Hello everybody, let's now tackle tariffs as a form of protectionism. We'll understand how they distort a market that was previously operating under free trade. What we're going to do is apply some of the arguments we've learned for protectionism to the use of it.
tariff. So we're going to leave those to one side for now, that's just a reminder of some of the big arguments why governments may look to adopt protections measures. But what we're looking for is on a big tariff diagram like this, where is the link to import reduction?
because that's what protectionism is all about, protecting domestic industries from competition abroad by squeezing imports. What I've drawn here is our normal free trade diagram. I've made a video before about free trade and how we get to this position here. So at this position, you can see we've got price and quantity, keep it generic for this one.
We've got domestic supply, we've got domestic demand, and we're assuming that the world... suppliers have got the comparative advantage. So the world supply comes in, it can charge a lower price than would be the case in the domestic market.
And the supply curve is perfectly elastic. It's horizontal. Why? Because of the levels of quantity that need to be supplied in just this domestic market. The rest of the world can happily supply those very low levels of quantity at the same price.
They don't need rises in price to supply greater levels of quantity. Such is the ease at which. that the rest of the world can supply such quantities.
So horizontal for that reason. So if we take this price, the lower world price, what is the domestic demand, what is the domestic supply? Well, domestic supply is going to be here at Q1.
Domestic demand is down there at Q2. So where the world supply, where the price here, cuts the domestic supply and demand curves is where you find those two quantities. So you can see there is an issue.
Q1 is being supplied domestically at this low price of PW, but Q2 is demanded. There is an excess demand. Big excess demand. So, normally to ration the excess demand the price would rise, but because the world supplies have got the price of PW, there is no chance of that price rising. So, the rest is going to be imported.
So, the difference between Q1 and Q2 would be imports. Let's now assume that the domestic government says, okay, we want to reduce the number of imports coming into the country, maybe because of one of these reasons here. We want to adopt a tariff as a form of protectionism.
Remember what a tariff is. A tariff is a tax on imports. Any time a tax is imposed on a market, it shifts the supply curve upwards.
So this tax comes on imports from world suppliers, so it affects the supply of the world curve. and it shifts it up. So the SW curve shifts up to, let's call it SW plus tariff. So there is it shifting upwards.
And the vertical distance between the two supply curves, between SW and SW plus tariff, is the actual value of the tariff. What does this do to the market? Well, it raises the price, doesn't it?
So the price of the market goes up from PW. to PW plus the tariff now. We can now work out what's happened to domestic demand and domestic supply.
Domestic supply extends from Q1 to Q3. There is an extension there of supply with this high price. Domestic demand has contracted though from Q2 to Q4 and that makes a logical sense as well because with a higher price you would expect that consumers are less willing and able to buy these products now.
So demand contracts, we move up the demand curve, contracting demand we move up the supply curve which is an extension of supply. So domestic supply has increased to Q3, domestic demand has decreased to Q4. What's happened to imports now?
Well look, there's demand. there's domestic supply. So the excess demand remains, but it's much, much smaller than what it was before.
The distance between Q3 and Q4 is much smaller than what the distance was before between Q1 and Q2. So imports have been squeezed because domestic demand has contracted, because domestic supply has extended. So we've squeezed the quantity of imports coming into the country.
There is more to analyse on this diagram, though. Now, these three little sections in the middle are from... very meaningful, they say a lot. The first one I'm going to show you in green. That green box represents the tariff revenue generated for the government to collect.
So the tariff The vertical distance between the two supply curves is the value of the tariff, and that tax, that tariff, is charged on every quantity unit of import coming in. So each unit of import coming in is being charged that tariff, so you times that vertical distance. by the total number of imports coming in, so the difference between Q3 and Q4, times what the tariff gives you this green box.
What we can also shade in are areas of losses. So this red triangle here is a deadweight loss. It's a deadweight welfare loss.
of consumer surplus. If you want to understand why, you can watch my next video, the detailed dissection of the tariff diagram. But you can work it out. So initial consumer surplus under PD...
was this massive triangle. When you raise the price of the PW plus tariff, the triangle of the consumer surplus has got smaller, so the total general loss of consumer surplus is this kind of trapezium here. Okay?
But... This is one area that's not recovered. It's a deadweight loss of consumer surplus.
Watch my next video, I should say, if you want detail on this and why. And this triangle here represents a deadweight loss, a deadweight welfare loss. But this time it's a world efficiency. Okay? What we're trying to say here is because domestic suppliers are producing extra units from Q1 to Q3, when they shouldn't be producing it, there is a loss of efficiency that comes from it.
So those units there were previously being supplied by very efficient world suppliers. suppliers that had the comparative advantage in producing whatever this product would be. But now with domestic suppliers actually producing more from Q1 to Q3 because of an artificial price advantage with the price going up, they have now decided to supply more from Q1 to Q3. supply these extra units, even though they are less efficient at producing so.
A good little trick for you to realise is that the supply curves here also represent the marginal cost of production. I'll write that on the side. So if that's the case, if we compare the marginal cost of production between world supplies and domestic supplies, all the units after Q1, the marginal cost for world supplies is constant. It always comes back to this cost level unit. Each extra unit produced is the same kind of cost each time.
Whereas, if you compare to domestic suppliers, to produce every unit after Q1, they are less efficient than world suppliers are. Let's look at that in more detail. So, in black here.
So, to produce that extra unit, it would have cost world suppliers that cost, but it's cost domestic suppliers a bit more. The unit after, it would have cost world suppliers that much again, same cost, but it's cost domestic suppliers more. And that... point is true all the way until Q3.
So every X unit being produced from Q1 to Q3 is being produced at an extra cost when domestic suppliers are producing it than if world suppliers were producing it. So in that sense, resources are being provided to inefficient producers when they should have been going to the world suppliers. They should have been the ones producing those units, but they aren't. So that triangle there represents a loss, a deadweight loss of world efficiency.
little chunks you need to be aware of. The green box here is government revenue. Always useful to show that. And the two boxes on the other side are deadweight losses.
One is of consumer surplus, one is of world efficiency. So when we come back to these items that we talked about before, can we relate those to this diagram? Well, in an essay, this is how you use the diagram. You draw it like this. with the three bits shaping in, you then use these kind of arguments on the one hand to back up why a tariff might be a good idea.
We talked about protecting infant industries and allowing them to grow and to gain from economies of scale as they increase their output. Is that being seen here? Of course it is. it is, domestic supplies increase from Q1 to Q3. So that allows further growth and further benefits from economies of scale.
So that is happening. We can tick that one off, prove that on the diagram. Another argument is to protect against dumping. So again, to increase the price of imports coming in. If a government feels like the price of goods actually being dumped in the domestic market are being dumped at a very artificially low price.
So to protect against dumping and tariff can raise that price and maybe make them... less competitive. Is that happening here? Yes.
The price of these imports is rising, which maybe offsets any artificial reduction in price that comes from dumping. To protect against losses of domestic employment, is that happening here? We can see the increase in domestic supply from Q1 to Q3 probably will need an increase in workers to supply that, or at worst, just keep the same labour force.
So in that sense, domestic employment is protected. To protect against artificial adventures abroad, like low-cost labour, well again, we're squeezing imports. imports, aren't we?
So imports from Q3 to Q4 is being squeezed, and the price of imports coming in has actually increased, offsetting any advantages from low-cost labour. The increase in government revenue, we've seen that with the green box here. And we've also talked about how protectors might be used to improve the current account position of a nation.
Well, look, the squeeze of imports from Q1, Q2 to now only Q3, Q4 implies that less import expenditure will be taking place, and that in theory... theory will improve a country's current account position and maybe will lead to a current account surplus. Who knows?
So that is the tariff diagram. Learn it. Very nice diagram.
Very logical. My next video will really dissect it and look at very specific parts of this diagram. I'll make another video about the problems of protectionism and especially the tariff as well.
So stay tuned for the next two very important videos. Thanks for watching. See you next time.