Question

An increase of tariff on steel in the US will increase domestic steel production and will reduce the quantity of steel imports in the US. Domestic producers of steel in the US will be better off, and domestic consumers of steel in the US will be worse off. With a tariff, the sum of the producers’ and the consumers’ surplus in the US steel market will decrease by an amount referred to as a deadweight loss. Is it true? Please explain, why?

Answer 1

The statement is false.

Effect of tariff is shown in following graph.

AB & CD are domestic demand and supply curves. Pre-trade equilibrium is at point E with price P1 and quantity Q1. With free trade, world price is P* (< P1), for which domestic consumption is Q2 and domestic production is Q3, so 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*

A tariff will increase the price of the good to Pt, at which domestic consumption is Q4 and domestic production is Q5, so imports equal (Q4 - Q5).

After tariff,

New CS = Area AHPt

New PS = Area CJPt.

Loss in CS = Area PtHFP*

Gain in PS = Area PtJGP*

Tariff revenue = Area PtHLP*

Deadweight loss = Area FHL + Area GJK

So, Deadweight loss = (Decrease in CS + Decrease in PS) - Tariff revenue