Lecture 4 - Tariff Analysis-2 | International Economics- In Depth Basics and Analysis PDF Download

 Page 1


Tariff Analysis-2 
1 
Institute of Lifelong Learning, University of Delhi 
  
 
 
 
 
 
 
 
 
 
Chapter: Tariff Analysis-2 
Content Developer: Amit Girdharwal 
College / University:  Dyal Singh College, 
University Of Delhi 
                   
 
 
 
 
 
 
 
 
 
Page 2


Tariff Analysis-2 
1 
Institute of Lifelong Learning, University of Delhi 
  
 
 
 
 
 
 
 
 
 
Chapter: Tariff Analysis-2 
Content Developer: Amit Girdharwal 
College / University:  Dyal Singh College, 
University Of Delhi 
                   
 
 
 
 
 
 
 
 
 
Tariff Analysis-2 
2 
Institute of Lifelong Learning, University of Delhi 
 
 
  
Table of Contents: 
1. Introduction 
2. The Stopler- Samuelson Theorem 
    (a) The Metzler Paradox  
    (b) The Lerner Paradox 
3. Theory of Optimum Tariff 
4. Effective Rate of Protection 
5. Conclusion 
6. Exercise 
7. References 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Page 3


Tariff Analysis-2 
1 
Institute of Lifelong Learning, University of Delhi 
  
 
 
 
 
 
 
 
 
 
Chapter: Tariff Analysis-2 
Content Developer: Amit Girdharwal 
College / University:  Dyal Singh College, 
University Of Delhi 
                   
 
 
 
 
 
 
 
 
 
Tariff Analysis-2 
2 
Institute of Lifelong Learning, University of Delhi 
 
 
  
Table of Contents: 
1. Introduction 
2. The Stopler- Samuelson Theorem 
    (a) The Metzler Paradox  
    (b) The Lerner Paradox 
3. Theory of Optimum Tariff 
4. Effective Rate of Protection 
5. Conclusion 
6. Exercise 
7. References 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Tariff Analysis-2 
3 
Institute of Lifelong Learning, University of Delhi 
 
 
1. Learning Goals: 
After reading this chapter, you will be able to: 
? Understand The Stolper-Samuelson theorem and its implication regarding 
imposition of tariffs. 
? Analyze various exceptions of the Stolper-Samuelson theorem such as Metzler 
paradox and Lerner Paradox.  
? Explain the theory of optimum tariff. 
? Understand the effective rate of tariff and its implications. 
   Introduction 
    In this chapter we will discuss some theories related to tariff and analyze the 
various effects of tariff imposition on the factors of production because some factors 
are worse-off and some are better off, depending upon their abundance in the 
economy. However, there are some contradictions also in the conclusions of the 
various theories. So we will discuss Metzler and Lerner paradox. 
   The Stolper – Samuelson Theorem: 
W.F.Stolper and Paul A.Samuelson studied Heckscher- Ohlin theory and developed a 
new theory which is known as Stolper-Samuelson theorem. This theory illustrates the 
effect of trade in the distribution of income. According the theory, under certain 
restrictive assumptions, a tariff can raise both relative and absolute income of the 
relatively scarce factor of production and lower that of abundant factor.  
This theorem is based on the assumption that tariff will always increases the price of 
the imported good in the domestic market. In other words, there is no change in the 
terms of trade after imposition of the tariff. However, we could expect that terms of 
trade to improve with the tariff imposition. As a result the price of the imported good 
will fall in the domestic market, then the effect on distribution of income would be 
opposite of the statement suggested by the Stolper-Samuelson theorem. As the 
relative price of imports fall, there will be rise in the relative price of exports. This 
means that tariff would favour the production of the exportable goods and there will 
be shift of the factors of production from importing competing sector to the export 
sector. This will increase reward of the factors used intensively in the export sector, 
Page 4


Tariff Analysis-2 
1 
Institute of Lifelong Learning, University of Delhi 
  
 
 
 
 
 
 
 
 
 
Chapter: Tariff Analysis-2 
Content Developer: Amit Girdharwal 
College / University:  Dyal Singh College, 
University Of Delhi 
                   
 
 
 
 
 
 
 
 
 
Tariff Analysis-2 
2 
Institute of Lifelong Learning, University of Delhi 
 
 
  
Table of Contents: 
1. Introduction 
2. The Stopler- Samuelson Theorem 
    (a) The Metzler Paradox  
    (b) The Lerner Paradox 
3. Theory of Optimum Tariff 
4. Effective Rate of Protection 
5. Conclusion 
6. Exercise 
7. References 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Tariff Analysis-2 
3 
Institute of Lifelong Learning, University of Delhi 
 
 
1. Learning Goals: 
After reading this chapter, you will be able to: 
? Understand The Stolper-Samuelson theorem and its implication regarding 
imposition of tariffs. 
? Analyze various exceptions of the Stolper-Samuelson theorem such as Metzler 
paradox and Lerner Paradox.  
? Explain the theory of optimum tariff. 
? Understand the effective rate of tariff and its implications. 
   Introduction 
    In this chapter we will discuss some theories related to tariff and analyze the 
various effects of tariff imposition on the factors of production because some factors 
are worse-off and some are better off, depending upon their abundance in the 
economy. However, there are some contradictions also in the conclusions of the 
various theories. So we will discuss Metzler and Lerner paradox. 
   The Stolper – Samuelson Theorem: 
W.F.Stolper and Paul A.Samuelson studied Heckscher- Ohlin theory and developed a 
new theory which is known as Stolper-Samuelson theorem. This theory illustrates the 
effect of trade in the distribution of income. According the theory, under certain 
restrictive assumptions, a tariff can raise both relative and absolute income of the 
relatively scarce factor of production and lower that of abundant factor.  
This theorem is based on the assumption that tariff will always increases the price of 
the imported good in the domestic market. In other words, there is no change in the 
terms of trade after imposition of the tariff. However, we could expect that terms of 
trade to improve with the tariff imposition. As a result the price of the imported good 
will fall in the domestic market, then the effect on distribution of income would be 
opposite of the statement suggested by the Stolper-Samuelson theorem. As the 
relative price of imports fall, there will be rise in the relative price of exports. This 
means that tariff would favour the production of the exportable goods and there will 
be shift of the factors of production from importing competing sector to the export 
sector. This will increase reward of the factors used intensively in the export sector, 
Tariff Analysis-2 
4 
Institute of Lifelong Learning, University of Delhi 
and the income distribution will turn in the favour of the country’s abundant factor, 
and scarce factor will suffer loss. 
  
Assumptions: 
 This theorem is based on several assumptions. These are 
1. This theorem is based on 2×2×2 model. There are two countries home and 
foreign, two commodities, X and Y, with two factors of production, labor and 
capital. 
2. Production functions of both commodities are linear and homogenous of 
degree one. 
3. Good X is labor intensive and good Y is capital intensive. 
4. Supply of the factors is fixed. 
5. There is perfect competition in the goods and factor market. 
6. Terms of trade between the countries remains constant. 
 
Explanation: 
 Given these assumptions, the effect of imposition of the tariff by the home country 
on income distribution is illustrated in the Edgeworth Box diagram in figure 9, where 
labor is measured along horizontal axis and capital along vertical axis. Dimensions of 
the edgeworth box measure the total available supply of factors in the home 
country. It is assumed that the home country exports the labor intensive good X and 
imports the capital intensive good Y. 
Page 5


Tariff Analysis-2 
1 
Institute of Lifelong Learning, University of Delhi 
  
 
 
 
 
 
 
 
 
 
Chapter: Tariff Analysis-2 
Content Developer: Amit Girdharwal 
College / University:  Dyal Singh College, 
University Of Delhi 
                   
 
 
 
 
 
 
 
 
 
Tariff Analysis-2 
2 
Institute of Lifelong Learning, University of Delhi 
 
 
  
Table of Contents: 
1. Introduction 
2. The Stopler- Samuelson Theorem 
    (a) The Metzler Paradox  
    (b) The Lerner Paradox 
3. Theory of Optimum Tariff 
4. Effective Rate of Protection 
5. Conclusion 
6. Exercise 
7. References 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Tariff Analysis-2 
3 
Institute of Lifelong Learning, University of Delhi 
 
 
1. Learning Goals: 
After reading this chapter, you will be able to: 
? Understand The Stolper-Samuelson theorem and its implication regarding 
imposition of tariffs. 
? Analyze various exceptions of the Stolper-Samuelson theorem such as Metzler 
paradox and Lerner Paradox.  
? Explain the theory of optimum tariff. 
? Understand the effective rate of tariff and its implications. 
   Introduction 
    In this chapter we will discuss some theories related to tariff and analyze the 
various effects of tariff imposition on the factors of production because some factors 
are worse-off and some are better off, depending upon their abundance in the 
economy. However, there are some contradictions also in the conclusions of the 
various theories. So we will discuss Metzler and Lerner paradox. 
   The Stolper – Samuelson Theorem: 
W.F.Stolper and Paul A.Samuelson studied Heckscher- Ohlin theory and developed a 
new theory which is known as Stolper-Samuelson theorem. This theory illustrates the 
effect of trade in the distribution of income. According the theory, under certain 
restrictive assumptions, a tariff can raise both relative and absolute income of the 
relatively scarce factor of production and lower that of abundant factor.  
This theorem is based on the assumption that tariff will always increases the price of 
the imported good in the domestic market. In other words, there is no change in the 
terms of trade after imposition of the tariff. However, we could expect that terms of 
trade to improve with the tariff imposition. As a result the price of the imported good 
will fall in the domestic market, then the effect on distribution of income would be 
opposite of the statement suggested by the Stolper-Samuelson theorem. As the 
relative price of imports fall, there will be rise in the relative price of exports. This 
means that tariff would favour the production of the exportable goods and there will 
be shift of the factors of production from importing competing sector to the export 
sector. This will increase reward of the factors used intensively in the export sector, 
Tariff Analysis-2 
4 
Institute of Lifelong Learning, University of Delhi 
and the income distribution will turn in the favour of the country’s abundant factor, 
and scarce factor will suffer loss. 
  
Assumptions: 
 This theorem is based on several assumptions. These are 
1. This theorem is based on 2×2×2 model. There are two countries home and 
foreign, two commodities, X and Y, with two factors of production, labor and 
capital. 
2. Production functions of both commodities are linear and homogenous of 
degree one. 
3. Good X is labor intensive and good Y is capital intensive. 
4. Supply of the factors is fixed. 
5. There is perfect competition in the goods and factor market. 
6. Terms of trade between the countries remains constant. 
 
Explanation: 
 Given these assumptions, the effect of imposition of the tariff by the home country 
on income distribution is illustrated in the Edgeworth Box diagram in figure 9, where 
labor is measured along horizontal axis and capital along vertical axis. Dimensions of 
the edgeworth box measure the total available supply of factors in the home 
country. It is assumed that the home country exports the labor intensive good X and 
imports the capital intensive good Y. 
Tariff Analysis-2 
5 
Institute of Lifelong Learning, University of Delhi 
 
The origin for X commodity is shown as O and that of Y is O
1
. OO
1
 is the contract 
curve. The isoquant for the good X ix aa, while bb is the isoquant of Y. They are 
tangent to each other at the point N on the factor price line pp under free trade. 
When a tariff is imposed on the capital intensive good Y, their domestic price of Y 
rises and their imports declines. 
 The increase in price of Y attracts home producers to increase the production of Y. 
Now country produces more Y and less of X. this leads to the diversion of capital and 
labor from X production to Y production. This is shown by the shifting of the isoquant 
aa of X downward to a
1 
a
1
 and the isoquant of Y bb to upward to b
1
b
1
. The new 
production point is M where the two isoquants a
1 
a
1 
and b
1
b
1 
is tangent at the factor 
price line P
1
P
1
. Since Y is capital intensive, relative demand for capital rises. Since 
there is perfect mobility of factors in the country, both labor and capital will move 
from X industry to Y industry. But the relative demand for capital is greater than 
that of labor, since Y is more capital intensive than X, this tends to bid up the 
relative price of capital. This leads to substitution in both industries of labor for 
capital. It means that capital- labor ratio falls in production of both commodities. 
This is shown by the less steep slope of the factor price line P
1
P
1 
as against the pp 
line before the tariff is imposed. As more labor is used with each unit of capital, the 
marginal productivity of labor and its real wages fall. Conversely, the fall in the 
capital – labor ratio means that the marginal productivity of capital and the real 
returns to capital have risen in production of both commodities. 
To conclude we can say that as the country moves from N to M with the imposition 
of tariff, its national income is lowered. The returns to scarce factor capital increases 
and the wages of the abundant factor labor falls in both relative and absolute terms 
with the reallocation of resources.