What is a Tariff?
A tariff is a form of tax imposed on imported goods or services. Tariffs are a common element in international trade The primary reasons for imposing tariffs include (1) the reduction in the importation of goods and services by increasing their prices and (2) the protection of domestic producers.
Forms of tariffs
Tariffs usually take two forms: specific and ad valorem. A specific tariff is a tariff imposed on one unit of a good (e.g., $1,000 tariff on each imported car). An ad valorem tariff is a tariff levied as a certain percentage of a good’s value (e.g. 10% of the value of an imported car).
How do tariffs work?
In order to understand how the tariffs work, let’s consider the following example:
The world price on imported computers in a country is $1,000. It is less than the equilibrium price of $1,500 (the price of domestic production) because if the price on the imported computers is higher than the price of locally manufactured computers, there is no incentive to buy computers from other countries.
On the graph above, you can see that at the world price of $1,000 per computer, domestic manufacturers produce 10 million computers while consumers purchase 30 million computers. The shortage of 20 million computers is imported from foreign manufacturers.
However, the government decides to support the domestic computer manufacturers and imposes a tariff of $200 per unit of imported computers. Due to the new tariff, the price per computer increases to $1,200.
Due to the price increase, consumers will purchase fewer computers (25 million) while the domestic producers will increase their output to 15 million. Subsequently, the quantity of the imported computers will decline to 10 million (25 million – 15 million).
Why are tariffs imposed?
There are several reasons why governments impose tariffs on imported goods. Some of the most common reasons include:
#1 To protect domestic producers
Sometimes, governments want to protect domestic producers and industries that may experience problems from cheap imported goods. In addition, supporting the domestic producers prevents a potential increase in unemployment.
#2 To protect domestic consumers
Some cheap imported goods may be dangerous to consumers. For example, the goods may contain elements that may harm consumers. By making the goods more expensive, the government discourages their excessive consumption.
#3 To preserve national security
The government may want to protect industries with a strategic significance to national security from overdependence on imports.
#4 To protect infant industries
Tariffs may protect emerging and growing industries. The tariffs will attract more consumers to domestic products, and the growth of companies in the emerging industries will be stimulated.
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