Trade and tariffs | APⓇ Microeconomics | Khan Academy

Summary

The video explains how trade impacts the total economic surplus in a market and introduces the concept of tariffs. Initially, it discusses how opening a market to global trade, especially at a lower world price, benefits consumers by increasing total economic surplus, while producers may lose some surplus. The introduction of tariffs, however, decreases consumer surplus, raises domestic producer surplus, generates government revenue, and leads to deadweight loss. The video also briefly touches on quotas as another method governments use to limit imports and affect economic surplus.

Takeaways

• 📈 Trade increases total economic surplus by expanding consumer and producer benefits.
• 🌍 Opening a market to a lower world price benefits consumers but reduces producer surplus.
• 💰 Consumer surplus increases significantly with lower prices from international trade.
• 📉 Producers face losses when the world price is lower than the domestic equilibrium price.
• 💸 A tariff is a per-unit charge on imports often aimed at protecting domestic industries.
• ⚖️ Tariffs increase the domestic price of goods, reducing consumer surplus but increasing producer surplus.
• 🏛️ Tariff revenue goes to the government, but it also creates deadweight loss in the economy.
• ❌ Deadweight loss occurs due to reduced trade and inefficiencies introduced by tariffs.
• 📊 Total economic surplus decreases when tariffs are introduced, despite government revenue gains.
• 🚫 Quotas, like tariffs, limit imports and can further affect economic surplus and market dynamics.

Q & A

What is the effect of opening a market to international trade on the total economic surplus?

Opening a market to international trade typically increases the total economic surplus. This happens because consumers gain access to goods at lower world prices, increasing consumer surplus, even though producer surplus may decrease.

How does a tariff affect consumer and producer surplus?

A tariff reduces consumer surplus because it raises the price consumers have to pay. It increases producer surplus by protecting domestic producers from cheaper foreign goods, allowing them to sell at higher prices.

What is the purpose of a tariff in the context of the sugar market example?

The tariff is intended to protect domestic sugar producers who are hurt by the lower world prices. By imposing a 50-cent tariff, the government helps domestic producers by making imported sugar more expensive.

What happens to government revenue when a tariff is imposed?

When a tariff is imposed, the government generates revenue from the tariff. The revenue is equal to the amount of the tariff multiplied by the quantity of imported goods. In the sugar example, this would be the 50 cents per pound times the imported quantity of sugar.

What is deadweight loss, and how does it arise in the case of tariffs?

Deadweight loss refers to the lost economic efficiency when the total surplus is reduced due to market distortions, like tariffs. In the case of tariffs, deadweight loss occurs because some of the surplus that could have benefited consumers or producers is neither captured by them nor by the government, leading to inefficiencies.

How does the world price of sugar impact the market when it is lower than the domestic price?

When the world price of sugar is lower than the domestic price, consumers in the domestic market benefit by purchasing sugar at a lower cost, increasing consumer surplus. However, domestic producers lose some surplus because they have to compete with cheaper imported sugar.

How does the quantity of sugar consumed change when the market opens to world prices?

When the market opens to world prices, the quantity of sugar consumed increases because the price is lower. Consumers are willing to buy more sugar at the reduced price, driving up demand.

What happens to the quantity of sugar consumed when a tariff is imposed?

When a tariff is imposed, the quantity of sugar consumed decreases compared to the free trade scenario because the price for consumers rises. However, it remains higher than when the market was completely isolated.

How does a tariff affect total economic surplus?

A tariff reduces total economic surplus. Although it benefits domestic producers and generates government revenue, the overall surplus decreases because part of the surplus becomes deadweight loss, and consumers pay higher prices.

What is the difference between a tariff and a quota in terms of market impact?

A tariff increases the price of imported goods by adding a charge per unit, while a quota directly limits the quantity of imports. Both reduce consumer surplus, but a quota directly caps the volume of trade, whereas a tariff allows more flexibility in the amount imported depending on how much consumers are willing to pay.

Outlines

00:00

📊 Trade and Economic Surplus in a Domestic Market

This paragraph explains how trade impacts economic surplus within a market, particularly through the lens of sugar imports in a country operating in isolation. The concept of economic surplus is introduced, dividing it into consumer and producer surplus. The focus shifts to the scenario where the country opens to global trade, with a world price lower than the domestic price. Consumers benefit from lower prices, expanding their surplus, but producers experience a reduction in their surplus. Despite this, the total economic surplus increases, highlighting the potential advantages of trade for the overall economy.

05:00

💡 The Effect of Tariffs on Market Surplus

This section dives into the impact of tariffs on economic surplus when a government introduces a tariff to protect domestic producers. A hypothetical 50-cent tariff on imported sugar raises the effective price for consumers, reducing their surplus and increasing the surplus for domestic producers. The government also gains revenue from the tariff, but part of the economic surplus becomes deadweight loss. The paragraph illustrates how tariffs can reduce total economic surplus while generating revenue and protecting domestic industries, but at the cost of market inefficiencies.

Keywords

💡Economic surplus

Economic surplus refers to the total benefit that both consumers and producers gain from participating in a market. It is the area between the supply and demand curves, and is divided into consumer surplus and producer surplus. In the video, economic surplus is used to explain how trade affects both consumers and producers, increasing the total economic benefit when the market opens up to international trade.

💡Consumer surplus

Consumer surplus is the difference between what consumers are willing to pay for a good and what they actually pay. It represents the area above the price level and below the demand curve. In the video, consumer surplus increases when the country opens its sugar market to the world price of $1.50, as consumers are able to buy sugar at a lower price than before.

💡Producer surplus

Producer surplus is the difference between the price producers receive for a good and the minimum amount they are willing to accept to produce it. It represents the area below the price level and above the supply curve. In the video, producer surplus decreases when the sugar market opens up to trade because domestic producers have to compete with the lower world price.

💡World price

The world price is the price at which a good is traded globally, often determined by supply and demand on a global scale. In this context, the world price of sugar is $1.50, which is lower than the domestic price. When the market opens to the world price, consumers benefit from lower prices, but domestic producers lose some of their market share.

💡Tariff

A tariff is a tax or fee imposed by a government on imported goods to protect domestic industries or generate revenue. In the video, a 50-cent tariff is applied to imported sugar, raising the effective price for consumers and reducing the consumer surplus. It also provides some government revenue, but it introduces deadweight loss by reducing total economic surplus.

💡Deadweight loss

Deadweight loss refers to the loss of economic efficiency when the equilibrium outcome is not achieved, often due to market distortions like tariffs. In the video, the introduction of a tariff on sugar creates deadweight loss by reducing the total quantity of sugar traded, leading to a loss of economic surplus that neither producers, consumers, nor the government capture.

💡Import quantity

Import quantity refers to the amount of a good that a country imports from abroad. In the video, the difference between the domestic production and the total consumption after the introduction of the world price represents the quantity of sugar imported. This import quantity is reduced when a tariff is applied, as it raises the price of imports.

💡Equilibrium price

The equilibrium price is the price at which the quantity of a good demanded by consumers equals the quantity supplied by producers. In the video, the domestic sugar market initially has an equilibrium price of $3, but when the market opens to trade, the equilibrium is disrupted by the lower world price, affecting both consumer and producer surpluses.

💡Government revenue

Government revenue refers to the money the government collects, often through taxes or tariffs. In the context of the video, government revenue is generated from the tariff on sugar, calculated by multiplying the tariff amount by the quantity of imported sugar. This revenue partially offsets the economic losses caused by the tariff but also contributes to deadweight loss.

💡Quota

A quota is a limit set by the government on the quantity of a good that can be imported. In the video, the idea of a quota is mentioned as an alternative to tariffs, potentially limiting the amount of sugar that can be imported to protect domestic producers. Like tariffs, quotas can reduce total economic surplus by restricting the benefits of free trade.

Highlights

Introduction to how trade affects the total economic surplus in a market and the concept of tariffs.

Explanation of economic surplus, including consumer surplus and producer surplus.

Description of how a country operating in isolation has a specific equilibrium price and quantity.

Opening up the market to the world price of $1.50 per pound and the impact on the consumer and producer surplus.

Increase in consumer surplus when the market opens up to a lower world price.

Producers' loss in surplus due to the market opening up to the lower world price.

Total economic surplus increases when opening up to the world price, benefiting consumers.

Introduction of a tariff by the government to protect domestic producers.

Effect of a tariff of $0.50 per pound on the market and consumers' price increasing.

Consumer surplus decreases relative to the free trade scenario when a tariff is introduced.

Increase in domestic producer surplus due to the introduction of the tariff.

Government revenue generated from the tariff, calculated by tariff amount times the imported quantity.

Introduction of deadweight loss due to the tariff, resulting in reduced total economic surplus.

Comparison of free trade and tariffs, noting that tariffs reduce total economic surplus, while benefiting domestic producers and generating government revenue.

Introduction to the concept of a quota as an alternative government measure to control imports, affecting economic surplus.

Transcripts

- [Instructor] In this video, we're gonna think about how

trade affects the total economic surplus in a market,

and we're also gonna think about tariffs,

which are a per unit charge that a government

will often put on some type of good that is being imported,

usually to protect a domestic industry,

but sometimes it's also to raise revenue.

So, right over here, we have a simple model

for the sugar market in some country.

And we're originally initially going to assume

that this country is operating in isolation.

So, this is the supply curve for the suppliers of sugar

in that country, and then this is the demand curve

for the people who would want to use sugar in that country.

And you can see the equilibrium

price and quantity in that country.

Now, in this world, we've reviewed this in many videos,

what's the total economic surplus?

Well, the total economic surplus would be

defined by this triangle right over here.

It's the area above the supply

curve and below the demand curve.

And we know that the part above this horizontal line

at the price of three, this would be the consumer surplus;

and then down here, this would be the producer surplus.

Now, let's say that this market opens up

to the world, to the world price.

And let's say when it does so, it does not affect

the world price itself, the world market is so large,

and let's say this country's market is relatively small.

And so, the world market, let's say that sugar

is trading at $1.50 per pound.

So, this right over here is the world price,

$1.50 per pound, let me write it right over there.

So, this is our world, our world price.

Now, if we assume that it's opened up

to this world price, what will happen?

Well, at the world price, the consumers in this market,

the people who are using the sugar,

well, they're going to use a lot more.

At $1.50, the place where that

intersects the demand curve is out here.

So, now, what is the consumer surplus

in this country, in this market?

Well, the consumer surplus in this

country is now much larger.

It contains the triangle that it contained before,

and then all of this area that I am now shading in.

And that has come at the cost of the producer surplus.

The producers in this country, or in this market,

they are now only getting that

producer of surplus right over there.

But if you look at the total economic

surplus, it has definitely grown.

The total economic surplus, instead of just being that

original triangle, it has now extended to include

this entire area that goes all the way out there.

And you could see that that completely contains

the previous total economic surplus,

which we had right over here.

So, theoretically, when a market opens up

to the world price like this,

it's going to increase your total economic surplus.

And if that world price is below the equilibrium price

in your isolated economy, then it's probably going to be

to the benefit of the consumers, but the producers

are going to lose out on some of their surplus.

Now, let's say that a government comes into power

in this market, and says, hey, I've been elected

by the sugar producers of this country.

I don't like this thing going on.

Our sugar producers in our country are getting hurt a lot,

and they're a big voting block,

so I am going to enact a tariff.

And once again, a tariff is a per unit charge,

or it's oftentimes a per unit charge.

And let's say the tariff is 50 cents per pound,

per pound on imported sugar.

Well, then what is the world price going to look like

to the market that we're talking about?

Well then, for the consumers in this market,

instead of being able to get the world price at $1.50,

they would have to pay 50 cents per pound higher than that.

So, the tariff would make the price go over here.

So, in that situation, what has just happened?

Well, now, where we intersect the demand curve

is a lower quantity than when we used the world price.

At the world price, we were consuming

a lot of sugar in this market,

and now we're going to consume a little bit less sugar.

But since, even with the tariff, our price is still lower

than our previous equilibrium price,

when we were operating in isolation,

we're still consuming more sugar, using more sugar,

demanding more sugar in this market

than we were when we did not have it opened up to trade.

Now, what did this tariff do to the surpluses?

Well, the consumer surplus has now gone down

relative to the free trade scenario.

We've lost this area down here.

So, now, the consumer surplus,

I will shade it in this blue color.

And we have increased the domestic producer surplus.

It has increased to this, right over here.

But what about this region that we seem,

that seems to no longer be there,

either in the consumer or the producer surplus?

Well, some of it is the government revenue.

What's the government revenue going to be?

Well, it's going to be the amount

of the tariff times the quantity.

So, the amount of the tariff is going to be that 50 cents,

so that's that height right over there.

And then what's the quantity that

they're getting that tariff on?

Well, this whole section right over

here is the imported quantity.

This section right over here is the domestic production,

and this is the imported quantity,

so the imported quantity times the tariff,

so this area right over here,

that is going to be government revenue.

But you do have some of that total economic surplus

that is just, becomes deadweight loss now.

You have this region right over here

that is now deadweight loss, and this region

right over here that is deadweight loss.

So, I'll leave you there.

As you can see here, that when you open up to trade,

theoretically, it increases the total economic surplus.

But that could have consequences on the producers.

And actually, there's cases where it can have

consequences on the users of whatever,

or the people who are the buyers in this market.

And many times, a government will enact a tariff.

Now, you can see that that tariff

will reduce the total economic surplus.

Some of that will go towards revenue,

while other parts of it will just be deadweight loss.

Another idea that a government might sometimes do

is an idea of a quota, where they're saying,

hey, we just don't like the total amount

of imports that are happening,

so they might just put a cap on it.

I'll let you think about how you might deal with a quota

and how that might also affect the economic surplus.