The goal of tariff taxes is to increase the demand price paid by domestic consumers (and reduce the supply price received by foreign producers) and thus reduce the quantity of imports from the foreign sector to the domestic economy. With fewer and more expensive imports coming in, buyers presumably turn to domestic production to take up the slack.

The Why of Tariffs

• Domestic Employment: Because foreign imports are produced in other countries by foreign workers, decreasing imports and increasing domestic production also increases domestic employment.


• Low Foreign Wages: Placing tariffs on imports produced by foreign workers who receive lower wages "levels the competitive playing field" compared to domestic goods produced by higher paid domestic workers.


• Infant Industry: If foreign imports compete with a relatively young domestic industry that is not mature enough nor large enough to benefit from economies of scale, then tariffs on imports protect the "infant industry" while it matures and develops.


• Unfair Trade: The foreign imports might be sold at lower prices in the domestic economy because foreign producers engage in unfair trade practices, such as "dumping" imports at prices below production cost. Tariffs then balance the competitive playing field.


• National Security: Tariffs can also discourage imports and encourage domestic production of goods that are deemed critical to the security of the national economy.

Sundial Imports to Csonda: An Example

The left panel in this exhibit contains the domestic Csondan market for sundials. The domestic market demand is represented by the negatively-sloped demand curve, labeled Dc. The domestic market supply is represented by the positively-sloped supply curve, labeled Sc. In the absence of imports, the domestic Csondan market achieves equilibrium at a price of 12 csonds (which is the domestic currency in Csonda). The quantity exchanged at this equilibrium is 200 sundials.

Imports of Queoldiolan sundials changes this domestic equilibrium. The right panel presents the international market for sundials. The import demand curve, labeled Dm, is the shortage derived from the Csondan sundial market for prices less than 12 csonds. The export supply curve, labeled Sx, is based on the surplus generated by the Queoldiolan sundial market (not shown) for prices above 8 csonds.

The international market achieves a sundial price of 10 csonds such that Csonda imports 100 sundials from Northwest Queoldiola. The goal of the Csondan Sundial Manufacturers Association is to reduce the quantity of imports and to increase the price. Click the [Imports] button to highlight this situation.

Now a Tariff

This tariff causes the export supply curve, Sx in the international market to decrease (shift to the left and upward) to Sx'. The result is a new equilibrium in the international market at 11 csonds. This increases the price in the Csondan sundial market from 10 csonds to 11 csonds. (Half of the 2 csond tariff is paid by the Csondan importers and half is actually paid by the Queoldiolan exporters). A click of the [Tariffs] button reveals the resulting equilibrium condition.

Some of he consequences of this tariff are much as expected, others not.

• First, the higher price (11 csonds versus 10 csonds) increases the domestic quantity of Csondan sundials produced from 50 to 75 in accordance to the law of supply. Moreover, this higher price also decreases the domestic quantity of Csondan sundials consumed from 250 to 225 in accordance with the law of demand.


• Second, with these changes in quantity supplied and quantity demanded, there is less of a domestic Csondan shortage of sundials to fill with imports. As such Queoldiolan imports decline from 100 sundials to 50.


• Third, Csondan sundial manufacturers produce a larger quantity (175 versus 150) at a higher price (11 csonds versus 10 csonds). As a result, more revenue flows to the domestic Csonda producers. They are definitely better off, which is probably the exact result they were seeking.


• Fourth, Csondan sundial buyers consume a smaller quantity (225 versus 250) and at a higher price (11 csonds versus 10 csonds). They are paying more for sundials and receiving fewer sundials. As a result, they are worse off.


• Fifth, the Csondan government gains a bit of revenue, 100 csonds to be exact. It collects a tariff of 2 csonds on each of the 50 Queoldiolan sundials imported into the country. This is revenue that the Csondan government had not previously collected. Moreover, it is a tax on the Csondans who purchase the imported Queoldiolan sundials.

Two Other Foreign Trade Policies

• Import Quotas: Import quotas are legal restrictions on the quantities of imports that are imposed by the domestic government. Import quotas can be established as a simple aggregate, presumably satisfied on a first-come-first-serve basis. Once the total is reached, then no more imports of the particular good are allowed. Alternatively, the total quota can be divided among foreign producers, perhaps pro-rated based on past imports. While import quotas benefit domestic producers they are harmful to domestic consumers. With fewer imports available in the domestic economy, consumers have fewer choices and those choices more often than not come at higher prices.


• Export Subsidies: An export subsidy is a payments made directly to domestic producers to encourage exports of production to the foreign sector. This export subsidization effectively increases the overall revenue received by the domestic firms when exporting production, which is bound to encourage exports. Export subsidies are usually justified as a means of helping domestic producers compete with lower cost imports. While imports might have lower costs due to comparative advantage, they also might be subsidized by foreign governments. Unlike tariffs and import quotas, domestic consumers, like domestic producers, tend to benefit from lower prices of both imports and domestic production. However, domestic taxpayers end up paying for this subsidization.