Tariffs always cause a net welfare loss”

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The world more and more needs trade. The question is which way it should be done. Free trade, which is a kind of “laissez faire” policy where government do not impose any regulation that would impede or encourage free exchange of goods, or autarky, where the government impose such restrictive regulations that eliminates all incentives for international trade. These are the extremes which, in thereal world, are difficult to exist. However all nations impose some form of trade policies and, since most countries are somewhere in the middle, the discussions are more focus on which direction, free trade or autarky, they should move. So “tariffs” is one of the ways to control the trade and, as we are going to explain, “they always cause a net welfare loss”. Although, as we are going toevaluate, “always” is a very strong word for such a complex problem that all countries have to face.

Protectionism is defined as a trade policy imposed by governments to benefit domestic industries by reducing international competition. They can have several forms: “tariff” when a fixed tax is imposed on a good; “ad valorem tariff” when a percentual tax is imposed; “quota” when the quantity of thatgood is restricted; “subsidy” either to the production or the export of that good. All these are forms to restrict or impede free trade, which, at least since Adam Smith's publication of The Wealth of Nations, many economists have been strong supporters of free trade among nations.

In autarky a good is sold at price P0 and the quantity demanded is Q0 as shown in Fig.1. However the world price islower at P1, which means that the domestic supply is Q1 but the demand is Q2, so the difference is imported from abroad. However if the government wants to help the domestic suppliers which are face with a lower price, can impose a tariff (T). Supposing it is a small country in the world market the domestic price will be P1+T as in Fig.1. This means that the domestically produced quantity rises toQ3, the demanded quantity falls to Q4 and the imports also falls.

The domestic Suppliers, which were loosing the difference between P0 and P1, gain from the price rise, the area marked by 1 (a,b,g,h), that is the price increase from P1 to P1+T (Fig.2) minus the increased marginal cost of each additional unit above Q1.

The Government has two gains, not only has domestic production withincreased profitability but also an extra revenue equal to the area marked in the figure with the number 3 (the rectangle b,c,e,f) by collecting the tariff on imports. The only ones to loose are the consumers, due to the price rise their surplus was reduced by the area market by 1+2+3+4 (a,c,d,h). Indeed the loss in economy is considerable as the total welfare change is negative, that is, area3-(1+2+3+4) equal to the “deadweight loss” triangles 2+4 (b,f,g and c,d,e). So the application of that tariff is a loss in net welfare.

However this is not always true. If this tariff is applied in a country with great influence in the world market, the price will fall, for instance from P1 to P2 (Fig.3) but the domestic price keeps being P1+T, because the tariff has to be paid for the imports. Likethat Government will gain more revenues from that tax (area 3) and this can generate a net gain to the all economy to a point that can offsetting the other welfare losses. A tariff which maximizes the net gain is called an optimal tariff.

As explained tariffs are a case sensitive in all nations and not “always” cause a net welfare loss to the nation that have applied it but, just a small tariffin a large country that has strong influence in the world market of that good, can have large effects on other countries. Inside the country the price raises, consequently the producers of that good improve their profits but, on the other hand, it lowers the imports of that good from other nations which can cause, for example, unemployment on the labour force attached to the production of that...
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