8 Effects of Tariffs on the Imposing Country

ADVERTISEMENTS:

Kindleberger has discussed eight effects of tariff on the imposing country: (a) protective effect; (b) consumption effect; (c) revenue effect; (d) redistribution effect; (e) terms of trade effect; (f) income effect; (g) balance of payment effect; and (h) competitive effect.

In words of Kindleberger, a tariff “is likely to alter trade, price, output, consumption, and to reallocate resources, change factor proportions, redistribute income, change employment and alter the balance of payments.” All these effects of tariffs are discussed below:

1. Protective Effect:

ADVERTISEMENTS:

A tariff has protective effect for the domestic industries. It tends to raise the domestic price of the imported commodity, reduce the domestic demand for that commodity and thereby stimulates its domestic produc­tion.

In Figure 2, DD and SS are the domestic demand and supply curves of the commodity in question. In the absence of trade, the equilibrium is at point E, the price is OP3 and country’s production and consumption is P3E. Under free trade conditions, becomes the supply curve which in­cludes both domestic and foreign supply.

Foreign supply is assumed to be perfectly elastic. Equilibrium is at point T and the price is OP. At this price, quantity OQ2 is demanded, of which OQ1 is produced at home and the rest Q1Q2 is im­ported.

Now the government imposes a tariff equal to the amount P P2, thus shifting the supply curve to and raising the price to OP2.

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As a result, the quantity demanded falls from OQ2 to 0Q4, the quantity produced at home increases from OQ2 to OQ3 and the quantity imported reduces from Q1Q2 to Q3Q4. In this case, the protective effect (which is another name for production effect) is Q1Q3

2. Consumption Effect:

Imposition of tariff raises the price, and as a result, the demand for the commodity falls. Total outlay on consumption of the commodity is larger or smaller depending upon whether demand is inelastic or elastic.

In Figure 2, before the imposition of tariff, the consumers demand OQ2 at price OP1. With the imposition of tariff (i.e., P,P2), the price rises from OP, to OP2 and the quantity demanded falls from OQ2 to 0Q4. thus, Q4Q2 is the consumption effect.

ADVERTISEMENTS:

3. Revenue Effect:

Tariff brings revenue to the government. The revenue to the government is equal to the amount of the import duty multiplied by the quantity of imports. In Figure 2, the revenue effect is P1P2 x Q3Q4 = KLMN.

4. Redistribution Effect:

Redistribution Effect refers to the transfer of real income from the consumers to the producers as a result of tariff. The tariff-imposed price increase (from OP1 to OP2) results in the loss of consumer’s surplus equal to the amount P1p2LT. Of the total loss suffered by the consumers, P1P2 KR amount is transferred to the domestic producers.

ADVERTISEMENTS:

This is the redistribution effect. KLMN amount is transferred to the government as tariff revenue.

The loss of consumer’s surplus represented by the triangles KRM and LNT is transferred neither to the producers nor to the government; do KRM + LNT represent the total net real loss to the economy as a result of tariff.

KRM is the net real loss suffered by the society due to inefficient use of the resources; increased output (i.e., Q1Q3) as a result of the tariff is possible by diverting factors of production from other sectors of the economy at higher cost (as represented by the rising supply curve). LNT is the net real loss due to the reduction in consumption (i.e., Q4Q2)

The above discussed effects of tariff (in Figure 2) can be summarises below:

ADVERTISEMENTS:

1. Tariff imposed: P1P2.

2. Effect on price: from OP1 to OP2, i.e., P1P2.

3. Effect on imports: from Q1 Q2 to Q3 Q4

4. Protective effect: from OQ1 to 0Q3, i.e. Q1Q3.

5. Consumption effect: from OQ2 to OQ4 i.e., Q4 Q2.

6. Revenue effect: KLMN

7. Redistribution effect: P1P2KR

8. Real loss on production: KRM

9. Real loss on consumption: LNT

10. Total real cost of tariff: KRM + LNT

5. Terms of Trade Effect:

When a country imposes a tariff duty, its willingness to receive imports is reduced. For a given quantity of exports, the country now demands a larger quantity of imports because a part of these imports are to be surrendered to the customs authorities in the form of tariff payment.

Or, putting the same thing differently, the country is now willing to offer less of ex­ports in exchange for a given quantity of imports.

Thus, the tariff reduces the country’s offer of exports for imports. In diagrammatic terms, the tariff shifts the country’s offer curve to the left. This increases the country’s terms of trade or the rate at which exports are exchanged for imports.

The terms of trade is given by the slope of line OT. Country H is exporting OW wheat and importing OC cloth from country F. Now suppose the country H imposes a tariff on imports of cloth from country F.

As a result, the offer curve of country H will shift from OH to OH’. The new equilibrium is at point E’ and the new term of trade is given by the slope of line OT’. Now, the country H exports OW, of wheat in exchange for OC, of cloth from country F.

The change in the terms of trade (i.e., from OT to OT’), as a result of the imposition of tariff, is in favour of country H because it now offers less of its wheat in exchange for a certain quantity of country Fs cloth. The fall in imports from country F (i.e. CC,) is less than the fall in exports from country H (i.e., WW,).

6. Balance of Payments Effect:

Tariff has favourable effect on the balance of payments position of the imposing country. It reduces imports and increases the export surplus of the country. Thus, through tariffs, a deficit in the balance of payment can be corrected.

7. Income Effect:

As a result of tariff, the expenditure on imported goods is reduced. This will increase the export surplus of the country and thereby the income from foreign trade.

The money shifted from imports can now be spent on the domestically produced goods. If the country is at less than-full employment level, this will raise income and employment in the country.

8. Competitive Effect:

Tariff protects the domestic industry from foreign competition. Under this protec­tion an infant industry after a period of time, grows into an economically strong industry which can fully compete in the world market.

But, the sluggish and lazy industry may not like to face the competition and remain inefficient even under the protection cover provided through tariffs.

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