Question

Let’s compare a tariff (tax on imports) to an increase in money supply in the short term, assuming that both depreciate the currency. How do they differ in effects on welfare? Why do many economists believe there are restrictions on countries ability to use tariffs to expand domestic output that are not present in the original model?

Answer 1

Tariff and increase in money supply differ in the welfare effect made by these two initiatives. Implementing tariff is going to increase the price in the economy with efficiency where consumers have to pay a higher price for lesser quality goods. It reduces the welfare of people in the economy, though it benefits domestic producers of the protected industries. In contrast to increase in money supply, increases the welfare, as it makes borrowing to be cheaper for households and firms. Besides, it creates jos for the people in labor market. Hence, economy expands as well. So, overall welfare increases with increase in money supply, even if it also contributes to the rise in price. Here, rise in price is due to the increased in spending of the people.

Economists believe in the restrictions, because putting tariff, promotes higher price and higher inefficiency in domestic goods. It makes consumers to pay more and disposable income decreases for other goods. It makes demand for other goods to decrease and these unprotected industries contract, and lay off workers. It decreases AD in the economy and real output does not increase. So, putting tariff, is not going to expand output in the economy.