Question

how do we calculate effect of a tariff

Answer 1

Effect of tariff can be calculated by use of a graph, as follows.

In following graph, AB & CD are domestic demand & supply curves of the good. Pre-trade equilibrium is at point E with price P1 & quantity Q1. With free trade, world price is P* for which domestic consumption is Q2 and domestic production is Q3, therefore imports equal (Q2 - Q3).

Consumer surplus (CS) = Area between demand curve and world price = Area AFP*

Producer surplus (PS) = Area between supply curve and world price = Area CGP*

Imposition of tariff will increase the price of the good, and domestic price rises to Pt, at which domestic consumption is Q4 and domestic production is Q5, therefore imports equal (Q4 - Q5). The tariff leads to a fall in import.

After tariff, New CS = Area AHPt and new PS = Area CJPt.

Loss in CS = Area PtHFP*, therefore consumers lose.

Gain in PS = Area PtJGP*, therefore producers gain.

Tariff revenue = Area PtHLP*, therefore government gains in terms of tariff revenue.

Social inefficiency (deadweight) loss = Area FHL + Area GJK