EC 340

Lecture 4 - Protectionism

from last time
effective rate of protection
indifference curve analysis of a tariff
other barriers to trade
costs of trade barriers
arguments for protection

From Last Time


A tariff is a tax on imports.
effects of a tariff The tariff raises the domestic price above the world price. Consumers are losers because they pay a higher price and buy less of the product. Since the domestic price rises, domestic firms increase output and see their profits rise.

Effective Rate of Protection

Tariffs also have an effect on industries that sell material inputs to the protected industry, and firms in the protected industry are affected by tariffs on their inputs. This complicates looking at who is being protected by a set of tariffs.

The effective rate of protection is the percentage by which the entire set of a nation's trade barriers raises the industry's value added per unit of output.

Suppose that under free trade, the input costs of a bicycle are $220 and the world price is $300. Value added equals $80.

Suppose a 10% tariff is imposed on bicycle imports so the domestic bicycle price rises to $330 and a 5% tariff is placed on its inputs so that input costs rise to $231. Value added now equals $99.

The effective rate of protection for the bicycle industry equals (99-80)/80 or 23.8%, not the 10% nominal tariff. This tells us that income rises by 23.8% in the bicycle industry.

Indifference Curve Analysis of a Tariff

A tariff distorts consumption so we end up on a lower indifference curve. Production of the import good rises and that of the export good falls.


A quota is a limit on the amount of imports. For example, the U.S. allows 1 million tons of sugar to be imported but no more than that.
effects of a quota The tariff has the same effects on producers and consumers as a tariff. The domestic price rises above the world price.

Other Barriers to Trade

Costs of Trade Barriers

consumer losses per job saved
orange juice$240,000
color TV's420,000
specialty steel1,000,000
sugar 60,000

Arguments for Protection

  1. optimal tariff
    optimal tariff
  2. spillover effects
  3. creation of domestic jobs
    promote domestic production
  4. infant industries
  5. infant government
  6. national pride
  7. income redistribution
  8. national defense
  9. balancing the balance of trade
  10. creation of a "level playing field"
  11. strategic trade policy

David A. Latzko
318 COB
Department of Business and Economics
Wilkes University
Wilkes-Barre, PA 18766
phone: (717) 408-4718
fax: (717) 408-4917