AGEC 652 Lectures 26 and 27 VIOLATIONS OF FREE TRADE ASSUMPTIONS: EXTENSIONS I. Comparison of Tariff, Quota, and Variable Levy (VL) II. Differences in Market Effects of Tariff, Quota, and VL III. Tax/Tariff: Ad Valorem vs. Specific IV. Joint Products and Trade Policy V. Sector Linkages and Trade Policy VI. Rate of Effective Protection
I. Comparison of a Tariff, Quota, and Variable Levy (VL) 1. Main difference between tariff, quota and VL: 2. Tariff: The level of the tariff is the target: T m P m = P x + T m 3. Quota: The level of imports is the target: Q m The linkage between price is broken: P m P x 4. VL: The internal price is the target: P m The VL is NOT the target but rather the internal price. P m = P x + VL or VL = P m - P x 5. Their effects on markets and prices can be quite different given changes in internal and external conditions.
II. Effects of Quota, VL, and Tariff Under Changing Conditions Change in Internal Conditions (Sm ) Change in External Conditions (Sx ) ES US ES US Quota ED ROW ED ROW ES US ES US Variable Levy ED ROW ED ROW ES US ES US Tariff ED ROW ED ROW
III. Tariff-Rate Quota: Combination of a Tariff and a Quota A Normal Tariff or Import Quota D S ES Pm P Quota ED ED (Tm )
III. Tariff-Rate Quota: Combination of a Tariff and a Quota (cont d) With a tariff-rate quota, the target changes from the level of imports to the level of the tariff by setting two different tariff levels: (1) a lower tariff below the Quota level ( (Tm )) and (2) a higher tariff beyond the Quota ( (Tm 1 )). D S ED (Tm ) ED Quota ED (Tm 1 )
III. Tariff-Rate Quota: Combination of a Tariff and a Quota (cont d) The internal and external price levels (Pm and Px, respectively) depend on the level of the. D S ES Pm ED (Tm ) Px ED Quota ED (Tm 1 )
III. Tariff-Rate Quota: Combination of a Tariff and a Quota (cont d) As ES shifts right, Px declines but Pm and imports remain at the quota level For you to ponder: What would happen if the ES curve D S shifted left instead? ES Pm ED (Tm ) Px ED Quota ED (Tm 1 )
III. Tariff-Rate Quota: Combination of a Tariff and a Quota (cont d) but when the ES crosses the lower portion of the ED curve (ED (Tm 1 )), both prices drop with the difference equal to the outside tariff level (Tm 1 ) and imports increase beyond the quota level. D S Pm ES Quota ED (Tm 1 ) Px ED
IV. Ad Valorem Tax/Tariff vs. Specific Tax/Tariff P ES(t x ) ES (T x ) ES P x ED P m ED Q x Q x Q x Q
V. Joint Product Markets and International Trade in Soybeans and Soybean Products Example: Import Tariff on the Primary Product (Soybeans) DS SS ESS PS SOYBEAN SECTOR EDS S 2 S 1 XS 1 DM SM ESM SOYMEAL SECTOR PM EDM M 2 M 1 XM 1 ESO DO SO PO SOYOIL SECTOR EDO O 2 O 1 XO 1
V. Joint Product Markets and International Trade in Soybeans and Soybean Products Example: Import Tariff on the Joint Product (Soymeal) DS SS ESS PS SOYBEAN SECTOR EDS S 2 S 1 XS 1 DM SM ESM SOYMEAL SECTOR PM EDM M 2 M 1 XM 1 ESO DO SO PO SOYOIL SECTOR EDO O 2 O 1 XO 1
VI. Sector Linkages and International Trade A. Horizontal Linkage in Production Example: Corn and Soybeans VL on Corn DS SS ESS SOYBEAN SECTOR PS EDS S 2 S 1 XS 1 DC SC ESC CORN SECTOR PC EDC C 2 C 1 XC 1
B. Vertical Linkage in Production (Supply Chain) Example: U.S. Feeder Cattle Import Restrictions and the North America Cattle and Beef Supply Chain DFC SFC ESFC Mexico U.S. Feeder Cattle Market PFC F 1 F 2 MF 1 EDFC DSC SSC ESSC Canada U.S. Slaughter Cattle Market PSC EDSC S 2 S 1 XS 1 DB SB ESB Beef Market PB EDB Mexico B 2 B 1 XB 1
C. Horizontal Linkage in Consumption Example: Sugar and Artificial Sweeteners and U.S. Sugar Import Quota DS SS EOS PS U.S.: Sugar Market EDS S 1 S 2 MS 1 SA U.S.: Artificial Sweetener s Market DA
VII. Rate of Effective Protection The nominal import tariff rate does not indicate the actual level of protection provided to the processing industry of an import-competing commodity for 2 reasons: (1) imported inputs may also be charged a tariff and (2) the tariff charge as a % of the per unit profit of the processor (i.e., the per unit value added) is higher than it is a % of the per unit revenue (i.e. the price) The Rate of Effective Protection (g) measures the percentage increase in the per unit domestic value added (V) as a result of tariffs: (1) g = V V V If a i = ratio of the cost of the input i (c i ) to the price of the final product (p) in the absence of tariffs (i.e., c i /p) t m = the nominal ad valorem import tariff on the final product t i = the nominal ad valorem import tariff on input i Then the per unit value added is V = p-σc i. And since a I = c i /p, then: (2) V = p-pσa i = p(1-σa i ) With a tariff on imports of the final product and the inputs, the per unit value added is: (3) V = p(1 + t m ) pσa i (1 + t i ) and therefore. V V (4) g = = V Cancelling terms gives: p(1 + t m ) pσa i (1 + t I ) p(1 Σa i ) p(1 Σa i ) (5) g = t m Σa i t i 1 - Σa i A one input example: soybeans (input) and soymeal (final product). Given t m = 2% (soymeal) and t i = 1% (soybeans) and a i = 8%, then: g = (.2.8*.1)/(1-.8) =.12/.2 =.6 The EFFECTIVE tariff rate is while the NOMINAL tariff rate is only.