Class sample: Task 2: applying trade theory

I. The fundamentals of trade policy
A. Trade restrictions
1. Tariffs

    b = loss from overproduction (MC>Pf)
    d = loss from underconsumption (MB>Pf)

    In the real world, the true impact of a tariff on domestic activity is typically much greater than its nominal rate.

    Nominal tariff rate (tnom)
    = tariff as a % of price
    Tariff schedules report this

    Effective tariff rate (teff)
    = tariff as a % of value added (VA)
    VA = price minus cost of materials per unit = true impact (worksheet)
    Tariff schedules do not report this

    Basic idea: the beneficiaries of tariffs are the owners of the primary inputs (labor and capital) used in the exact stage of production that is protected. They are the ones who get the value added.

    Usually, teff > tnom: 
    Example: instant coffee: teff > tnom if tnom=0 on raw coffee
    Free trade: Pcoffee = $5, Materials = $3 => VAf=$2
    Tariff on coffee = 20%: P=$6, CM = 3$ => VAt=3$ => teff = 50%

    Possibly, teff < 0: 
    Example: garments: teff < 0 if cotton tariff > garment tariff
    Free trade: Pg = $50, Cost of materials = $30 => VAf=$20
    Tariff on garments = 20%, Tariff on materials = 50%: Pg=$60, M = $45 => VAt=15$ => teff = -25%

2. Quotas

    = a nontariff trade barrier to trade (NTB): reach the same basic end as tariffs, but by restricting Qm instead of directly raising prices.
    economists generally feel they are much worse than tariffs.

    Mostly illegal now under the WTO
    In the past, allowable as part of agricultural price support programs: dairy products, meat, sugar, peanuts
    Government enforces quotas by issuing import licenses
    Since quotas raise domestic P above world P, these licenses can be profitable to have
    Who gets the profits depends on how the import licenses are distributed:
    --government if import licenses are auctioned off
    --importing firms at home if given away to domestic importers
    --exporting firms abroad if given away to foreign countries

    Refer to quota worksheet 
    Key trick: Quota => shift S to the right by the size of the quota

        The key question is: What happens to box c?
    With tariff, c = tariff revenue
    With quota = quota rents (profits)

    --a domestic transfer if quota licenses go to a domestic resident or are auctioned off by the government => domestic quota rents = c
    --a loss of national welfare if the licenses are given to exporters

    All trade restrictions raise the domestic price of imported items.
    The question separating them is, how much of that higher price goes to the exporter.

    Empirical impact of dairy quotas:
    CS: -$1.2B
    Jobs "saved" = 2,400
    => cost to consumers per job "saved": 
    $1.2B / 2,400 = $500,000

    For WTO members:
    Quotas in agriculture ended in 2001
    replaced by tariffs: tariffication

    Every quota has an equivalent tariff (and vice versa) => the same results in terms of domestic price and output effects.

    WTO: "For many ... products, ... market access restrictions involved non-tariff barriers. This was frequently, though not only, the case for major temperate zone agricultural products. The Uruguay Round negotiations aimed to remove such barriers. For this purpose, a 'tariffication' package was agreed which, amongst other things, provided for the replacement of agriculture-specific non-tariff measures with a tariff which afforded an equivalent level of protection."

    Ex. in dairy handout: a tariff of $1 is equivalent to a quota of 2 billion pounds