INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY;
A’s
import
 Charles van Marrewijk, 2006; 1
“Optimal” tariffs
A’s offer
We have seen how to
curve
derive an ‘offer curve’,
showing combinations of
exports offered in
exchange for
imports at different
price levels.
A’s
export
INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY;
A’s
import
 Charles van Marrewijk, 2006; 2
“Optimal” tariffs
A’s offer
Look at point C; on the price
curve
line it is the best deal
available to country A
Obviously, if country
A would get more
imports for the same
exports its welfare
would rise
C
A’s
export
INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY;
A’s
import
U2
 Charles van Marrewijk, 2006; 3
“Optimal” tariffs
A’s offer
This implies that through
curve
each point on the offer
curve we can draw an
Iso-welfare curve
1
U
for country A. This
curve must be
tangent to the price
line from the origin
through that point.
U0
Welfare for country A
increases to the northwest: U0 < U1 < U2
A’s export
INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY;
 Charles van Marrewijk, 2006; 4
“Optimal” tariffs
If country A is a small country The offer curve it
faces from the
A’s
offer
A’s
Rest of the
curve
import
World (ROW)
1
U
is a straight
line (country A
U2
cannot
D
influence its
0
U
terms of trade)
An omniscient
central planner
ROW offer
Maximizes country A’s
curve
welfare given this restriction
at point D: no tariffs
A’s export
INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY;
If A is a
A’s
import
large
country
A’s offer
curve
 Charles van Marrewijk, 2006; 5
“Optimal” tariffs
The ROW offer curve is not a straight
line (country A
can influence
its terms of
1
U
trade)
U2
D
U0
ROW offer
curve
An omniscient
central planner
does not maximize
country A’s welfare given
this restriction at point D
A’s export
INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY;
old
A’s
import
new
U2
E
 Charles van Marrewijk, 2006; 6
“Optimal” tariffs
A’s welfare given the ROW offer
curve is maximized at point E
This gives the
central planner
U3
an incentive to
U1
manipulate
ROW offer
curve
D
0
U
Country A’s
offer curve
using an “optimal” tariff
such that the new offer
curve intersects at point E
A’s export
INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY;
ROW
export
 Charles van Marrewijk, 2006; 7
“Optimal” tariffs
For ROW, however, the situation is reverse
Through each point on the ROW offer curve is an isowelfare curve tangent to a line through the origin.
Welfare increases to the south-east
ROW import
INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY;
ROW
export,
A’s
import
 Charles van Marrewijk, 2006; 8
“Optimal” tariffs
ROW, therefore, has an incentive to manipulate
its offer curve through
‘optimal’ tariffs to go from
point D to point F
D
F
new
ROW import,
A’s export
INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY;
 Charles van Marrewijk, 2006; 9
“Optimal” tariffs
A wants to be clever to move from D to E ROW wants to be clever
to move from D to F
new
ROW
The end result of all
export,
this cleverness is a
A’s
move from D to G;
import
everyone is worse off
E
G
D
F
new
Further
retaliation
may worsen
the situation
ROW import,
A’s export