welfare implications of trade barriers
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Welfare Implications of Trade Barriers. Chapter 14. Consumer Surplus. A demand curve represents willingness to pay by demanders Demand curves array these different individuals’ preferences in order of their willingness to pay. Consumer Surplus. P. Demand for Shania Twain - PowerPoint PPT PresentationTRANSCRIPT
Welfare Implications of Trade Barriers
Chapter 14
Consumer Surplus
• A demand curve represents willingness to pay by demanders
• Demand curves array these different individuals’ preferences in order of their willingness to pay
Consumer Surplus
D
Q
PDemand for Shania Twaintickets (or anything else)is downward-sloping. Those who are most willing to pay appearon the upper part of the curve;those less willing to pay are loweron the curve
Consumer Surplus
D
Q
PSuppose the price of a Shania Twain ticket is P*
P*
Consumer Surplus
D
Q
PSo the first consumer gets a deal:he or she is willing to pay P1, but only has to pay P*
P*
P1
Consumer Surplus
D
Q
PThe first consumer gets a surplusequivalent to the shaded area
P*
P1
Consumer Surplus
D
Q
PThe second consumer is willingto pay a bit less, P2. But he orshe still makes out well, sincethe actual market price is only P*
P*
P2
Consumer Surplus
D
Q
PThe second consumer receives asurplus equivalent to the shadedregion. Each consumer who purchases this product gets a littlesurplus.
P*
P2
Consumer Surplus
D
Q
PAll of the individuals’ surplusescan be added together to form ameasure of consumer well-being.CS is the area between the demandcurve and the price.
P*
Consumer Surplus
• If the price rises, CS gets smaller and consumers are worse off
Consumer Surplus
D
Q
P
P*
Consumer Surplus
D
Q
PIf the price rises to P*
1, CS fallsto the area of the green triangle,reflected diminished consumer well-being
P*
P*1
Consumer Surplus
D
Q
PThe yellow shaded area is theloss in consumer surplus
P*
P*1
Consumer Surplus
• If the price falls, CS gets larger and consumers are better off
Consumer Surplus
D
Q
P
P*
Consumer Surplus
D
Q
PIf the price falls to P*
1, consumer surplus rises. Consumers are betteroff.
P*
P*1
Producer Surplus
• A supply curve arrays suppliers in order according to their marginal costs
• The first firm on the supply curve has the lowest marginal cost, the second firm has the second-lowest marginal cost, etc.
Producer Surplus
S
Q
P
Supply is upward-sloping. Those firms with the lowest MC appearon the lower part of the supplycurve; those suppliers with higherMC are farther up
Producer Surplus
S
Q
PSuppose the market price is P*
P*
Producer Surplus
S
Q
P
So the first supplier gets a deal:he or she is able to charge P*, but only incurs costs of P1
P*
P1
Producer Surplus
S
Q
P
The first supplier receivesa surplus (like profit) equalto the area of the shaded rectangle
P*
P1
Producer Surplus
S
Q
P
When we add together thefirst supplier’s surplus to the second’s (and all the others) we get total producersurplus (PS)
P*
PS is the area between the price and the supply curve.It is a measure of overall well-being of producers
Changes in PS
• PS rises when the price rises
• PS falls when the price falls
Tariffs: A Welfare Analysis• What happens when a country imposes a tariff?
Its domestic price rises• We know from before that tariffs:
– benefit domestic producers
– harm domestic consumers
– generate tariff revenue for the government
• What’s the overall effect on the domestic economy? Could a tariff ever increase a country’s welfare?
Tariffs: A Welfare Analysis
D
Q
P S
$1
Suppose the free trade
price is $1; 1000 units are
imported
1000 2000
Tariffs: A Welfare Analysis
D
Q
P S
$1
A 35% tariff raises the price to
$1.35, lowering imports to 500
units$1.35
1000 20001250 1750
Tariffs: A Welfare Analysis
D
Q
P S
$1
CS declines by the shaded area
$1.35
1000 20001250 1750
Tariffs: A Welfare Analysis
D
Q
P S
$1
We can quantify this: the area
of the rectangle is (1750)*.35
= $612.50 The triangle’s area is
.5(.35)250 = $43.75. Thus we can
calculate total CS loss as $656.25.$1.35
1000 20001250 1750
Tariffs: A Welfare Analysis
D
Q
P S
$1
Meanwhile, PS rises by the shaded
area
$1.35
1000 20001250 1750
Tariffs: A Welfare Analysis
D
Q
P S
$1
Again, this is quantifiable: the
area of the rectangle is (1000*.35)
= $350. The area of the triangle is
(.5)(250)(.35) = $43.75. The total
gain to producers is $393.75
$1.35
1000 20001250 1750
Tariffs: A Welfare Analysis
D
Q
P S
$1
To recap: the loss in CS is bigger
than the gain in PS, so we are
faced with an overall loss
equivalent to the shaded area:
$1.35
1000 12501750 2000
Tariffs: A Welfare Analysis
D
Q
P S
$1
Happily, some of this loss is
recaptured in the form of tariff
revenue
$1.35
1000 12501750 2000
Tariff revenue = 500*.35 = $175
Tariffs: A Welfare Analysis
D
Q
P S
$1
What remains is called
deadweight loss (DWL): society
is worse off by the area of the
two DWL triangles
$1.35
1000 12501750 2000
Tariffs: A Welfare Analysis
D
Q
P S
$1
DWL = (.5)(250)(.35) +
(.5)(250)(.35) = $87.50
$1.35
1000 12501750 2000
Deadweight Loss
• One can calculate DWL by – figuring out the area of the two triangles, or– summing the loss in CS, the gain in PS, and the
gain in tariff revenue
• You should get the same answer either way!
DWL
Loss in CS: -$656.25
Gain in PS: $393.75
Gain in revenue: $175.00
===================
DWL: -$ 87.50
Note: this is the same number we calculated before
Tariffs: Larger Countries
• In the previous analysis, the tariff caused the imposing country’s price to rise by the full amount of the tariff
• This would mean that the imposing country is “small”; if it imposes a tariff, it is unable to affect the world price
• What if a country is not “small”?
Tariffs: Larger CountriesP
Q
P
Q
S
D
S
D
Importing CountryImporting Country Exporting CountryExporting Country
PICA
PECA
Tariffs: Larger CountriesP
Q
P
Q
S
D
S
D
Importing CountryImporting Country Exporting CountryExporting Country
PICA
PECA
PFT
Tariffs: Larger CountriesP
Q
P
Q
S
D
S
D
Importing CountryImporting Country Exporting CountryExporting Country
PFT
Tariff causes price
to rise in imposing
country
Tariff causes price to fall
in exporting country
Tariffs: Larger CountriesP
Q
P
Q
S
D
S
D
Importing CountryImporting Country Exporting CountryExporting Country
PFT
Imports fall Exports fall
Tariffs: Larger CountriesP
Q
P
Q
S
D
S
D
Importing CountryImporting Country Exporting CountryExporting Country
PFT
CS falls
Tariffs: Larger CountriesP
Q
P
Q
S
D
S
D
Importing CountryImporting Country Exporting CountryExporting Country
PFT
PS rises
Tariffs: Larger CountriesP
Q
P
Q
S
D
S
D
Importing CountryImporting Country Exporting CountryExporting Country
PFT
Tariff revenue
is created
Tariffs: Larger CountriesP
Q
P
Q
S
D
S
D
Importing CountryImporting Country Exporting CountryExporting Country
PFT
Revenue paid by
imposing-country
consumers
Tariffs: Larger CountriesP
Q
P
Q
S
D
S
D
Importing CountryImporting Country Exporting CountryExporting Country
PFT
Revenue paid by
exporters
Tariffs: Larger Countries
• After we account for the loss in consumer welfare:
Tariffs: Larger CountriesP
Q
P
Q
S
D
S
D
Importing CountryImporting Country Exporting CountryExporting Country
PFT
CS falls
Tariffs: Larger Countries
• After we account for:– the loss in consumer welfare, and– the gain in producer welfare
Tariffs: Larger CountriesP
Q
P
Q
S
D
S
D
Importing CountryImporting Country Exporting CountryExporting Country
PFT
PS rises
Tariffs: Larger Countries
• After we account for:– the loss in consumer welfare, and– the gain in producer welfare and– the gain in revenue
Tariffs: Larger CountriesP
Q
P
Q
S
D
S
D
Importing CountryImporting Country Exporting CountryExporting Country
PFT
Tariffs: Larger Countries
• After we account for:– the loss in consumer welfare, and– the gain in producer welfare and– the gain in revenue,
• We are left with our DWL triangles (as a loss), and part of our tariff revenue box (as a gain)
Tariffs: Larger CountriesP
Q
P
Q
S
D
S
D
Importing CountryImporting Country Exporting CountryExporting Country
PFT
DWLRevenue gain
Tariffs: Larger Countries
• It’s possible for a country to improve its welfare if the revenue captured from exporters exceeds the DWL.
• This happens when the imposing country is large, because in that case the imposing country’s price rises by very little and the exporting country’s price falls by a lot.
Import Quotas: Welfare Implications
• Recall that quotas and tariffs can be designed to be equivalent
• The difference is that with quotas the government generally doesn’t collect revenue, holders of the import licenses get the rent
• So the welfare implications of a quota are the same as those of a tariff:
Import Quotas: Welfare Implications
• The quota-imposing country will see CS fall, and PS rise
• The quota-imposing country will see DWL, but also rent
• Overall, the country will be better off if the rent gained from the other country exceeds the DWL; this could happen for larger countries
• Small countries are worse off for quotas
Tariffs vs. Quotas
• If protection is necessary, tariffs may be preferable to quotas since:– rent is not available for all citizens (only
license-holders– tariffs allow for technological advance– quotas encourage inefficient “rent-seeking”
behavior
Voluntary Export Restraints: Welfare Effects
• Similar to tariffs or quotas, VERs raise the domestic price which– lowers CS– raises PS
• Rent, however, is captured by the exporting country
• The imposing country will lose not only the DWL triangles, but also the rent rectangle
Voluntary Export Restraints: Welfare Effects
Bottom line: VERs lower a country’s short run welfare in both the large and the small country cases
Export Taxes: Welfare Implications
• As we know, export taxes cause the price in the imposing (i.e., exporting) country to fall, since some of what had been exported is not anymore
• We’d predict an increase in CS, a decrease in PS, and a gain in revenue
• What is the overall effect?
Export Taxes: Welfare Implications
P
Q
S
D
PFT
Exports
Export Taxes: Welfare Implications
P
Q
S
D
PFT
PET
The export tax causes
the domestic price to
fall, and exports to
decrease
exports
Export Taxes: Welfare Implications
P
Q
S
D
PFT
PET
CS rises by the shaded
area
Export Taxes: Welfare Implications
P
Q
S
D
PFT
PET
PS falls by the shaded
area
Export Taxes: Welfare Implications
P
Q
S
D
PFT
PET
Revenue rises by
the shaded area
Export Taxes: Welfare Implications
P
Q
S
D
PFT
PET
Overall welfare falls
by the DWL triangles
Export Taxes: Welfare Implications
• For the small country, the loss in producer welfare outweighs the gain in consumer welfare and in tax revenue
• Overall, the small country is worse off as a result of imposing the export tax
• What about larger countries?
Export Taxes: Larger CountriesP
Q
P
Q
S
D
S
D
Importing CountryImporting Country Exporting CountryExporting Country
PICA
PECA
PFT
Export Taxes: Larger CountriesP
Q
P
Q
S
D
S
D
Importing CountryImporting Country Exporting CountryExporting Country
PFT
ET causes price
to rise in importing
country
ET causes price to fall
in imposing country
Export Taxes: Larger CountriesP
Q
P
Q
S
D
S
D
Importing CountryImporting Country Exporting CountryExporting Country
PFT
Imports fall Exports fall
Export Taxes: Larger CountriesP
Q
P
Q
S
D
S
D
Importing CountryImporting Country Exporting CountryExporting Country
PFT
CS rises
Export Taxes: Larger CountriesP
Q
P
Q
S
D
S
D
Importing CountryImporting Country Exporting CountryExporting Country
PFT
PS falls
Export Taxes: Larger CountriesP
Q
P
Q
S
D
S
D
Importing CountryImporting Country Exporting CountryExporting Country
PFT
Tax revenue is generated
Export Taxes: Larger CountriesP
Q
P
Q
S
D
S
D
Importing CountryImporting Country Exporting CountryExporting Country
PFT
Tax revenue from
importing country
Tax revenue from
domestic exporters
Export Taxes: Larger Countries
• After we account for:– the loss in producer welfare, and– the gain in consumer welfare and– the gain in revenue,
• We are left with our DWL triangles (as a loss), and part of our tariff revenue box (as a gain)
Export Taxes: Larger CountriesP
Q
P
Q
S
D
S
D
Importing CountryImporting Country Exporting CountryExporting Country
PFT
Revenue from
importing country
DWL
Export Taxes: Larger Countries
• It’s possible for a country to improve its welfare if the revenue captured from the importing country exceeds the DWL.
• This happens when the imposing country is large, because in that case the imposing country’s price falls by very little and the importing country’s price rises by a lot.
Export Subsidies
• Export subsidies– increase volume of exports– raise price in exporting country (b/c less is
available on the domestic market)– do not generate revenue, but rather generate
costs to the imposing country government– may lower the world price, if the subsidy-
imposing country is large enough
Export Subsidies: Welfare Effects
• CS falls• PS rises• But there is no revenue; instead cost• Overall, export subsidies are welfare-
diminishing for small countries and for large countries
• There could be long-run gains; there aren’t any in the short run