The impact of a tariff on domestic markets.

The question of tariffs and how they affect an economy is one of the more difficult to follow. It seems so obvious that adding a tariff to protect domestic jobs is a good thing, since people manufacturing items that otherwise would have been imported get to keep their jobs, but, unfortunately it is not so simple as all that.

When, for example, a tariff is placed on imported steel it is clearly good for steel workers who no longer have as great a pressure form the international market. However, what of the people who make washing machines, automobiles, playground equipment, etc. These people are now forced to work in an environment includes a higher price for one of their basic materials; steel. As a result of the increased price of steel workers "downstream" are cut back and laid off. Additionally, everyone who buys anything that contains steel must pay a higher price due to the attempt by the manufacturer to pass on the effect of the tariff.

Exploration: Using domestic supply and demand, combined with a prevailing world price for computers, what is the effect of a tariff on imported computers?

Exercise 16.3 follows an example of computers in Brazil and the impact of a tariff. Following the same structure this graphing exercise allows you to make several changes to the situation and explore the outcome of each. Notice that you can shift the domestic supply and demand and that when you use the green triangle to increase price the new price is automatically entered as a combination of the world price plus the tariff.

1. In this case what is the domestic equilibrium price in the absence of trade?
   
2. At the world price of $800, what is the domestic price of computers if free trade is established?
   
3. At the new domestic price, how many computers will be manufactured in Brazil?
   
4. Who gains and who loses from the opening of trade in Brazilian computers?
   
5. How many computers will be imported under a free trade regime?

Exploration: What happens when a tariff is imposed?

Often the domestic suppliers of an item undertake a political remedy to the loss of sales due to imports. They petition the legislature for trade protection in the form of a tariff, or a tax on goods coming in to a country. While the tariff often does what is intended, protect domestic manufacturers of import competing goods, it also has many unintended consequences.

1. If, in the situation above with free trade, domestic manufacturers of computers begin to go out of business, what will be the initial impact on the price and quantity of domestically produced computers?
   
2. Suppose the domestic computer manufacturing industry is successful in a attempt to get a tariff passed to protect themselves from the foreign competition. What happens to the price and quantity of computers if the tariff protects all the remaining jobs in the industry?
   
3. If, in the negotiation between the computer manufacturers and the legislature it is determined that a tariff which eliminates all foreign trade is simply not warranted, and that the government wishes to maximize the revenue from the tariff, at what level should the tariff be set?

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Exercise picked up from the 2e Economics textbook.