Chapter 7

Obstacles to Trade and Trade Restrictions

Chapter 8
Commercial policy : the tariff issue

International Economics Revised Edition

by H.G. Mannur
 Chapter-7
The purpose of this chapter is to analyze various types
of barriers to trade

 Natural Barriers to trade: natural cost and distance in

moving goods
 Imposed Barriers to trade
results from policy action
constitute either visible or invisible barriers to
international trade
Commercial policy- tariff, non tariff, Custom Union

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 Ch-7: Natural Obstacles to Trade: Transport Costs

 International movement of goods and services involves the

cost of transporting them across national boundaries. Transport
Costs includes:
 Actual cost paying for the freight
 Insurance
 Handling
 Storage

Transport Costs are assumed to be paid by exporter and

importer.
Free on board in case of export & cost+insurance+freight in
case of import
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Ch-7: Natural Obstacles to Trade: Transport Costs

Price
S
S

PA
Export
PE
Import
PB

D
D
Quantity
Zero Transport cost
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Ch-7: Natural Obstacles to Trade: Transport Costs

Price
S
S

Export
PE
Import

Transport cost AD
D
Quantity
Transport costs Present
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 Ch-7: Man Made Obstacles To Trade

Commercial Policy instrument which constitute man

made/imposed obstacle to trade:

 Tariff : Types, Motive, Effect…etc.

 Non-Tariffs Barriers: Includes

Quantitative Restrictions: Quota
Monetary Restrictions: Foreign exchange control
Administrative and Technical Regulations: Custom
restrictions, health regulations, safeties…etc
Government Procurement policies
Etc.
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 Ch-8 : Commercial Policy
The Tariff Issue

 Tariff: Tax imposed on goods/services when they cross

the boarder of a nation.
Types of Tariff
 Specific Tariff
 Ad Valorem Tariff
 Compound Tariff
 Discriminatory Tariff
 Non- Discriminatory Tariff
 Revenue Tariffs
 Protective Tariffs
 Retaliatory tariffs
 Countervailing tariffs
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 Ch-8 : Commercial Policy
The Tariff Issue
Arguments for Tariffs
 Preservation of home market
 Keeping money at home
 Pauper labor argument
 National security
 Self sufficiency
 Protecting high wage
 Full employment
 Industrialization
 Infant industry
 Anti dumping
 Revenue
 BOP
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 Ch-8 : Commercial Policy
The Tariff Issue
Effects Of Tariffs
 The theory of Tariffs: Some partial aspects
 We will analyze the effect of a tariff in a simple geometric
fashion in a partial way ; disregarding all secondary effects
The Effect of a tariff
 Price Effect
 Consumption Effect
 Production or Protective Effect
 Revenue Effect
 Trade Balance Effect
 Economic Welfare or Consumer Surplus Effect
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 Commercial Policy
The Tariff Issue

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 Commercial Policy
The Tariff Issue

• Tariff t2 is an example of prohibitive tariff, a tariff high

enough to curtail all import.
• Lets consider tariff t1.
 Consumer loss is FKDP. Part of CS goes to govt. as tariff
revenue, JHKL. Another part goes to producer in the form of
producer’s surplus, PIHF.
 The triangles IJH and KLD unaccounted for, these measure the
cost of protection for the society as a whole.
 IJH=production cost of protection. KLD= consumption cost of
protection.

Copyright © 2003 Pearson Education, Inc. Slide 6-11

 Commercial Policy
The Tariff Issue

When a tariff levied on a good we would expect :

 It’s price in domestic market would increases by the whole
amount of tariff.
 Decrease consumption of that good
 Imports fall
 Foreign exchange probably decrease
 Domestic production of that good would increase
 The govt. revenue increases

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 Commercial Policy
The Tariff Issue

 The national income will fall if the sum of two triangle is

greater than the rectangle area of govt. revenue. That is if
IJH+KLD >HJLK. In normal case national income falls due to
tariffs.
 The higher the tariff, higher the production and consumption
cost.

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 Commercial Policy
The Optimum Tariff Rate
 The optimum tariff rate of a tariff imposing country is defined
by following formula:
t=1/ (e-1)
t= optimum tariff rate
e= elasticity of foreign country’s offer curve ( elasticity of
foreign demand for domestic nations)
• As long as e is less or equal to 1, home country can impose or
increases tariff > gain terms of trade > increase the level of
economic welfare.
• As long as e is greater than1, home country should reduce
tariff> suffer adverse terms of trade and increase the level of
economic welfare.
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 Ch-8: Commercial Policy
Import Quotas

 Direct limitation of the physical quantity of imports and

exports permitted with in a country
Types of Quotas
1. Unilateral : Global – non discriminationary or allocated-
discriminationary

2. Bilateral quotas: agreement between country through

negotiation

3. Mixing or indirect quotas: domestic producer have to use a

fixed proportion of local and foreign materials

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 Ch-8: Commercial Policy
Import Quotas
Similarities between tariffs and quotas
 Same objectives: reduce the amount of import, BOP, trade
balance, protect domestic products……..etc.
 Tariff is quota equivalent and quota is tariff equivalent.
 Similar effects

Differences between tariffs and quotas

 Tariffs bring revenue to the government whereas quotas do
not.
 Distribution of import licenses may rise corruption or binary
whereas its possibility is lower in case of tariffs.

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 Ch-8: Commercial Policy
Import Quotas
 Quotas could be more effective than tariffs when demand and
supply curves for a product are inelastic.

See Diagram : 7
 The terms of trade effects of tariffs are predictable but those
determine by quotas are unpredictable

 Tariff imposition -----shift Offer curve up-----makes TOT

steeper-------improvement for the country------Predictable.
See diagram 8A
 Quota imposition-----TOT may improves or worsens-------
Unpredictable.
See diagram 8A
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 Ch-8: Commercial Policy
Import Quotas
Preference to use quotas over tariffs

 Easy to impose, remove, change, monitor

 International attitudes is more permissive for quotas
 High tariff level damages the public image
 Quota would be more protective for domestic producers
 Quotas allow at least a given imports into the country whereas
prohibitive tariff do not
 Producer prefer quota rather than tariff due to having revenue
in their own pocket rather than for govt.

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 Ch-8: Commercial Policy
Effective rate of Protection
 The nominal rate of protection / tariff is the rate of duty on the
value of the imported final goods which consumer consume.
 We need to consider raw materials and intermediate goods too
as they are also traded internationally.

The effective rate of protection :

e = (t – ar) / (1 – a)
Where, t = nominal tariff rate
a= percentage of imported input
r= tariff rate on imported input

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 Ch-8: Commercial Policy
Effective rate of Protection

Five important case showing how effective rate of

protection varies with the level of t, a, and r

 1. e > t if r = 0 holding a unchanged

 2. e will reduces as r increase
 3. e = t if a= 0 whatever the value of r
 4. e < t if r > t
 5. e = 0 if t = ar

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