Free Trade and Protection

Tariff Model

Free Trade Model (Before Tariff)
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In free trade, we see a large area of consumer surplus but a small area of producer surplus. Consumers pay the world price at Pw for a large quantity of goods or services at Q4. The goal of a tariff is to increase the small green producer surplus, by imposing a tax that increases the price of imported goods or services higher than the world price towards the domestic price.

 

The government shouldn't impose a tariff that makes the price equivalent to the domestic price, as while this would greatly increase domestic producer surplus, it would not generate any revenue.

 

The Tariff Model

In this model, a tariff has occurred, meaning that the price of imports is no longer at Pw, but rather at Pt.

 

This results in a loss of consumer surplus equal to areas A + B + C + D as consumers pay a higher price at Pt and receive a lower quantity from Q4 to Q3.

However, producer surplus will increase by area A, as they receive a higher price for their goods or services at Pt, meaning domestic market share increases from Q1 to Q2. Tariffs are a tax meaning that governments will receive area C in government revenue.

 

Tariffs place a burden on society as they result in a deadweight loss of area B + D. These areas of lost consumer surplus are not translated into producer surplus or government revenue and are lost forever, resulting in a decrease in total surplus and net society loss.

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