Tariff
What is Tariff?
A tariff is a tax on imported goods that raises their price and protects domestic producers from foreign competition.
It raises government revenue and helps domestic producers, but raises prices and reduces quantity for consumers, creating deadweight loss. It reduces imports and the overall gains from trade. Tariffs are a common form of trade protection.
Tariff: a worked example
Let domestic demand be Qd = 90 - P and domestic supply Qs = P - 10, with the world price at 20 dollars. Before any tariff, buyers take 70 units, domestic firms supply 10 units, and imports fill the 60 unit gap. Impose a tariff of 10 dollars per unit, so imported units now sell at 20 + 10 = 30 dollars. At 30 dollars quantity demanded drops to 60, domestic output rises to 20, and imports shrink to 40 units. Government revenue is 10 × 40 = 400 dollars. Deadweight loss is the production triangle ½(10)(10) = 50 plus the consumption triangle ½(10)(10) = 50, totalling 100 dollars. Consumers give up ½(70 + 60)(10) = 650 dollars of surplus, of which 150 reaches producers and 400 reaches the treasury.
The mistake students make with tariff
The exporting country gets named as the party that pays the tariff. Importers write the cheque to the treasury, so the tax reads like a charge on foreigners. In the standard small country diagram the world supply line is flat at 20 dollars, so foreign sellers still collect 20 while the domestic price rises by the full 10 dollars to 30. Domestic buyers absorb the entire tariff, which is why consumer surplus falls by 650 dollars while producers and the treasury together gain only 550.
Tariff questions
How do you calculate tariff revenue?
Tariff revenue equals the tariff per unit multiplied by the quantity still imported once the tariff is in place. Find the new domestic price by adding the tariff to the world price, read domestic quantity demanded and domestic quantity supplied at that higher price, then take the difference between them. Multiplying by the larger pre-tariff import quantity is the usual slip, since the tariff itself shrinks imports. On a graph the revenue rectangle spans only the remaining imports.
Who benefits from a tariff?
Domestic producers gain, since the higher price lets them sell more units at a better margin, and the government collects revenue on every imported unit. Workers in the protected industry keep jobs that import competition threatened, and suppliers to that industry pick up orders. Those gains together fall short of what consumers give up, so the country as a whole ends up worse off by the size of the two deadweight loss triangles.
Why does a tariff create deadweight loss?
A tariff creates deadweight loss on two margins. Domestic firms with costs above the world price get drawn into producing units that could have been imported more cheaply, wasting resources. Consumers who valued the good above its world cost but below the tariff-inclusive price walk away, losing surplus that nobody captures. The two triangles flanking the revenue rectangle measure exactly those losses.
Formula / Example
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Related terms
Common comparisons
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