Question

Can import duties have unintended side effects? Discuss in detail its effect on (1) consumers, (2) producers and (3) government.

Answer 1

An import duty (import tariff) increases domestic price compared to pre-tariff price, which decreases consumer surplus (CS) with the unintended effect of deadweight (social inefficiency) loss. However, producer surplus (PS) rises and government collects tariff revenue.

In following graph, AB and CD are domestic demand and supply curves intersecting at point E with autarkic price P1 and quantity Q1. With free trade, relevant price is P* (world price, assuming this is a small country). Quantity demanded is Q2, quantity supplied is Q3 and imports equal (Q2 - Q3). CS (area between demand curve and market price) equals area AFP* and PS (area between supply curve and market price) equals area CGP*. When a tariff is imposed, price rises to Pt. Quantity demanded falls to Q4, quantity supplied rises to Q5 and imports equal (Q4 - Q5) [< (Q2 - Q3)]. CS (area between demand curve and market price) falls to area AHPt (Loss in CS equals area P*FHPt) and PS (area between supply curve and market price) rises to area CJPt (Gain in PS equals area P*GJPt). Government collects tariff revenue equal to area JHLK. There is a deadweight loss equal to sum of area FHL and area GJK.