International Trade

Tariffs - Large Country, Analysis using Offer Curves

We can use the offer curve analysis to see the effect of a tariff on a large country's economy.

Free Trade

Under free trade, one country (which we'll call the home country) has an offer curve OH. [1] Similarly, a foreign country has an offer curve OF. [2]

The point where these intersect is the equilibrium price E. [3] The line connecting this to the origin marks the exchange ratio between the two goods. [4]

Protection

By imposing a tariff, the country changes its domestic price from Pd = PX/PM to P'd = PX/(P'M(1+t)) [1] (for now, let's assume that P'M(1+t) > PM), where P'M is the price of the importing good in the world market after tariffs.

As H's offer curve OH intersects the new domestic price at E', [2] with the prevailing price, H is willing to export X1 [3] and import M1. [4] However, the foreign country F is satisfied if it imports X2 for exporting M1. [5]

In summary, by tariff, H exports X1 and imports M1, while F exports M1 and imports X2. The difference (X2 - X1) represents H's tariff revenue. [6]

Questions

  • Is X at E' the same as X at E"?

    Yes, provided there is a balance of trade.


  • How does the tariff affect the welfare of the countries?

    The home country's welfare is not clear, because its offer curve changes. It depends on the shape of the new offer curve.
    The foreign country's offer curve stays the same, so we can compare its welfare before and after tariff, and we find that its welfare decreases.
    Because the foreign country's welfare decreases, it will look for ways of increasing it by imposing its own tariff. This can lead to a trade war and, ultimately, autarky.


  • Is X2 < X1 always? In other words, does the tariff on M result in higher or lower exports?

    As for the small country case, this depends on the shape of the offer curve.


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[Topic] Tariffs


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