Country A is a large country while Country B is a small country. Both countries decided to impose tariffs on their imports. What will be the impact of this decision on their producers, suppliers and economy as a whole? Explain with the help of diagrams
The impact of tariffs on a large country (Country A) and a small country (Country B) can vary significantly due to their different market sizes and their respective influence on global trade.
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To understand these impacts, let’s explore the effects of tariffs on producers, suppliers, and the economy of both countries, with the help of diagrams.
1. Large Country (Country A)
Impact on Producers and Suppliers
- Domestic Producers: When Country A imposes tariffs, domestic producers benefit from reduced competition from foreign producers, which can lead to increased domestic production and potentially higher prices for their goods.
- Domestic Consumers: Consumers in Country A face higher prices for imported goods due to the tariffs, which can lead to reduced consumption and a potential welfare loss.
Economic Impact
- Terms of Trade: A large country has the ability to influence international prices. By imposing tariffs, Country A can potentially improve its terms of trade, meaning it may be able to buy imports at a lower price relative to the price of its exports. This is because its tariff can lead to a decrease in the global supply of the imported goods, causing the world price of those goods to rise.
- Revenue: The government of Country A collects tariff revenue, which can be used to fund public services or reduce other taxes. This revenue is a transfer from foreign producers to the domestic government.
- Deadweight Loss: The imposition of tariffs creates deadweight loss, represented by the loss of consumer surplus and producer surplus that is not fully captured by the tariff revenue.
Diagram for a Large Country
- Pre-Tariff Equilibrium:
- Supply and Demand Curve: Show the equilibrium price and quantity with free trade.
- Post-Tariff Equilibrium:
- Tariff Effect: The tariff shifts the supply curve up (or left) by the amount of the tariff.
- Price Increase: Domestic prices rise to the new equilibrium.
- Consumer Surplus: Decreases due to higher prices.
- Producer Surplus: Increases as domestic producers receive higher prices and produce more.
- Government Revenue: Represented by the area of the tariff.
- Deadweight Loss: Shown by the triangles representing the loss in consumer and producer surplus that is not captured by the government.
2. Small Country (Country B)
Impact on Producers and Suppliers
- Domestic Producers: In a small country, producers also benefit from reduced competition due to tariffs. However, their increased market share might be smaller compared to that of a large country.
- Domestic Consumers: Consumers in Country B face higher prices for imported goods due to the tariffs, similar to consumers in the large country. The reduction in consumption can be significant, but the overall economic impact is smaller.
Economic Impact
- Terms of Trade: A small country cannot influence global prices. Therefore, imposing a tariff will not change the world price of the imported goods. Instead, the small country bears the full cost of the tariff in terms of higher prices and decreased consumption.
- Revenue: The government of Country B also collects tariff revenue, which, like in Country A, can be used for public spending or other purposes.
- Deadweight Loss: The deadweight loss in a small country is typically less than in a large country due to the smaller impact on global prices.
Diagram for a Small Country
- Pre-Tariff Equilibrium:
- Supply and Demand Curve: Show the equilibrium price and quantity with free trade.
- Post-Tariff Equilibrium:
- Tariff Effect: The tariff shifts the domestic price up (or left) by the amount of the tariff.
- Price Increase: Domestic prices rise to the new equilibrium.
- Consumer Surplus: Decreases due to higher prices.
- Producer Surplus: Increases due to higher prices and increased production.
- Government Revenue: Represented by the area of the tariff.
- Deadweight Loss: Smaller compared to the large country, showing less consumer and producer surplus loss not captured by the government.
Summary
- Large Country: Imposing tariffs can improve the terms of trade, leading to potentially favorable outcomes for the large country, though it still incurs consumer losses and deadweight losses.
- Small Country: Imposing tariffs does not affect global prices, so the small country absorbs the cost of higher prices directly and faces a smaller deadweight loss compared to a large country.
In both cases, tariffs create inefficiencies in the economy, leading to higher prices for consumers, increased domestic production, and tariff revenue for the government, but with different magnitudes of impact depending on the size of the country.