INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY;  Charles van Marrewijk, 2006; 1

Tariff, general equilibrium

We consider the situation for a small
Y country faced with the production possibility
pworld frontier as drawn in the figure below.
At the given world price pworld it
Q* would produce at point Q* and
trade at world prices to
consume at point C*

C*
U*

ppf
0 X
INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY;  Charles van Marrewijk, 2006; 2
Tariff, general equilibrium
If the country imposes a tariff, t, on
Y its import good (good X) this rotates
pworld pworld(1+t) the price line for domestic
producers clockwise to pworld(1+t)
Q* They will start to
produce at point Q2

Q2
C*
U*

0 X
INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY;  Charles van Marrewijk, 2006; 3
Tariff, general equilibrium
Despite the tariff the country can still
Y trade with ROW at the price pworld
pworld pworld(1+t) So the income available to the
economy is represented by an income
Q* line parallel to the initial income line
through the new production point

Q2
C*
U*

0 X
INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY;  Charles van Marrewijk, 2006; 4
Tariff, general equilibrium
Consumers, like producers, face the price pworld(1+t)
Y They equalize the marginal rate
p world
pworld(1+t) of substitution with the distorted
price line along the new income
Q* line; a point like C2
The difference in production
and consumption income
(domestic prices) represents
Q2 tariff revenue
We assume that
this is redistributed C*
C 2

lump-sum to the U*
consumers U2

0 X
INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY;  Charles van Marrewijk, 2006; 5
Tariff, general equilibrium
Tariffs result in a double distortion. First,
Y producers change production and thus income.
pworld pworld(1+t) Welfare U1 at point C1 is still
attainable. Second, consumers are
Q* also confronted with distorted
prices, which lowers welfare to U2

Q2
C*
C 2 C1
U*
U2 U1

0 X
INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY;  Charles van Marrewijk, 2006; 6
Tariff, general equilibrium
Here is an enlargement of the welfare loss arising from the tariff
First, the production (income) loss
Second, the consumption loss
Check for yourself that the second loss
does not arise if a production subsidy is
given, rather than a tariff imposed.
C2 C*
C 1

U*

U2 U1