Protectionist Policies: Tariffs (AQA A Level Economics)

How a Tariff Works

• A tariff is a tax on imported goods/services (customs duty)
  

• Domestic producers/retailers have to pay the tariff when the good/service crosses the border into the country

  • This raises the cost of production for domestic firms

  • Firms often pass on the increased costs to consumers in the form of higher prices

  • These higher prices allow some domestic firms to increase their output (law of supply)
    

• Due to the tariff, more inefficient domestic firms are now producing more at the expense of more efficient foreign firms, which reduce their output due to the tariff

  • With increased domestic output, employment may increase
    

Diagram: Tariff Imposed on Imports

A tariff raises the price of world supply from P_W to P_W + Tariff. This reduces the quantity of imports from Q₁Q₂ to Q₃Q₄

Diagram analysis

• World supply (W_s) is considered to be infinite, and this supply curve is added to the domestic demand (DD) and supply (SD) curves

• The pre-tariff market equilibrium is seen at P_wQ₂

  • Domestic firms supply up to Q₁ at a price of P_w

  • Foreign firms supply the difference equal to Q₁Q₂ (the level of imports), at a price of P_w 
    
    

• After the tariff is imposed, the world price increases from P_w to P_w + Tariff 

  • Following the law of demand, the quantity demanded contracts from Q₂ to Q₄

  • Following the law of supply, the quantity supplied by domestic firms extends from Q₁ to Q₃

  • The new market equilibrium is seen at P_w+tariff Q₄ 

  • The level of imports is reduced from Q₁Q₂ to Q₃Q₄

    • Domestic producer surplus has increased by area 2

    • Domestic consumer surplus has decreased by areas 1, 2, 3 & 4

    • The government receives tax revenue equal to ((P_w+tariff) - P_w) x (Q₄-Q₃)

      • This is equivalent to area 3 on the diagram

The Impact of a Tariff

• The best way to consider the impact of a tariff on stakeholders is to explain it using a diagram

Diagram: The Impact of Tariffs on Stakeholders

A tariff impacts domestic producers, consumers, foreign producers and the government

The Impact of Tariffs on Stakeholders 

Impact on standards of living

• The standards of living for consumers worsen as the value of their income is eroded as they are paying higher prices

• Domestic firms that benefit from increased production may increase employees' wages

  • This would increase the standard of living for employees
    

Impact on equality

• Workers in industries that have been experiencing structural unemployment due to foreign competition will feel that the tariff results in them being treated more fairly