Basic Analysis of a Tariff
Introductory Notes and Caveats
These notes focuses mainly on mechanics, and getting comfortable with a model that we can use to picture the effects of different kinds of import restrictions on particular markets. We will concentrate on the policies of tariffs and quotas. In this discussion, the question you should always be able to answer is “who benefits and who suffers from this policy?”
You may notice that when we analyze tariffs and quotas we are applying microeconomic tools, looking only at markets in individual goods and not at the big picture of overall trading patterns. This is because in order to focus in on a few questions we have to make tons of simplifying assumptions. One of those assumptions is the economist’s favorite ceteris paribus (“other things being equal”), which is the convenient assumption that we can look at changes in one market while assuming that everything else in our economy is not changing. (Note for example that in Ricardian trade theory we do assume that one market affects another, when productive factors from one industry move into another industry.) We also bring over a lot of other simplifying assumptions from neoclassical micro, such as the assumption of perfect competition in domestic industry. So beware: these are starkly oversimplified models that are useful because they help us think about issues. But be careful about naively using the results from a model as a guide to policy.
The core intuition of this theory, which is similar to that of the broader trade theory we examined earlier, is that restrictions on trade move the global economy farther away from an ideal international general equilibrium in which everyone buys or sells at the same set of prices. In neoclassical theory, this one global set of prices would guide efficient use of resources.
A Tariff in a Small Country
A tariff is a