Essay on the Overall Impact of Tariff on World Economy

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The application of the theory of comparative advantage explains that tariffs are inefficient for the world as a whole. They cause the production and consumption levels of the world as a whole to fall.

1. Effect on World Production:

Tariff causes the domestic relative price of imports in terms of exports (q) to exceed the foreign relative price (p). The fact q > p means that the marginal rate of transformation of exportables for importables (MRTxm) is greater at home.

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In other words, more exports must be sacrificed to produce one more importable at home than abroad. This further implies that the world can produce more of either of both goods if (a) the home country shifts its resources from producing importable; (b) the rest of the world does the opposite; and (c) international trade increases.

2. Effect on World Consumption:

Tariff causes the domestic relative price of imports in terms of exports to exceed the foreign relative price (i.e., q>p). This means that the marginal rate of substitution of exports (MRSxm) of each domestic consumer exceeds marginal rate of substitution of exports for imports of each foreign consumer.

In other words, each domestic consumer is willing to sacrifice more of exports to obtain one more import than each foreign consumer would require to supply it. Thus, the consumers in both the countries can be made to increase their consumption levels by trading more.

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The conclusion that tariffs are inefficient for the world as a whole does not mean that it is not beneficial to the imposing country.

The truth is that the tariff imposing country receives both favourable and unfavourable effects through the imposition of a tariff and it is also likely that the favourable effects outweigh the unfavourable effects.

But, the important implication of overall harmful effect of tariff on the world economy is that if a country gains from a tariff, it is at the expense of the rest of the world.

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