping.Itisflatterthanthedomesticdemandcurveintheimportingcountry.BasicTariffAnalysis65PropertiesoftheimportdemanP2P*AD*S*P1XSPrice,PPrice,PQuantity,QQuantity,QS*2–D*2S*2D*2Figure8-2:DerivingForeign’sExportSupplyCurveBasicTariffAnalysisD*1S*1S*1–D*166P2P*AD*S*P1XSPrice,PPrice,PQPropertiesoftheexportsupplycurve:Itintersectstheverticalaxisattheclosedeconomypriceoftheexportingcountry.Itisupwardsloping.Itisflatterthatthedomesticsupplycurveintheexportingcountry.BasicTariffAnalysis67PropertiesoftheexportsupplFigure8-3:WorldEquilibriumXSPrice,PQuantity,QMDPWQW1BasicTariffAnalysis68Figure8-3:WorldEquilibriumXUsefuldefinitions:Thetermsoftradeistherelativepriceoftheexportablegoodexpressedinunitsoftheimportablegood.Asmallcountryisacountrythatcannotaffectitstermsoftradenomatterhowmuchittradeswiththerestoftheworld.Theanalyticalframeworkwillbebasedoneitherofthefollowing:TwolargecountriestradingwitheachotherAsmallcountrytradingwiththerestoftheworldBasicTariffAnalysis69Usefuldefinitions:BasicTarifEffectsofaTariffAssumethattwolargecountriestradewitheachother.SupposeHomeimposesataxof$2oneverybushelofwheatimported.Thenshipperswillbeunwillingtomovethewheatunlessthepricedifferencebetweenthetwomarketsisatleast$2.Figure8-4illustratestheeffectsofaspecifictariffof$tperunitofwheat.BasicTariffAnalysis70EffectsofaTariffBasicTarifXSPTMDD*S*DSPW2QT1QWBasicTariffAnalysisFigure8-4:EffectsofaTariffP*T3tPrice,PQuantity,QPrice,PQuantity,QPrice,PQuantity,QHomemarketWorldmarketForeignmarketHomemarketWorldmarketForeignmarket71XSPTMDD*S*DSPW2QT1QWBasicTariIntheabsenceoftariff,theworldpriceofwheat(Pw)wouldbeequalizedinbothcountries.Withthetariffinplace,thepriceofwheatrisestoPTatHomeandfallstoP*T

(=PT

–t)atForeignuntilthepricedifferenceis$t.InHome:producerssupplymoreandconsumersdemandless

duetothehigherprice,sothatfewerimportsaredemanded.InForeign:producerssupplylessandconsumersdemandmoreduetothelowerprice,sothatfewerexportsaresupplied.Thus,thevolumeofwheattradeddeclinesdueto