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LEARN IT WELL! TARIFF
and factors affecting success of tariff
as a protectionistic measure


A tariff is a tax on imports. Like all indirect taxes, tariffs have the impact of reducing the supply and raising
the equilibrium price of the import. This makes domestic products relatively cheaper, resulting in a fall in
imports. With reference to diagram 1, world supply is shown as Sw and consumers would pay a price P1.
Consumption of the good would be Q4. At this price, Q1 would be supplied by the domestic producers and
Q1Q4 will be imported. The imposition of tariff would shift the supply curve upwards. This would increase
the price to domestic consumers from P1 to P2. Production by domestic producers would increase from Q1
to Q2. Area B+D is the loss in societys welfare or deadweight loss due to the imposition of the tariff. Tariffs
distort market forces and prevent consumers from benefiting from all the advantages of international
specialization and trade.

Duagram 1: Effects of a tariff on price and output

















Evaluation:
Advantages : However, despite the welfare loss a tariff may make sense. It is a source of government
revenues that may be impossible to replace. Also the adjustment cost for displaced workers due to free
trade may be prohibitively high. Govt may not have the resources to cope with the displaced workers in
other ways e.g though training

Limitation:
(i) Dependent on PEDm:
The effectiveness of a tariff in reducing quantity demanded of imports depends on the elasticity (sensitivity)
of demand for the imported good. If the demand for the imported goods is very price inelastic then a tariff
has to be very large in order to reduce quantity demanded significantly. In diagram 1(a) if the PEDm is
more price elastic, a higher level of tariff (P1Pa) is required to reduce imports by the same amount.

Sd
Dd
P2

P1
Q1
Q4
Q2 Q3
Price of good X
Quantity of good X
Sw
A B C
D
Sw + tariff
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Diagram 1(a) : Effects of a tariff on price and output

















(ii) Dependent on PESm:
The effectiveness of a tariff in reducing quantity demanded of imports depends on the elasticity (sensitivity)
of demand for the imported good. If the demand for the imported goods is very price inelastic then a tariff
has to be very large in order to reduce quantity demanded significantly. In diagram 1(a) if the PESm is
more elastic a higher level of tariff (P1Pa) is required to reduce imports by the same amount.

Diagram 1(b) : Effects of a tariff on price and output




















Sd (inelastic)
Dd
Pa
P2
P1
Q1
Q4
Q2 Q3
Price of good X
Quantity of good X
Sw
Sw + tariff (tariff = P1Pa)
Sd(elastic) Sd
Sw + tariff (a) (tariff = P1P2)
Dd(elastic)
Sd
Dd (inelastic)
Pa
P2
P1
Q1 Q4 Q2 Q3
Price of good X
Quantity of good X
Sw
Sw + tariff (tariff = P1Pa)
Sw + tariff (tariff = P1P2)
Price elastic ss curveLower tariff
(P1P2) needed to reduce imports to
Q2Q3
Price inelastic ss curve Higher tariff
( P1Pa) needed to reduce imports to
the same amount
Price elastic dd curveLower tariff
(P1P2) needed to reduce imports to
Q2Q3
Price inelastic dd curve Higher
tariff ( P1Pa) needed to reduce
imports to the same amount
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(iii) Retaliation by trading partners
The tariff may invite retaliation from its trading partners leading to reduction in world trade. A devaluation
could be ineffective if trading partners retaliate erecting protectionistic measures such as tariffs, quotas or
by devaluing their currencies in response. A tariff is a tax on imports. Tariffs have the impact of reducing
the supply and raising the equilibrium price of the import. This makes domestic products relatively cheaper,
resulting in a fall in imports of the foreign country which is the export of SG. Illustrate with a tariff diagram.
The SGs exports ( USs import) to US falls from Q1Q4 to Q2Q3 because of the tariff. Thus the tariffs
negate some of the increase in exports due to the devaluation of the SGD. It leads to a lower increase in
real output (Y3) than otherwise (Y2).

Diagram 2b : Effects of a tariff on price and output













Diagram 2c : Effects of Retaliation


















(iii) Domestic firms/ industries may become over-reliant on state support and are complacent and inefficient.




Sd
P2
P1

0


Price of good X
Quantity of good X
Sw
Dd
Sw + tariff
Q1 Q2 Q3
Q4
Real National Income




AS1
0
AD1 AD3


General Price Level
E1


AD2

Y1 Y3 Y2 Yf
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ALTERNATIVE WAY OF LOOKING AT THE PEDm and PEDX

Limitation:
(i) Dependent on PEDm:
The effectiveness of a tariff in reducing quantity demanded of imports depends on the elasticity (sensitivity)
of demand for the imported good. Figure 1 (c) illustrateS that the effectiveness of a tariff in reducing
quantity demanded of imports depends on the PED for the domestically produced substitutes.

Diagram 1(c) : Effects of a tariff on price and output
















The more price elastic demand (Dd (elastic)) then a tariff is more effective as it reduces quantity of imports
more significantly to Q2Qb compared to when demand is more price inelastic (Dd) where the quantity of
imports falls to only Q2Q3.


Figure 1(d) : Effects of a tariff on price and output
















Dd(elastic)
Sd
Dd
P2

P1
Q1
Q4
Q2 Qb Q3
Price of good X
Quantity of good X
Sw
Sw + tariff
Sd
Dd
P2

P1
Q1
Q4
Q2 Qa Q3
Price of good X
Quantity of good X
Sw
Sw + tariff
Sd(elastic)
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Figure 1 (d) illustrates that the effectiveness of a tariff in reducing quantity of imports depends on the PES
of the domestically produced substitutes. The more price elastic supply curve is (Sd (elastic)) then a tariff is
more effective as it reduces quantity of imports more significantly to QaQ3 compared to when supply is
more price inelastic (Sd) where the quantity of imports falls to only Q2Q3.