45 Krugman/Obstfeld/Melitz • International Economics: Theory & Policy, Ninth Edition
The analysis presented here takes a partial equilibrium view, focusing on demand and supply in one market,
rather than the general equilibrium approach followed in previous chapters. Import demand and export
supply curves are derived from domestic and foreign demand and supply curves. There are a number of
trade policy instruments analyzed in this chapter using these tools. Some of the important instruments
of trade policy include specific tariffs, defined as taxes levied as a fixed charge for each unit of a good
imported; ad valorem tariffs, levied as a fraction of the value of the imported good; export subsidies, which
are payments given to a firm or industry that ships a good abroad; import quotas, which are direct restrictions
on the quantity of some good that may be imported; voluntary export restraints, which are quotas on trading
that are imposed by the exporting country instead of the importing country; and local content requirements,
which are regulations that require that some specified fraction of a good is produced domestically.
The import supply and export demand analysis demonstrates that the imposition of a tariff drives a wedge
between prices in domestic and foreign markets, and increases prices in the country imposing the tariff and
lowers the price in the other country by less than the amount of the tariff. This contrasts with most textbook
presentations which make the small country assumption that the domestic internal price equals the world
price times one plus the tariff rate. The actual protection provided by a tariff will not equal the tariff rate if
imported intermediate goods are used in the production of the protected good. The proper measurement,
the effective rate of protection, is described in the text and calculated for a sample problem.
The analysis of the costs and benefits of trade restrictions require tools of welfare analysis. The text explains
the essential tools of consumer and producer surplus. Consumer surplus on each unit sold is defined as the
difference between the actual price and the amount that consumers would have been willing to pay for
the product. Geometrically, consumer surplus is equal to the area under the demand curve and above the
price of the good. Producer surplus is the difference between the minimum amount for which a producer
is willing to sell his product and the price which he actually receives. Geometrically, producer surplus is
equal to the area above the supply curve and below the price line. These tools are fundamental to the
student’s understanding of the implications of trade policies and should be developed carefully.
The costs of a tariff include distortionary efficiency losses in both consumption and production. A tariff
provides gains from terms of trade improvement when and if it lowers the foreign export price. Summing
the areas in a diagram of internal demand and supply provides a method for analyzing the net loss or gain
from a tariff. The gain from a tariff is larger the greater the decrease in foreign export price from the tariff
(as the tariff-imposing country is able to pass some of the costs of the tariff onto foreign exporters). Since
large countries will have a larger influence on export prices than small countries, a large country is more
likely to gain, and therefore impose an import tariff.
Other instruments of trade policy can be analyzed with this method. An export subsidy operates in
exactly the reverse fashion of an import tariff. An import quota has similar effects as an import tariff
upon prices and quantities, but revenues, in the form of quota rents, accrue to the quota license holders,
who are often foreign producers. Voluntary export restraints are a form of quotas in which import licenses
are held by foreign governments. Local content requirements raise the price of imports and domestic goods
and do not result in either government revenue or quota rents.
Throughout the chapter the analysis of different trade restrictions are illustrated by drawing upon specific
episodes. Europe’s common agricultural policy provides and example of export subsidies in action. The
case study corresponding to quotas describes trade restrictions on U.S. sugar imports. Voluntary export
restraints are discussed in the context of Japanese auto sales to the United States. The oil import quota in
the United States in the 1960s provides an example of a local content scheme.
The Appendix discusses tariffs and import quotas in the presence of a domestic monopoly. Free trade
eliminates the monopoly power of a domestic producer and the monopolist mimics the actions of a firm
in a perfectly competitive market, setting output such that marginal cost equals world price. A tariff raises
domestic price. The monopolist, still facing a perfectly elastic demand curve, sets output such that marginal
cost equals internal price. A monopolist faces a downward sloping demand curve under a quota. A quota
is not equivalent to a tariff in this case. Domestic production is lower and internal price higher when a
particular level of imports is obtained through the imposition of a quota rather than a tariff.
