I wanted to take a moment to talk about tariffs and international trade with all of the policies coming out of Washington with regards to trade imbalances, tariffs, and all of the trade wars that are happening. Countries can gain from trade if they have a comparative advantage in a product or service it makes sense to do so.
There are a few terms we need to define before we get into this short lesson on tariffs and international trade. First, what is a Tarriff?
A tariff is just a tax on imports. So, when America trades with another country, the good or service that we get from them is an import. The good or service they get from us is an export. So, bottom line, a tariff is just a tax on imports and is imposed to protect domestic producers but making any imports more expensive.
When we say PROTECT the domestic producers, that is anyone based in the United States that is creating a product. The overarching economic policy of helping our domestic producers by imposing tariffs, quotas or other regulations to make imports more expensive but NOT hurt our owns workers is called PROTECTIONISM.
Applying all of this to supply and demand, let’s look at a supply and demand chart. The equilibrium price where domestic supply intersects domestic demand reflects the price and quantity with NO TRADE.
With FREE TRADE, meaning American consumers can go out and get clothing from anywhere in the world without any tariffs or government intervention look what happens, the NEW FREE TRADE equilibrium price is lower and the quantity demanded is more because of the lower price.
That all sounds fine and dandy right? More stuff available at a lower price, who wouldn’t want that?!?!? But check out what happens. The domestic producers CANNOT charge more than the world producers so where the world supply line intersects the domestic supply line reflects the quantity that domestic producers are willing to produce at the new price. Because quantity demanded is greater than the quantity supplied with the new FREE TRADE line, the difference between the two are IMPORTS.
This should all make sense. Bet now lets add a tariff. If you understand how the different lines moves in the preceding charts, adding a tariff will be easy to understand, it’s just going to make the chart look messy. Messy is good right? How does your room look right now? Ha! Gotcha!!! I don’t want to get anyone in trouble, so let’s get back to the chart. All we are going to do is add a parallel line above the world price because a tariff is just a tax, so it just makes the new price higher than the free trade price. The important thing to look at is where the new TARIFF line intersects the demand curve. The quantity demanded is LESS because the price is more. Where the new line intersects the SUPPLY CURVE shows that domestic producers are willing to produce MORE because they get a higher price for it. As before the amount imported is simply the difference between quantity demanded and quantity produced. IT IS LESS. So a tariff will reduce the amount of imports and make domestic producers more money.
Is this good or bad? Well, depends on who you are talking about. A tariff is good for domestic producers and bad for international producers. When more stuff is made here, that means more jobs are created. But. . .it also means that because SO MUCH of what we consume is an import that stuff will be more expensive if it is imported. Walk down the aisle of Walmart, or go into your closet and see if the clothes, toys, electronics, or whatever says MADE IN CHINA, or MADE IN USA. A tariff would make ANYTHING that doesn’t say made in USA more expensive. So that’s the tradeoff. We may think that FREE TRADE is great because we all want cheap stuff, but when we lose jobs nobody can afford it anyways. Or we may say, I don’t care if things are more expensive because people actually have jobs to afford more stuff. WHOA?!?!? This does start to get complex as now we have jumped headfirst into the deep end of POLITICS. We are not going to get into what is right or wrong as the goal is to get you all to understand what a tariff is, how it affects trade, and what the consequences both good and bad are from these changes.