Chapter 4: Problem 7

What factors influence the size of the revenue, protective, consumption, and redistributive effects of a tarift?

Short Answer

Expert verified

The influential factors for the effects of a tariff include tariff rate, quantity of imported goods, price elasticity of demand, availability of domestic substitutes, competitiveness of the domestic industry, consumers' and producers' responsiveness to price changes, and general market conditions.

Step by step solution

Understanding of Tariff Policy

Initial step is to understand the fundamental principles behind tariff policy and their effects. A tariff is a tax imposed on imported goods and services. It impacts the economy in several ways including revenue generation for governments, protection for domestic industries, influencing domestic consumption, and redistribution of income.

Factors Influencing Revenue Effect

The revenue effect is determined by the tariff rate and the quantity of imported goods. The higher the tariff rate or the quantity of imports, the greater the revenue. Moreover, it also depends on how sensitive the demand is to changes in price, termed as price elasticity of demand.

Factors Influencing the Protective Effect

Protective effect is influenced by the competitiveness of the domestic industry, the tariff rate, and the degree of substitution between domestic and imported goods. If there are close substitutes available domestically, then the protective effect will be higher.

Factors Influencing Consumption Effect

The consumption effect is influenced by the responsiveness of domestic consumers to price changes (price elasticity of demand), existence of substitutes, and price increment due to the tariff. A higher tariff reduces the consumption of imported goods.

Factors Influencing Redistributive Effect

A domestic tariff redistribution causes income transfer from consumers to producers, hence depends on consumers' and producers' price elasticity, availability of substitutes, and other market parameters. Lower consumer elasticity and higher producer elasticity favors producers by allowing them to sell goods at higher prices, resulting in larger profit shares.