applications: the costs of taxation & international trade chapters 8-9

Applications: The Costs of Taxation & International Trade

Chapters 8-9

Figure 1 The Effects of a Tax

Copyright © 2004 South-Western

Size of tax

Quantity0

Price

Price buyerspay

Price sellersreceive

Demand

Supply

Pricewithout tax

Quantitywithout tax

Quantitywith tax

Tax Revenue

If tax is $T per unit, tax revenue equals …

TQ

Figure 2 Tax Revenue


Taxrevenue (T × Q)

Size of tax (T)

Quantitysold (Q)

Quantity0

Price

Demand

Supply

Quantitywithout tax

Quantitywith tax

Price buyerspay

Price sellersreceive

Recall …

Consumer Surplus:

Area under demand curve and above price line.

Producer Surplus:

Area above supply curve and below price line.

Figure 3 How a Tax Effects Welfare


A

F

B

D

C

E

Quantity0

Price

Demand

Supply

= PB

Q2

= PS

Pricebuyers

pay

Pricesellers

receive

= P1

Q1

Pricewithout tax

Deadweight Loss

The fall in total surplus that results from a market distortion, such as a tax.

Buyers have an incentive to consume less and sellers an incentive to produce less.

Figure 4 The Deadweight Loss


Cost tosellersValue to

buyers

Size of tax

Quantity0

Price

Demand

SupplyLost gainsfrom trade

Reduction in quantity due to the tax

Pricewithout tax

Q1

PB

Q2

PS

Figure 5 Tax Distortions and Elasticities


(a) Inelastic Supply

Price

0 Quantity

Demand

Supply

Size of tax

When supply isrelatively inelastic,the deadweight lossof a tax is small.



(b) Elastic Supply

Price

0 Quantity

Demand

SupplySizeoftax

When supply is relativelyelastic, the deadweightloss of a tax is large.



Demand

Supply

(c) Inelastic Demand

Price

0 Quantity

Size of taxWhen demand isrelatively inelastic,the deadweight lossof a tax is small.



(d) Elastic Demand

Price

0 Quantity

Sizeoftax Demand

Supply

When demand is relativelyelastic, the deadweightloss of a tax is large.

Figure 6 Deadweight Loss and Tax Revenue from Three Taxes of Different Sizes


Tax revenue

Demand

Supply

Quantity0

Price

Q1

(a) Small Tax

Deadweightloss

PB

Q2

PS



Tax revenue

Quantity0

Price

(b) Medium Tax

PB

Q2

PS

Supply

Demand

Q1

Deadweightloss



Tax

rev

enue

Demand

Supply

Quantity0

Price

Q1

(c) Large Tax

PB

Q2

PS

Deadweightloss

Figure 7 How Deadweight Loss and Tax Revenue Vary with the Size of a Tax


(a) Deadweight Loss

DeadweightLoss

0 Tax Size

Ronald Reagan’s Deadweight Loss

I came into the Big Money making pictures during WWII. You could only make four pictures and then you were in the top bracket. So we all quit working after four pictures and went off to the country.

Figure 7 How Deadweight Loss and Tax Revenue Vary with the Size of a Tax


(b) Revenue (the Laffer curve)

TaxRevenue

0 Tax Size

Application: International Trade

Export Industries

If a country has a comparative advantage in a good or service, the world price will be above the domestic (no-trade) price.

The country will export those goods and services for which it has a comparative advantage.

Figure 1The Equilibrium without International Trade


Consumersurplus

Producersurplus

Priceof Steel

0 Quantityof Steel

Domesticsupply

Domesticdemand

Equilibriumprice

Equilibriumquantity

Figure 2 International Trade in an Exporting Country


Priceof Steel

0Quantityof Steel

Domesticsupply

Priceaftertrade World

price

DomesticdemandExports

Pricebeforetrade

Domesticquantity

demanded

Domesticquantitysupplied

Figure 3 How Free Trade Affects Welfare in an Exporting Country


D

C

B

A

Priceof Steel

0 Quantityof Steel

DomesticsupplyPrice

aftertrade World

price

Domesticdemand

Exports

Pricebefore

trade

Welfare effects of an export industry

Consumers are worse off—they consume less at higher prices.

Producers are better off—they produce more at higher prices.

Producers’ gains > consumers’ losses.

Net gain from trade.

Imports

If a country does not have a comparative advantage, the world price will be below the domestic (no trade) price.

Figure 4 International Trade in an Importing Country


Priceof Steel

0 Quantity

Priceafter

trade

Worldprice

of Steel

Domesticsupply

Domesticdemand

Imports

Domesticquantitysupplied

Domesticquantity

demanded

Pricebeforetrade

Figure 5 How Free Trade Affects Welfare in an Importing Country


C

B D

A

Priceof Steel

0 Quantityof Steel

Domesticsupply

Domesticdemand

Priceafter trade

Worldprice

Imports

Pricebefore trade

Figure 5 How Free Trade Affects Welfare in an Importing Country


C

B D

A

Priceof Steel

0 Quantityof Steel

Domesticsupply

Domesticdemand

Priceafter trade

Worldprice

Imports

Pricebefore trade

Producer surplusafter trade

Consumer surplusafter trade

Tariffs

Taxes on imports, used to discourage importing and protect domestic industry.

Figure 6 The Effects of a Tariff


Priceof Steel

0 Quantityof Steel

Domesticsupply

Domesticdemand

Pricewith tariff Tariff

Importswithout tariff

Equilibriumwithout trade

Pricewithout tariff

WorldpriceImports

with tariff

QSQS QD QD



Priceof Steel

0 Quantityof Steel

Domesticsupply

Domesticdemand



Pricewithout tariff

Worldprice

QS QD

Producer surplusbefore tariff

Consumer surplusbefore tariff



A

B

Priceof Steel

0 Quantityof Steel

Domesticsupply

Domesticdemand




Pricewithout tariff

WorldpriceImports

with tariff

QSQS QD QD

Consumer surpluswith tariff



C

G

A

ED F

B

Priceof Steel

0 Quantityof Steel

Domesticsupply

Domesticdemand



Pricewithout tariff

WorldpriceImports

with tariff

QSQS QD QD

Deadweight Loss

Import Quotas

Government restricts quantity of imports.

Licenses are assigned to exporters.

Figure 7 The Effects of an Import Quota


A

E'C

B

G

D E" F

Priceof Steel

0 Quantityof Steel

Domesticsupply

Domesticsupply

+Import supply

Domesticdemand

Isolandianprice with

quota

Importswithout quota

Equilibriumwith quota


Quota

Importswith quota

QD

Worldprice

Worldprice

Pricewithout

quota=

QS QDQS

Arguments for Restricting Trade

1. Jobs

2. National Security

3. Infant Industry

4. Unfair competition

5. Protection as a bargaining chip

The first era, from the late 1800's to World War I, was driven by falling transportation costs, thanks to the steamship and the railroad. That was Globalization 1.0, and it shrank the world from a size large to a size medium. The second big era, Globalization 2.0, lasted from the 1980's to 2000, was based on falling telecom costs and the PC, and shrank the world from a size medium to a size small. Now we've entered Globalization 3.0, and it is shrinking the world from size small to a size tiny. That's what this outsourcing of white-collar jobs is telling us — and it is going to require some wrenching adjustments for workers and political systems.

--Thomas Friedman, NYT 3/4/04

Shaking up trade theory' has some interesting points but reflects confusions in the public debate rather than dissensions in trade theory. The [Paul A.] Samuelson paper is not about offshoring of services through the Internet or other mediums, which created a panic wave, but really about a different and indeed conventional question that has recurred for half a century: Can changes such as productivity increases outside the U.S. hurt the U.S.?

Thus, imagine that you are exporting aircraft, and new producers of aircraft emerge abroad. That will lower the price of your aircraft, and your gains from trade will diminish. You have to be naive to believe that this can never happen. But you have to be even more naive to think that the policy response to the reduced gains from trade is to give up the remaining gains as well.

The critical policy question we must address is: When external developments, such as the growth of skills in China and India, for instance, do diminish the gains from trade to the U.S., is the harm to the U.S. going to be reduced or increased if the U.S. turns into Fortress America? The answer is: The U.S. will only increase its anguish if it closes its markets. Every trade economist understands this.

Jagdish BhagwatiArvind PanagariyaColumbia University, New York

End of Chapter Problems

8:11

Several years ago the British government imposed a “poll tax” that required each person to pay a flat amount to the government independent of his or her income. What is the effect of such a tax on economic efficiency? What is the effect on economic equity? Do you think this was a popular tax?

9:10

When the government of Tradeland decides to impose an import quota on foreign cars, three proposals are suggested: (1) Sell the licenses in an auction. (2) Distribute the licenses in a lottery. (3) Let people wait in line and distribute the licenses on a first-come, first-served basis. Compare the deadweight losses of the three policies.

applications: the costs of taxation & international trade chapters 8-9

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