Question

discuss (with full explanation) the effects of tariffs on consumption, production and trade.

Answer 1

A tariff is a type of tax imposed on some imported goods. It is a tax on imports imposed by the government mainly to promote the domestic production of those goods by making the imported goods costlier than they were when there was free trade.

Effects of tariff on consumption:

Due to the imposition of the tariff, foreign goods become costlier as domestic customers now have to pay import tax on them. On the other hand, domestic producers start producing these goods and sell them at less price as compared to the price of imported goods after tariff. Consumers switch to domestic goods but with decreased demand as compared to when they were importing goods when there was free trade between nations.

In free trade, there are no restrictions such as tariffs and quota. Every country specializes in the production of the good that they are efficient in production and thus that leads to the lower world price of that product.

When there was free trade (without tariff), domestic consumers were importing and fulfilling all their demands at the world price (which is quite lower than the domestic price).

Thus, now when they have no choice but to consume domestic goods (due to imposition of tariff) they are now consuming less and their consumer surplus has also decreased (consumer surplus is the difference between the amount the consumers are willing to pay for a good and the amount they actually pay for it).

Effects of tariff on production:

Due to imposition of the tariff, foreign goods have become costlier and people will switch to domestic goods (which are priced higher than the world price during free trade but priced lower than the price of foreign goods after tariff imposition).

Thus the domestic producers benefit because they are supplying the goods to domestic consumers. Domestic production of that good increases. In a way, this country has become self sufficient in the production of that particular good. Due to this, the producers surplus increase in the country (producer surplus is the difference between the price that the producers are willing to accept for the good and the price they actually receive for it).

Thus, the domestic producers benefit from the tariff imposition, and their producers surplus also increases.

Effects of tariff on trade:

Due to the imposition of the tariff, trade between the foreign country stops as the domestic consumers fulfill their demand from domestic production of that good. But the domestic consumers are paying a higher price and hence there is an overall welfare loss and it is not an efficient way. The efficient way would have been free trade between nations where consumers could enjoy the goods at a lower price.

But after tariff, domestic producers are at the gain and the nation is becoming self-sufficient in the production of that good, even if the consumers are facing loss in consumer surplus.