In: Economics
"Beijing charged Australia a heavy penalty for Australian Prime Minister's support on Trump's Covid-19 comment. China imposed 80.5 percent tariff on Australi's barley export. Three quarters of Australian exports were to China. Australi, which is the number one barley supplier of China, was exporting 1.5-2 billions dollars worth of barley here and this accounted for half of all of their export. Chinese Minister of Commerce declared that the tax will stand for the next 5 years."
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1) Show the partial equilibrium effects of the tariff China imposed on barley bought from Australia by drawing graph. What are the effects of this tariff on consumer surplus, producer surplus and government income.
2)What is the effect of this tariff on China's total welfare.
3) When determining the tariff, how China should use the fact that it is a big country and it has the power to effect the barley price in the world?
4)How will this tariff effect Australia's welfare? Using the trade policy, how should Australia respond to China's tariff on barley?
Now, the tariff that has been imposed by China on Australia will effect both China and Australia in its own way. So, the pretty high 80% tariff has been imposed by China on the Barley imports that come from Australia. China is the world's largest producer and consumer of beer, and Australian barley exporters are highly dependant on China as three quarters of its exports are to China. Now, tariff is a type of counterveiling duty levied by the government which is imposed on the goods and services imported from other countries. This increases the price of the imported goods, because the producers tend to shift the tax burden to the consumers. Seeing this, even the domestic producers have no pressure to reduce their prices and domestic consumers are left to pay higher prices in the process. The higher prices benefits the domestic producers, and the government benefits from the tax revenue, but both take place at the expense of consumers.
1) Let us see what the partial equlibrium effects of this increase in tariff will be:
Production Effect:
As tariffs restrict the flow of barley from foreign, the domestic producers find an opportunity to raise the domestic production of the import substitutes. This effect of tariff is known as the import substitution effect. The world supply curve is perfectly elastic, domestic supply is positively sloping, domestic demand curve slopes negatively. Before the tariff is imposed, SW is the world supply curve, pre-tariff price is OP0, and at this price, the domestic supply is OQS and demand is OQD. Now, this gap between the demand and the supply is filled via the import of the good from abroad. If a per unit tariff of PPT is imposed on the import, the price will increase to OP1 and the world supply curve will shift upwards to Sw' and at this increased price, the demand falls from OQD to OQD' and domestic supply increases from OQS to OQS'. So, the domestic production of import substitutes increases and reduces the demand for barley products from abroad i.e. Australia. So, this increase in domestic production is profitable to the producers. This is reffered to as producer surplus.
Consumer Effect:
This imposition of a high tariff effectively reduces consumer demand as well as a fall in the net satisfaction. When prices increase to OP1 , the consumption reduces from OQD to OQD'. Now, out of this, the the consumption of home-produced good is OQS' and QD'QS' is the consumption of foreign produced good. So, there is a fall in consumption and net loss in consumer satisfaction. This is reffered to as the consumer surplus.
Revenue Effect:
Now, the imposition of tariff provides a for, of government revenue. The original pre-tariff price OP0 there is no revenue reciepy available to the government. But when P1P0 per unit tariff price is imposed, the revenue reciepts of the government can be calculated by multiplying the per unit tariff P1P0 with the quantity imported i.e. QD'QS'. This is reffered to as government income.
So, we see, levying tariffs on the imports causes a reduction in the consumer surplus and on the other hand, increases the producer surplus or economic rent of the domestic producers, and gives revenue to the government.
So, we can see there is a loss in the consumer surpus:
RHP - RCP1 = P0HCP1
There's a gain the producer's surpus:
TBP1 - TAP0 = P0ABP1
Gain in the government revenue:
P0P1 * QS'QD' = BF * EF = BCEF
So, net loss in welfare = P0HCP1 - (P0ABP1 + BCEF) = BAF + CEH
Take a look at fig 1:
2) Whenever a large country like China implements a small tariff, it may raise the national welfare. However, if the tariff is set too high, like in this case, its 80.5%, so the national welfare will reduce. This means that the loss in consumer surplus will be more than the gain in producer surplus and government revenue.
3) It is generally believed that tariffs invite retaliation and big countries have the upper hand in this case. The bigger country is expected to gain from a tariff war. The big country has the ability to affect the barley price in the world, promoting domestic production and increasing the price domestic producers recieve, enabling profits and employment in the country. Big countries are price makers and small countries are price takers. But, in order to implement a tariff that will raise the national welfare, the importing country like China as its a big country, it needs to set the tariff rate accordingly. This will further improve the terms of trade which is basically the ratio of price of export goods to price of import goods.
4) Now, coming to the welfare of the exporting country, in this case being Australia, it reduces the national welfare considerably. It reduces the producer surplus, there is no govt revenue and there is a meagre increase in the consumer surplus. The farmers producing barley can see their profits being washed away as their demand for barley exports will fall due to the price getting nearly doubled due to the high tariffs. This leads to reduced production, employment,profits etc. There is a negative effect on teh production distortion, consumption distortion and a negative terms of trade. So, the sum of losses is more than the sum of the gains. So, there is a decrease in the overall national welfare of the exporting country.
Australia will need to export to other countries, though it will receive a much lesser price as it has lost its bargaining price now. It could take the possibility of retaliatory tariffs on the goods that are imported into Australia from China more seriously. It is however, actively considering an appeal to WTO, World Trade Organization which handles all overseas trade disputes.