Lecture 9 Import Tariffs and Quotas under Imperfect Competition Tariffs and Quotas with Home Monopoly

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Home Loss Due to Threat of Duty

  • A charge of dumping can sometimes lead Foreign firms to increase their prices, even without an antidumping duty being applied.

  • In that case, there is a loss for Home consumers (a + b + c + d) and a gain for Home producers (a). The net loss for the Home country is area (b + c + d).

5. The Infant Industry Argument: The Case of a Missing Market

What is an infant industry?

      1. There is a new industry that has a high starting cost

      2. But its average cost will decrease over time with the scale of production (future AC falls with current output)

      3. Average cost falls enough to make the industry profitable (Net Present Value>0)

      4. But private investment may not happen because of some market failure (particularly imperfections in the capital market)

=> Then a temporary tariff is justified because it cuts down on imports while the infant domestic industry learns how to produce low enough costs to compete without the help of a tariff.

    • Here a tariff leads to a sufficient increase in output and therefore a reduction in future costs.

    • This allows the firm to survive whereas otherwise it would not.

Three conclusions emerge in most case.

    • There can be a case for some sort of government encouragement

    • A tariff may or may not help

    • Some other form of help is better infant industry policy than tariff.

  • The infant industry argument states that developing countries have a potential comparative advantage in manufacturing and they can realize that potential through an initial period of protection.

Cost and Benefits calculus of infant industry
Infant Industry Protection

In the situation today (panel a), the average cost curve is AC and the industry would make losses at the world price of PW. A tariff increases the price from PW to PW+t , allowing the industry to produce at S2, with the net loss in welfare of (b+d).

But producing today allows the average cost curve to fall through learning. So in the future (panel b) the firm can produce and the price P* without tariff protection, and earns producer surplus of e.
Market Failure Justifications for Infant Industry Protection

  • Imperfect capital markets argument

    • If a developing country does not have a set of financial institutions that would allow savings from traditional sectors (such as agriculture) to be used to finance investment in new sectors (such as manufacturing), then growth of new industries will be restricted.

  • Appropriability argument: Pioneering firms in a new industry generate social benefits which they are not compensated, e.g., “start-up” costs of adapting technology to local circumstances or of opening new markets.

Some evidence on infant industry

  • Historical evidence

    • Example: The U.S. and Germany had high tariff rates on manufacturing in the 19th century, while Japan had extensive import controls until the 1970s.

  • A US success story: The case of U.S. tariff on imports of heavyweight motorcycles. Harley-Davidson was on the brink of bankruptcy in 1982-83. It applied to the International Trade Commission (ITC) for Section 201 protection. HD was able to secure a bank loan only after receiving protection. So the tariff may well have contributed to its continued survival.

        • Its near-bankrupt status was due to problems of poor management and lagging productivity, while its revival after 1983 was due to the introduction of improved products and production techniques.

        • It cannot be argued that this broad change in company practices was caused by the tariff, but it appears that the temporary tariff bought it some breathing room.

        • Its improved products later offered by Harley-Davidson (which were emulated by its Japanese rivals), the temporary tariff may well have contributed to long-run welfare gains for consumers.

Calculation of Deadweight Loss The deadweight loss relative to import value in 1983 is measured as

This table shows the effects of the tariff on imports of heavyweight motorcycles in the United States..

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