Whenever a large country implements a small tariff, it will raise national welfare. If the tariff is set too high, national welfare will fall. There will be a positive optimal tariff that will maximize national welfare. However, it is also important to note that not everyone’s welfare rises when there is an increase in national welfare.
For example, if the answer is “a tax on imports,” then the correct question is “What is a tariff?” The product of the specific tariff rate and the quantity of imports. Of increase, decrease, or stay the same, this is the effect of a tariff on the welfare of consumers of the product in the large importing country.
This means that a tariff implemented by a large importing country may raise national welfare. Whenever a large country implements a small tariff, it will raise national welfare. If the tariff is set too high, national welfare will fall. There will be a positive optimal tariff that will maximize national welfare.
Exercises. Of increase, decrease, or stay the same, this is the effect of a tariff on the welfare of the recipients of government benefits in the large importing country. Of increase, decrease, or stay the same, this is the effect of a tariff on the welfare of consumers of the product in the large exporting country.
Because the country is assumed to be small, the tariff has no effect on the price in the rest of the world; therefore, there are no welfare changes for producers or consumers there. Even though imports are reduced, the related reduction in exports by the rest of the world is assumed to be too small to have a noticeable impact.
Consumers of the product in the importing country are worse off as a result of the tariff. The increase in the domestic price of both imported goods and the domestic substitutes reduces consumer surplus in the market. Tariff effects on the importing country’s producers.
The free trade equilibrium is depicted in Figure 7.18 "Welfare Effects of a Tariff: Small Country Case", where PFT is the free trade equilibrium price. At that price, domestic demand is given by DFT, domestic supply by SFT, and imports by the difference DFT − SFT (the blue line in the figure).
Producers in the importing country are better off as a result of the tariff. The increase in the price of their product increases producer surplus in the industry.
Because there are only negative elements in the national welfare change , the net national welfare effect of a tariff must be negative. This means that a tariff implemented by a small importing country must reduce national welfare. Whenever a small country implements a tariff, national welfare falls.
The higher the tariff is set, the larger will be the loss in national welfare.
The government receives tariff revenue as a result of the tariff. Who will benefit from the revenue depends on how the government spends it. These funds help support diverse government spending programs; therefore, someone within the country will be the likely recipient of these benefits.
Generally speaking, the following are true: Whenever a large country implements a small tariff, it will raise national welfare. If the tariff is set too high, national welfare will fall. There will be a positive optimal tariff that will maximize national welfare.
Of increase, decrease, or stay the same , this is the effect of a tariff on the welfare of producers of the product in the large importing country.
Tariff effects on world welfare. The effect on world welfare is found by summing the national wel fare effects on the importing and exporting countries. By noting that the terms of trade gain to the importer is equal to the terms of trade loss to the exporter, the world welfare effect reduces to four components: the importer’s negative production distortion ( B ), the importer’s negative consumption distortion ( D ), the exporter’s negative consumption distortion ( f ), and the exporter’s negative production distortion ( h ). Since each of these is negative, the world welfare effect of the import tariff is negative. The sum of the losses in the world exceeds the sum of the gains. In other words, we can say that an import tariff results in a reduction in world production and consumption efficiency.
Tariff effects on the exporting country’s producers. Producers in the exporting country experience a decrease in well-being as a result of the tariff. The decrease in the price of their product in their own market decreases producer surplus in the industry.
Tariff effects on the importing country’s consumers. Consumers of the product in the importing country suffer a reduction in well-being as a result of the tariff. The increase in the domestic price of both imported goods and the domestic substitutes reduces the amount of consumer surplus in the market.
Since all three components are negative, the importer’s tariff must result in a reduction in national welfare for the exporting country. However, it is important to note that a redistribution of income occurs—that is, some groups gain while others lose. In this case, the sum of the losses exceeds the sum of the gains.
The net effect consists of three components: a positive terms of trade effect ( G ), a negative production distortion ( B ), and a negative consumption distortion ( D ).