2 management - School of International Business and ...

Günter S. Heiduk
Box 2 Effects of Tariffs
2a The small country case
It is assumed that a small country does not affect neither the world demand nor the world
market price. When a small country introduces a tariff, there is no effect on the world mar-
ket price. The supply on the large world market is fully elastic (SF).
The small country takes the world market price p(F) as exogenous. The exporters on the
world market deliver the quantity of good xwhich the importers in country I demand at the
given world market price: export x(F) x(F)* = import xI(F) x I(F)*. When country I imposes
a tariff t, the domestic price will rise by the amount of the tariff from p(F) to pI(t) resulting in
the decrease of imports (xI(t) xI(t)*). The three actors in country I (consumers, producers,
government) are affected by the tariff as shown in the table below: The increase in the
domestic price reduces the consumer surplus in the market (A+B+C+D). The producers
react to the higher price by expanding their domestic production. The producer surplus
increases (A), which means that the efficiency of the production decreases compared with
the free trade situation. The government receives tariff revenue (C) which it might spend to
subsidize specific groups of consumers. When summing up these effects, the tariff finally
reduces the welfare of country I (triangles B and D).
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