Question

Explain the economic effects of a tariff using the market model. Who pays the tariff?

Answer 1

Q. Explain the economic effects of a tarriff using the market model.

Ans. Tariff refes to duties or tax levied by the goverment on commodities which are imported into a country from abroad. It is import duties or custom duties.

A tariff raises the domestic price of the goods the tariffs is placed on.

Tariffs are used for two different purposes:

1. For Revenue

2. For Protection

Revenue tariifss are imposed on luxuary consumer goods. The lower the import duties, the larger is the revenue from them. Protective tariffs are meant to maintain and encourage those branches of domestic industry protected by the duties.

Economic effects of a tariff:

The effects of a tariff may be analysed from the point of the economy as a whole which is known as General Equilibrium analysis. If it is discussed from the point of view of a particular good or market, then it is known as partial equilibrium analysis.

Effects of Tariff under Partial Equilibrium:

It is the price effect that is first affected by a Tariff.

Price Effect: If a tariff is imposed on an imported commodity, the price of that commodity will rise, if the demand for the commodity is inelastic in the importing country. If demand for the imported commodity is highly elastic, the price of the commodity will not rise and the imort duty will be paid by the exporting country. If the position is inbetween, the price of the commodity in the importing country will not rise by the full amount of tax but only partly.

Charles Kindleberger has made an attempt to analyse effects of tariffs

1. Protective Effect: The Protective effects shows how th domestic industry can be protected from foreighn competition by imposing an import duty. The decrease in amount of imported goods due to price effects of tariffs is called production or protective effect. When the domestic producers face the higher price, they are able to cover the rising marginal cost of additional output and expand production.

2. Consumption effect: The Consumption effect of the tariff is to reduce the consumption of the commodity on which the tariff is imposed.

3. Revenue Effect: The Revenue Effect is the change in governments receipts as a result of the tariff. Revenue Effect is equal to the amount of the import duty multiplied by the quantity of imports.

4. Redistributive effect: The Redistribution effect results from producers receiving a high price for their commodity after the imposition of tarffiff. The redistribution effect is an addition to the producers is surplus derived by subtraction from consumer surplus. A part of loss of consumer's surplus which is neither transferable to the producers nor to the government is called, deadweight loss of the tariff or the cost of the tariff.

5. Terms of Trade Effect: If the supply of acommodity is perfectly inelastic in the exporting country and the demand for it fairly elastic in the importing country, the entire burden of the tariff will be borne by the exporting country. It means that after imposing the tariff, term of trade would move in favour of the country imposing the tariff.

6. Competitive Effect: The Competitive effect of a tariff is to protect the domestic industry from foreighn competition by imposing a tariff on the commodity imported.

7. Income Effect: The income effect refes to the effect of a tariff on the national income of a country imposing the tariff. A tariff reduces the demand for imported goods by rducing imports and increases the demand for domestic produced goods. This stimulates import substitution industries in the country. Expansion of these industries will mean more employment to people and increasing opportunities of earning income under conditions of less than full employment, import duty will raise money and real income and employment.

8. Balance of Payment Effect: A tariff reduces the country's intenational expenditure and bring stability in the balance of payments.