INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY;
Y
pworld
 Charles van Marrewijk, 2006; 1
Tariff, general equilibrium
We consider the situation for a small
country faced with the production possibility
frontier as drawn in the figure below.
At the given world price pworld it
would produce at point Q* and
Q*
trade at world prices to
consume at point C*
C*
U*
ppf
0
X
INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY;
Y
pworld
 Charles van Marrewijk, 2006; 2
Tariff, general equilibrium
If the country imposes a tariff, t, on
its import good (good X) this rotates
pworld(1+t) the price line for domestic
producers clockwise to pworld(1+t)
Q*
They will start to
produce at point Q2
Q2
C*
U*
0
X
INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY;
Y
pworld
 Charles van Marrewijk, 2006; 3
Tariff, general equilibrium
Despite the tariff the country can still
trade with ROW at the price pworld
pworld(1+t) So the income available to the
Q*
economy is represented by an income
line parallel to the initial income line
through the new production point
Q2
C*
U*
0
X
INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY;
Y
0
 Charles van Marrewijk, 2006; 4
Tariff, general equilibrium
Consumers, like producers, face the price pworld(1+t)
They equalize the marginal rate
world
p
pworld(1+t)
of substitution with the distorted
price line along the new income
line; a point like C2
Q*
The difference in production
and consumption income
(domestic prices) represents
tariff revenue
Q2
We assume that
C*
2
this is redistributed
C
U*
lump-sum to the
U2
consumers
X
INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY;
Y
pworld
 Charles van Marrewijk, 2006; 5
Tariff, general equilibrium
Tariffs result in a double distortion. First,
producers change production and thus income.
pworld(1+t) Welfare U1 at point C1 is still
attainable. Second, consumers are
Q*
also confronted with distorted
prices, which lowers welfare to U2
Q2
C2
C1
C*
U*
U1
U2
0
X
INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY;
 Charles van Marrewijk, 2006; 6
Tariff, general equilibrium
Here is an enlargement of the welfare loss arising from the tariff
First, the production (income) loss
Second, the consumption loss
Check for yourself that the second loss
does not arise if a production subsidy is
given, rather than a tariff imposed.
C2
C*
C1
U*
U2
U1