Effects of a Tariff
Economics 24
Effects of Protection
CONNECT TO ECO 24 WEB SITE
Consider the British corn industry, and suppose, initially, that there is free trade in corn. The
situation for the British corn market and a typical British corn farmer are shown in figure 1,
below. The world price of corn is PW. SB is the British domestic supply curve, and DB is British
demand for corn. The typical farmer produces qf1, and earns zero economic profit, and British
consumers import an amount of corn equal to QD1 - QS1.
P
SB
Marginal Cost
Average
Cost
PW
PW
qf1
One typical British corn farmer
© 2001 J. Douglass Klein
q
World
Supply
QS1
QD1
DB
Q
Entire British corn market
Effects of a Tariff
P
SB
Consider the effects of a tariff on the
British corn industry.
World-wide, the price of corn is Pw.
British farmers can produce corn along
the supply curve SB.
PW
World
Supply
Why is the world supply curve flat?
Why does SB have a positive slope?
QS1
How much corn does Britain import?
Why don’t British farmers grow more
corn?
© 2001 J. Douglass Klein
QD1
DB
Q
Entire British corn market
Effects of a Tariff
P
P
SB
Marginal Cost
Average
Cost
Pw + T
PW
PW
qf1
One typical British corn farmer
q
T
World
Supply
QS1
QD1
DB
Q
Entire British corn market
Suppose the British government imposes a tariff T on imported corn.
What happens in the SHORT RUN?
What happens in the LONG RUN?
Define SHORT RUN and LONG RUN.
© 2001 J. Douglass Klein
Effects of a Tariff
P
P
SB
Marginal Cost
Average
Cost
PW
PW
qf1
One typical British corn farmer
q
World
Supply
IMPORTS
QD1
QS1
DB
Q
Entire British corn market
NO TARIFF. LONG RUN EQUILIBRIUM.
With no trade barriers, British consumers import QD1 - QS1 corn.
British farmers sell QS1 units of corn.
Typical farmers earn zero excess profit.
What does it mean to say that farmers are earning zero profit?
Price = Average Cost
© 2001 J. Douglass Klein
Effects of a Tariff
P
P
SB
Marginal Cost
Average
Cost
Pw+T
Pw + T
PROFIT
PW
PW
qf1 qf2
q
One typical British corn farmer
T
World
Supply
QS1QS2QD2QD1
Entire British corn market
What happens in the SHORT RUN?
At the new higher price, British corn farmers make a profit.
At the new higher price, British consumers import less corn.
© 2001 J. Douglass Klein
DB
Q
Effects of a Tariff
P
P
SB
S’
S’’
S’’’
Marginal Cost
Average
Cost
Pw+T
Pw + T
PW
PW
qf1
q
One typical British corn farmer
T
World
Supply
QS1
Entire British corn market
What happens in the LONG RUN?
In the LONG RUN, entry can occur.
So long as profits exist, entry will continue.
How do we show entry on the graph?
How far will the British Supply curve shift?
© 2001 J. Douglass Klein
QD1
DB
Q
Effects of a Tariff
P
P
MC
SB
AC’
S’’
AC
Pw + T
Pw+T
P2
PW
PW
qf1
One typical British corn farmer
q
T
World
Supply
QS1
QD1
DB
Q
Entire British corn market
If Average Costs rise as the industry expands, for example if poorer
farm land is put into corn production, then profits of the newest (and
least productive) farms will fall to zero at a price higher than Pw.
The more productive farms may still earn the kind of profit called
economic rent, profit which cannot be eliminated by entry.
© 2001 J. Douglass Klein
Effects of a Tariff - SUMMARY
A tariff raises the price of a good.
With higher prices, domestic firms make a greater profit in the short run.
The higher profits provide an incentive for domestic entry.
As entry occurs, price begins to fall.
Whether price will eventually fall to (or below) the world price is hotly
debated.
One thing is clear. A tariff helps domestic producers, and at least in the
short run hurts domestic consumers.
© 2001 J. Douglass Klein