Lesson preview · Protection and trade agreements
Tariffs, quotas and trade deals: who pays for protection?
~8 min · Free to read
Imagine a country where bikes sell for 100 dollars, the world price (the price on the global market). People buy 100,000 a year. Local factories make 40,000, and the other 60,000 are imports (goods bought from abroad).
Then the government adds a tariff (a tax on imported goods) of 20 dollars a bike. Bikes now cost 120 dollars. Local factories make 50,000, people buy 90,000, and imports fall to 40,000. Who gained, and who paid?
Key Term
The world price and imports
A small country can buy all it wants at the world price without moving it. At that price, local firms make part of what people want. Imports fill the gap:
imports = quantity demanded − quantity supplied at home
For bikes: 100,000 − 40,000 = 60,000.
Key Term
What a tariff does
A tariff lifts the home price to the world price plus the tariff. Local firms charge it too, as buyers have no cheaper option. Then:
- Buyers pay more and buy less.
- Local firms make more and earn more.
- So imports, the gap between the two, shrink from both ends.
- The government collects tariff revenue = tariff × imports after the tariff: 20 × 40,000 = 800,000 dollars.
Buyers lose more than firms and the government gain. The difference, deadweight loss, is value that nobody gets.
Buyers pay for the whole strip. Local firms get one piece back as extra earnings, the government another as tariff revenue. The red triangles go to nobody, so the country loses overall, though its producers gain.
Key Term
A quota: same price, different winner
A quota caps how many units firms may import. Allow only 40,000 imported bikes, and the price again climbs to 120 dollars. At 120 dollars, local firms make 50,000 and people want 90,000: a gap of exactly 40,000.
The difference is who keeps the extra 20 dollars on each imported bike. A tariff hands it to the government. A quota hands it to whoever holds an import licence (a permit to import), unless the government sells the licences.
Trap · Common Misconception
"Foreign firms pay the tariff"
The importer, usually a home firm, pays the tariff at the border and adds it to its price. A small country can’t push the world price down, so its buyers pay the whole tariff. Foreign firms still get the world price, on fewer sales. Only a country that buys much of the world’s supply might push that price down, making foreign firms pay part.
Check yourself · no marks
The bike tariff costs buyers 1.9 million dollars a year. Local firms gain 0.9 million, and the government collects 0.8 million. How big is the deadweight loss, and where does it come from?
Commit to one first. Guessing and being wrong beats reading the answer cold.
Why protect? Protection means shielding home firms from foreign rivals with tariffs, quotas or other limits on imports. Governments give four reasons:
- Infant industries: a new industry may need shelter while it grows. The risk: it never grows up.
- Jobs: saving work in firms that compete with imports.
- Security: home-grown food, steel or energy in case of war.
- Dumping: selling abroad for less than at home. World trade rules allow an extra tariff on dumped goods that harm a home industry.
What protection costs. Buyers pay more, including firms that use the import, like carmakers buying steel. Other countries may retaliate: hit back with tariffs of their own.
In 2009 the United States put an extra tariff, starting at 35%, on car and light-truck tyres from China. A 2012 estimate found it saved at most 1,200 American jobs, each costing buyers at least 900,000 dollars in 2011. A 2016 study found no effect on US tyre jobs: tyres from other countries replaced Chinese ones. Evidence: robust that it saved few jobs, if any; mixed on the exact cost.
In 2010 China put tariffs on American chicken, saying it was being dumped. Many trade experts saw this as payback. US chicken sales there fell by almost 90%.
Trade deals. Countries can also agree to cut barriers. Their deals form a ladder, loosest at the top. Each rung keeps everything in the rows above it and adds one thing:
| Rung | What members add | Example |
|---|---|---|
| Free trade area | Almost no tariffs between members; each sets its own tariffs on outsiders | Association of Southeast Asian Nations (ASEAN) free trade area |
| Customs union | One shared tariff on outsiders: a common external tariff | Southern African Customs Union |
| Common market | Workers, capital (money to invest) and services move freely | European Union single market |
| Monetary union | One currency | Euro area |
Key Term
Three global institutions
- The WTO (World Trade Organization) looks after the rules of trade between countries and handles trade disputes.
- The IMF (International Monetary Fund) makes short- and medium-term loans to countries struggling to pay their bills abroad. In return, the borrowing government agrees to change some of its policies.
- The World Bank funds long-term projects in low- and middle-income countries, such as schools, water and electricity.
Check yourself · no marks
Order these, loosest first: common market, free trade area, monetary union, customs union.
Commit to one first. Guessing and being wrong beats reading the answer cold.
Practice · 1 / 6
Without trade, a bag of rice in Country X costs 5 dollars. The world price is 3 dollars. At 3 dollars, people in Country X want 200,000 bags a month, and local farms grow 80,000. Does Country X import or export rice, and how many bags a month?
Next
Like what you read?
Sign up free to save your progress, get spaced reviews tuned to you, and work through the whole course with interactive graphs and adaptive practice.