No Free Lunch: Economics for a Fallen World: Third Edition, Revised

Chapter Fifteen: Issues in International Economics 381 So how does a tariff work? In Figure 15.10 we can see how consumers and domestic producers gain from trade in a market where the world price of a good is below what the domestic price would be without trade. By being able to buy from foreign as well as domestic producers, the consumer benefits from the cheaper world price and receives the large consumer surplus illustrated by the green triangle. The domestic producer can only compete by supplying the small quantity (Q D1 ) and receives the producer surplus indicated by the blue triangle. Foreigners will supply the quantity between Q W and Q D1 . Now let’s imagine this was the steel market, and the steel producers successfully lobbied the President to push for a tariff on imported steel. That would never happen, would it? Nah. Figure 15.11 shows the effect of the tariff. With the tariff in place, consumers lose a large portion of their consumer surplus (compare the area of the green triangle in Figure 15.10 and 15.11 ) . Since they have to pay more because of the tariff, their quantity demanded will decrease to Q WT . The loss in consumer surplus is partially captured by the gains to domestic producers and the government in tax revenues, but there are also deadweight losses due to the lost gains from trade. Remember, value is created in exchange, and less exchange means less value is created. The deadweight loss is not the only loss, of course. Remember from our public choice chapter that if producers can gain a surplus at the expense of the consumers, they will expend resources to lobby Congress to gain passage of the tariff. At the limit, the domestic producers will spend up to the expected value of their gain in producer surplus to get the tariff passed in rent seeking activities. Unfortunately, the losses still don’t end. We’ve already shown earlier in the chapter that by producing according to each other’s comparative advantage, total world economic output will be higher and consumers from both trading nations benefit. Obviously foreign steel producers benefit from free trade and no tariffs, but domestic producers of other goods do as well. Let’s say that Japan is the source of the cheaper world steel. When Japan sells us steel, they receive dollars in exchange. With those dollars, they are able to purchase other Figure 15.10, Consumer and Producer Surplus with Free Trade. If the world price of steel (P W ) is lower than the domestic supply price (P D ), the consumer can purchase a much larger quantity than otherwise resulting in the large consumer surplus in the green-shaded region above. The domestic producers will only supply Q D1 and receive the small producer surplus shown by the blue triangle. Foreign supply will equal Q W minus Q D1 . P ($) S Domestic Q (#) Q D1 Q D Q W P D P W D Foreign Supply CS PS Figure 15.11, Tariff Application. If a tariff is applied against imports, the price will rise from the world price P W to P WT . The entire area below the demand curve between P W and P WT is lost consumer surplus that is transferred either to producers (P S ) or the government (tax revenue), or is simply lost due to the reduced quantity consumed (deadweight loss). Foreign supply shrinks down to the difference between Q WT and Q DT . P ($) S Domestic Q (#) Q DT Q WT Q W P WT P D P W D Steel Market w/ Tariff Deadweight loss CS TAX PS