Protectionist Policies: Tariffs (AQA A Level Economics)

• A tariff is a tax on imported goods/services (customs duty)
  
  
• Domestic producers/retailers have to pay the tariff when the good/service crosses the border into the country
  • This raises the cost of production for domestic firms
  • Firms often pass on the increased costs to consumers in the form of higher prices
  • These higher prices allow some domestic firms to increase their output (law of supply)
    
    
• Due to the tariff, more inefficient domestic firms are now producing more at the expense of more efficient foreign firms, which reduce their output due to the tariff
  • With increased domestic output, employment may increase
    

Diagram: Tariff Imposed on Imports

A tariff raises the price of world supply from P_W to P_W + Tariff. This reduces the quantity of imports from Q₁Q₂ to Q₃Q₄

Diagram analysis

• World supply (W_s) is considered to be infinite, and this supply curve is added to the domestic demand (DD) and supply (SD) curves

• The pre-tariff market equilibrium is seen at P_wQ₂
• Domestic firms supply up to Q₁ at a price of P_w
• Foreign firms supply the difference equal to Q₁Q₂ (the level of imports), at a price of P_w 
  
  

• After the tariff is imposed, the world price increases from P_w to P_w + Tariff 
  • Following the law of demand, the quantity demanded contracts from Q₂ to Q₄
  • Following the law of supply, the quantity supplied by domestic firms extends from Q₁ to Q₃
  • The new market equilibrium is seen at P_w+tariff Q₄ 
  • The level of imports is reduced from Q₁Q₂ to Q₃Q₄
    • Domestic producer surplus has increased by area 2
    • Domestic consumer surplus has decreased by areas 1, 2, 3 & 4
    • The government receives tax revenue equal to ((P_w+tariff) - P_w) x (Q₄-Q₃)
      • This is equivalent to area 3 on the diagram

• The best way to consider the impact of a tariff on stakeholders is to explain it using a diagram

Diagram: The Impact of Tariffs on Stakeholders

A tariff impacts domestic producers, consumers, foreign producers and the government

The Impact of Tariffs on Stakeholders 

Stakeholder	Impact on Stakeholder
Domestic producers	Before the tariff domestic producers produced output equal to 0Q1 and their revenue was equal to Pw x Q1 After the tariff was imposed domestic producers produced 0Q3 and their revenue was equal to Pw+tariff  x Q3  Domestic producer surplus has increased by area 1
Foreign producers	Before the tariff foreign producers sold output equal to Q1Q2 and their revenue was equal to Pw x (Q2 - Q1) After the tariff was imposed foreign producers sold output equal to Q3Q4 and their revenue was equal to Pw x (Q4 -Q3)  Foreign producer surplus has decreased by the areas underneath 2 and 4
Domestic consumers	Before the tariff domestic consumers consumed Q2 products at a price of Pw After the tariff domestic consumers consumed fewer products (Q4) at a higher price of Pw+tariff Domestic consumer surplus has decreased by areas 1,2 3 and 4 Some consumers have been priced out of the market (contraction of quantity demanded from Q2 → Q4
The government	After the tariff is imposed the government receives tax revenue equal to ((Pw+tariff) - Pw) x (Q4-Q3) This is equal to area 3
Downstream producers	Other producers who rely on the imported product as a raw material in their own production process, now have to pay more for it as prices are higher This increases their costs of production They may have to reduce output which could impact unemployment levels and government tax receipts in their industry
Society (welfare loss)	Less efficient domestic firms are now producing at the expense of more efficient foreign producers - there is a welfare loss equal to area 2 Consumers are frustrated with the higher prices and there is no longer allocative efficiency - there is a welfare loss equal to area 4 The net welfare loss is equal to areas 2 and 4

Impact on standards of living

• The standards of living for consumers worsen as the value of their income is eroded as they are paying higher prices
• Domestic firms that benefit from increased production may increase employees' wages
• This would increase the standard of living for employees
  

Impact on equality

• Workers in industries that have been experiencing structural unemployment due to foreign competition will feel that the tariff results in them being treated more fairly