IBEconomicsSLRevision Notes4. The Global Economy4.2 Types of Trade Protection4.2.1 Tariffs

Tariffs (SL IB Economics)

Revision Note

Steve Vorster

Expertise

Economics & Business Subject Lead

An Introduction to Protectionism

  • Free trade aims to maximise global output through national specialisation
  • However, there are numerous reasons why countries would seek to limit free trade in order to protect themselves from certain outcomes
  • This is called protectionism and may take the form of import tariffs, export subsidies, the use of quotas or embargoes

An Explanation of Tariffs

  • The most commonly used forms of trade protectionism include tariffs, subsidies, quotas and administrative barriers
     
  • A tariff is a tax on imported goods/services (customs duty)
    • The tax raises the selling price of the good/service within the country
         
  • The higher price allows more inefficient domestic firms to increase their production and market share
    • More efficient global competitors reduce their output due to the tariff
    • With increased domestic output, employment may increase
       

4-1-6-restrictions-on-free-trade

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

Diagram Analysis

  • World supply (SW) is considered to be infinite and this supply curve is included with the domestic demand (DD) and supply (SD) curves
     
  • The pre-tariff market equilibrium is seen at PwQ2
    • Domestic firms supply up to Q1 at a price of Pw
    • Foreign firms supply the difference equal to Q1Q2 at a price of Pw (imports)
       
  • After the tariff is imposed, the world price increases from Pw to Pw+ tariff
     
  • The new market equilibrium is seen at Pw+tariff and Q4 
    • 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 level of imports is reduced from Q1Q2 to Q3Q4

An Evaluation of Tariffs

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

4-1-6-restrictions-on-free-trade

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

The Impact of Tariffs on Stakeholders 


Stakeholder
Explanation of Impact

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 2
  • The net welfare loss is equal to areas 2 and 4



Examiner Tip

Tariffs are one of the most frequently examined sub-topics in Paper 2. When evaluating their use, consider how many jobs are protected (or created) in the industry that is targeted by the tariff as opposed to jobs which may be lost in multiple downstream industries due to higher prices.

For example, a tariff on solar panel imports protects a few firms who manufacture solar panels. However, the higher prices can cause a significant fall in the quantity demanded leading to the possible loss of thousands of jobs for installation experts.

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Steve Vorster

Author: Steve Vorster

Expertise: Economics & Business Subject Lead

Steve has taught A Level, GCSE, IGCSE Business and Economics - as well as IBDP Economics and Business Management. He is an IBDP Examiner and IGCSE textbook author. His students regularly achieve 90-100% in their final exams. Steve has been the Assistant Head of Sixth Form for a school in Devon, and Head of Economics at the world's largest International school in Singapore. He loves to create resources which speed up student learning and are easily accessible by all.