Wednesday, November 13, 2019

Tariffs always cause a net welfare loss :: Economics

Tariffs always cause a net welfare loss Explain and critically evaluate this statement. In this essay, I will be discussing the impact of protectionism, in focus, the impact of tariffs, import duties. As well discussing the overall effect on welfare from the tariff, the gainers and the losers will need to be identified. I will illustrate this diagrammatically. I will then move to discuss the value of the optimal tariff imposition. As well as discussing the first best argument, I will also look at the value of second best arguments, examining whether or not tariffs do always cause a net welfare loss. A tariff requires the importer to pay a given fraction of the world price to the government. This protects domestic producers by raising the world price well above the domestic price; this of course has a downside for the consumers. A tariff works like a tax from the consumer's perspective: there are transfers from the consumers to both the government in the form of revenue and to the producers in the form of higher profits. This can be illustrated effectively by looking at Figure A, it shows the demand and supply curves for the home economy, Pa is the point where there is no trade, where supply meets demand. Pw is the world price for the commodity, the point of free trade and Pw + t is the price plus the tariff. We can see that during free trade, at Pw the home economy should import (Qf - Cf) but when a tariff is implemented this means they will import (Qt - Ct). As we can see from Figure A, the government will gain the revenue from the tariff, area B. The price rise in imports means that there is a reduced demand for them and increased demand for domestic producers. This results in a gain for the producer, area E. The loss for the consumer, area C, this is where consumption is cut when Cf moves to Ct. Area A, is also a loss area, as when production increases from Qf to Qt production is inefficient, over the world price so this area is the extra cost that the economy pay for producing the good at home. We can summarize these gains and losses we can see that there is indeed a net loss for welfare: B - (E+A+B+C) + E = - (A-C). So are there any valid 'justifications' for the imposition of tariffs. The strongest argument (some would say the only) in favour of a tariff comes with the recognition that a domestic economy imports such a significant supply of the world market for a commodity that an

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