37The meaning of tariff. Describe its economic effects.

The effects of a tariff

Tariff - Tax on goods produced abroad and sold domestically

Free trade: Domestic price = world price

Tariff on imports: Raises domestic price above world price (By the amount of the tariff)

38Defi

e an import quota. Compare its economic effects with those of a tariff.

An import quota- Means of restricting the quantity of imports through import licenses, either of a certain item or from a certain country. See also import restrictions.

Similarities with tariffs

They both result in higher domestic prices, an increase in domestic production of the good and a decrease in imports.

Consumer surplus decreases by the same amount (for a tariff-equivalent quota). Producer surplus increases by the same amount.

Deadweight costs are the same. (If the quota rents are both captured by the importing country and not wasted on rent-seeking act

Differences from tariffs

Under an equivalent quota, the distribution of quota rents equivalent to the tariff revenue can vary. It can be given to domestic producers or importers, foreign governments or foreign producers, or auctioned and retained

In the longer run, a quota will impose larger distortions on an economy than would a tariff. When domestic demand increases, a tariff would allow the price to remain constant at the world price plus the tariff, and imports to increase. A quota will lead to a rising price, a constant level of imports, and larger deadweight

39Determine the arguments people use to advocate trade restrictions.

The jobs argument - “Trade with other countries destroys domestic jobs”

(Free trade creates jobs at the same time that it destroys them)

The national-security argument - “The industry is vital for national security”

When there are legitimate concerns over national security

The infant-industry argument

“New industries need temporary trade restriction to help them get started”

Difficult to implement in practice

The “temporary” policy – hard to remove

Protection is not necessary for an infant industry to grow

The unfair-competition argument

“Free trade is desirable only if all countries play by the same rules”

Increase in total surplus for the country

The protection-as-a-bargaining-chip argument - “Trade restrictions can be useful when we bargain with our trading partners”. The threat may not work

40 Describe what happens to the gains from trade when a tax is imposed.

ANSWER: A tax causes a reduction in the gains from trade by raising the price the buyer pays and reducing the price the seller receives. Hence, it will reduce the total volume of trade. This causes a loss of consumer surplus and producer surplus referred to as deadweight loss. The tax will reduce the gains realized from some trades and will discourage other trades from being made at

all

• 42 Describe why externalities can make market outcomes inefficient. Use the graphs to explain.

• Self-interested buyers and sellers neglect the external effects of their actions, so the market outcome is not efficient.

• Another principle from Chapter 1:

Governments can sometimes improve market outcomes.

Pollution: A Negative Externality

• Example of negative externality: Air pollution from a factory.

• The firm does not bear the full cost of its production, and so will produce more than the socially efficient quantity.

• How govt may improve the market outcome:

• Impose a tax on the firm equal to the external cost of the pollution it generates

Other Examples of Negative Externalities

• the neighbor’s barking dog

• late-night stereo blasting from the dorm room next to yours

• noise pollution from construction projects

• talking on cell phone while driving makes the roads less safe for others

• health risk to others from second-hand smoke

Positive Externalities from Education