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Tariffs and Protectionism - YouTube
Channel: Marginal Revolution University
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- [Alex] Okay, now we're going
to discuss international trade
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and how to model international trade
using demand and supply.
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We'll also look at how to model
the consequences of a tariff,
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a tax on trade.
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We'll look at the consequences
and also the cost of the tariff
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and the cost
of protectionism in general.
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By the way, remember
when we did demand and supply,
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I said that these concepts
are really, really important?
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Well now you see why:
it's because we're simply applying
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the same tools
over and over again.
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So if you understand
the fundamentals,
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then the applications
become much, much easier.
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So do make sure you understand
the fundamentals.
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Okay, let's get going.
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First, some quick definitions.
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Protectionism:
This is the economic policy
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of restraining trade
through tariffs, quotas,
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or other regulations
that burden foreign producers
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but not domestic producers.
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In particular, a tariff is simply
a tax on imports
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and a quota is
a quantity restriction on imports.
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For example, a quota may say
you're only allowed
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to import 10,000 automobiles
from Japan.
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Okay, let's get right into it.
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Here is the domestic supply curve.
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This is the supply curve
of the home country firms.
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If we're thinking about the US,
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this is the supply curve
from US firms.
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Here is the demand curve,
domestic demand,
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this is demand from US consumers.
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If we had no international trade
then as usual,
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we would find the equilibrium
where the quantity demanded
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is equal to the quantity supplied.
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That would give us the price
with no international trade
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and the quantity
both produced and consumed
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with no international trade
down here.
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Now let us suppose that the
consumers in this country
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can go out into the world
and they can buy
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as much of these semi-conductors
as they want at the world price.
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So in that case
if we had complete free trade,
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consumers would be able to buy
as much as they want
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at the world price or as given
by this world supply curve.
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The free trade equilibrium, then,
would involve greater consumption.
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That is, at the high price
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with no international trade,
the quantity demanded is here.
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With international trade,
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consumers get to buy
at the lower world price
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so their quantity demanded
increases.
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In terms of the diagram
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the quantity demanded
will increase to QD free trade.
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So domestic consumption
is equal to this distance
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or domestic consumption is equal
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to the quantity demanded
with free trade.
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Now what about production?
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Well, the domestic producers
can only charge
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as much as the world producers.
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They can't charge a higher price.
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So when the world price falls,
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when domestic consumers are able
to buy at the world price,
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domestic producers can only sell
at the world price,
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and they're going to be
less willing to sell.
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So the domestic production will fall,
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domestic production will fall
to this lower amount right here.
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At a lower price
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the domestic suppliers
are only willing to produce
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a less amount or lower amount
as given by QS free trade.
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Now notice that domestic consumption
is QD free trade,
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domestic production
is QS free trade
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and demanders are demanding
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more than the domestic suppliers
are willing to supply.
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The difference of course
is made up by imports.
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So with trade, domestic consumption
will be at QD free trade.
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Some of that will come from imports
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and some of that will come
from domestic suppliers.
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That's it. That's our analysis
of international trade
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using supply and demand.
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Now make sure you understand
each step in this diagram
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because the next slide,
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when we're going to add tariffs
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it's going to make the diagram
more complicated.
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Each step is actually simple,
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each step is actually no different
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than the ones we've already done,
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but the diagram will look
a little bit messier.
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So if you need to go through
this slide again
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make sure you understand
each step along the way.
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Okay let's do the same diagram
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but now we're going to do it
with a tax or a tariff.
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Let's remember that here
is the quantity
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demanded with free trade,
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here is quantity
supplied with free trade.
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The difference
between the quantity demanded
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and the quantity
supplied domestically
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is of course imports,
so this is imports with free trade,
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this distance right here.
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Now, a tariff is simply
a tax on imports.
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What the tariff does is
it raises the world price
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by the amount
of the tariff or the tax.
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So the world supply curve
or the world price shifts up
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until we get
to the new equilibrium.
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Of course what this means
is at a higher price
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domestic consumers are going
to demand a lower quantity.
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Domestic consumption falls
from Q free trade
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to Q quantity demanded
with the tariff.
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Domestic production falls
by this amount,
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or let's just add that
to the diagram,
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domestic consumption falls
from here to here.
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Okay, what about
domestic production?
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Well with a higher price,
domestic suppliers
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are now willing to supply more.
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Here is the price
of the world price,
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here's the world price.
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With a higher world price
domestic suppliers
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are willing to supply more
up until this point.
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Let's add that to the diagram.
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Domestic production
is going to increase
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from the quantity
supplied with free trade
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to the quantity
supplied with the tariff
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or again just putting that
into the diagram
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it's going to increase
from here to here
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along the domestic supply curve.
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But what about imports?
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Imports remember are the difference
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between the quantity demanded
and the quantity supplied.
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The quantity demanded
with the tariff is here,
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the quantity supplied is here,
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so imports are the difference
which is this distance right here.
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So notice that imports have fallen.
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Final thing to add, a tariff
is just a tax on imports,
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this is the quantity of imports,
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this is the amount
of the tax or the tariff.
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So the tariff will also
generate some revenues.
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This is the revenue from the tariff
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which is going to go
to the government.
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It's the tax or the tariff amount
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times the quantity
of imports with a tariff,
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so this is revenue
that flows to the government.
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Okay, that's it,
that's analysis of tariffs,
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now what I want to do
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is say what are
the welfare consequences of this?
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The welfare consequences
are going to depend
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upon this factor
the domestic production falling
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and this factor
the domestic consumption increasing.
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Let's take a closer look.
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Okay let's take a look
at the welfare costs
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and here I'm going to look
at the net costs.
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What I mean by that is
we could actually find the cost
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in two different ways.
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We could look at the costs
and the benefits to the consumers,
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the costs and benefits
to the producers,
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the cost and benefits
to government.
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We could sum all those up,
that would give us the net cost.
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I want to jump straight
to the net welfare costs
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of protectionism
and I'm going to do that
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by focusing on
the real factors which change
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and these are two;
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first domestic consumption
as I said falls,
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second domestic production
increases.
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Notice I haven't said anything here
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about the revenue from the tariff,
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that's because that's
a cost to consumers,
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they've got to pay more
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but it's a benefit
to the government,
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they have this revenue
that nets out
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so it's not going
to affect the net welfare.
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Instead the net welfare
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is going to depend
upon these two real changes.
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What I'm going to show is
that both of these effects
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somewhat surprisingly
reduce welfare.
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Why is this?
Well domestic consumption falls,
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the reason that reduces welfare
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is because there are
lost gains from trade
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and I'll say more
about that in a minute.
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Second, domestic production
increases,
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you might think that's
a good thing, except, however,
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we're going to have
wasted resources
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because the domestic producers
have higher costs
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than the world producers.
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On a net level there's going to be
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more resources going to production
than are necessary,
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there's going to be wasted resources.
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Can we measure
the value of these losses?
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In fact we can and I'll show that
in the next slide
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in a little bit more detail.
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In order to focus
on the welfare costs,
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I'm going to make
two simplifying assumptions.
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First I'm going to assume
that the world price is so low
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that if there were
complete free trade
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there would be
no domestic supply whatsoever.
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Think about a good like sugar,
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if we had complete
free trade in sugar
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we in the United States
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would probably import
all of our sugar.
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It's simply much more expensive
to produce sugar in Florida
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than it is to produce sugar
in a country such as Brazil.
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The problem is is that in Florida
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the opportunity cost of land
is very high
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and the climate in Florida
is not ideal for growing sugar
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so you have to invest
more real resources
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to produce sugar in Florida
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than you do
to produce sugar in Brazil.
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So if we had complete free trade,
there would be no domestic supply.
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I'm also going to assume
that with the tariff or the tax
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that it raises
the cost of imports so much
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that there are no imports,
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that it's simply too expensive
to import the good.
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Again this is actually
quite accurate or quite similar
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to what we have
for the case of sugar.
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With this very high tariff,
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the entire domestic consumption
is produced by domestic suppliers.
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Our tariff equilibrium
is given by this point
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and notice that
domestic consumption is lower.
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Okay, so what are
the costs of the tariff?
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There are two.
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First of all
the lost gains from trade.
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The demand curve can be read
as the willingness to pay.
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This is the willingness
to pay for sugar
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by domestic consumers.
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The world supply curve can be read
as the cost of producing sugar.
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This is the price
at which world suppliers
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are willing to supply the sugar.
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So there's lots of gains
from trade here.
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Consumers are willing to pay
more than the suppliers require
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in order to produce the good.
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So by getting together
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the consumers
and the world suppliers
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can earn these gains from trade.
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With the tariff however,
that's not possible.
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With the tariff,
we have reduced consumption
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and with that reduced consumption
is lost gains from trade
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given by this purple area.
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What else?
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Well the US supply curve
can be read as US costs.
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So what happens with the tariff
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is that instead of producing
the sugar in Brazil
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where it's cheap to produce sugar
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we produce the sugar in Florida
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where it's expensive
to produce sugar
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where we have to invest
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more real resources
in producing sugar.
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We've got to invest more
in irrigation,
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more in valuable land,
more in fertilizer.
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So these are wasted resources,
when the domestic industry expands.
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Because of the tariffs
we invest more resources
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in producing sugar
than are necessary.
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It would be cheaper,
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we would be able to import sugar
using fewer resources.
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We would be able to produce
that sugar internationally
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using fewer resources
than we can produce it
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in the United States.
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What the tariff does is
it switches production
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from the low-cost world producers
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to the high-cost
domestic producers,
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and that generates
wasted resources.
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Now in fact, with these numbers
we can calculate the sizes
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or the amount
of these wasted resources.
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What economists do quite often
is they make assumptions
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about these supply curves
and these demand curves
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and they can make
some of these calculations.
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Let's take a quick look.
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So with these numbers,
we can calculate these areas.
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This triangle for example
is half base times height.
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So the base is 20,
this is a base of 20.
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The height is 20 minus 9,
there's the 20, there's the 9.
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So the area of the triangle
is half base times height
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or 1.1 billion.
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What about the deadweight
loss triangle?
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You do the same calculation
it's 0.22 billion.
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So with these kind of numbers
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we can find out the cost
of the sugar tariff
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are $1.32 billion
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and economists do these kinds
of calculations all the time.
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Okay, let's summarize
and point out some further reading.
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First, tariffs increase
prices to consumers
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so domestic consumption falls
and that creates a deadweight loss.
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Second, tariffs divert production
from low-cost world producers
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to high-cost domestic producers
and that wastes resources.
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Now I haven't said much here
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about the distribution
of the losses and gains,
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exactly who benefits and who loses.
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Let me give you just a short story.
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Tariffs are bad for consumers
who have to pay more,
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they're good for domestic producers
who get to expand production.
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They're bad overall precisely
because of these two reasons
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which I've just described.
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If you want to look in detail,
I focused on the bad overall,
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if you want more detail on dividing
in between consumers and producers
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and the political economy of this,
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take a look at lots
of different textbooks
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but the one of course
I would recommend,
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Cowan and Tabarrok,
Modern Principles of Economics,
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that will go into more detail
on the distribution.
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Thanks.
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- [Narrator] If you want
to test yourself
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click Practice Questions.
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Or, if you're ready to move on
just click Next Video.
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