Analyse the partial equilibrium effects of a tariff imposed by a large country on its imports in terms of consumers' surplus.

Understanding Consumer Surplus

Consumer surplus is the area below the demand curve and above the market price. It represents the net benefit consumers receive from purchasing a good. A higher market price reduces consumer surplus, while a lower price increases it. In a free trade scenario, consumers benefit from lower prices due to imports, leading to a larger consumer surplus.

Impact of a Tariff on Imports

When a large country imposes a tariff on imports, several changes occur:

• Increase in Import Price: The tariff directly increases the price of imported goods for domestic consumers.
• Reduction in Import Quantity: The higher price leads to a decrease in the quantity of imported goods demanded.
• Shift in Supply Curve: The supply curve for the imported good shifts upwards by the amount of the tariff.
• Domestic Production Increase: Domestic producers, facing less competition from cheaper imports, may increase their production.

Analysis of Changes in Consumer Surplus

The imposition of a tariff leads to a clear reduction in consumer surplus. This reduction can be broken down into two components:

• Direct Loss: Consumers who continue to purchase the imported good now pay a higher price, directly reducing their surplus. This is represented by the increase in price multiplied by the quantity consumed after the tariff.
• Indirect Loss: Some consumers, priced out of the market by the higher price, stop consuming the imported good altogether. This represents a loss of surplus as they no longer receive the benefit of consuming the good.

The overall reduction in consumer surplus is represented by the area on a supply-demand diagram bounded by the original demand curve, the new (higher) price line, and the original supply curve. The magnitude of this loss depends on the elasticity of demand and supply.

Elasticity and Consumer Surplus Loss

The impact on consumer surplus is heavily influenced by the price elasticity of demand.

• Inelastic Demand: If demand is inelastic (consumers are not very responsive to price changes), the quantity demanded will fall only slightly, and the price will increase significantly. This results in a relatively small reduction in quantity but a large increase in price, leading to a substantial loss of consumer surplus.
• Elastic Demand: If demand is elastic (consumers are very responsive to price changes), the quantity demanded will fall significantly, and the price will increase only slightly. This results in a large reduction in quantity but a small increase in price, leading to a moderate loss of consumer surplus.

Example: US Steel Tariff (2018)

The imposition of tariffs on steel imports by the US in 2018 provides a real-world example. While intended to protect domestic steel producers, the tariffs increased the cost of steel for downstream industries like automobile manufacturing and construction, leading to higher prices for consumers and a reduction in their surplus.