Explain the price effect, protective effect, consumption effect, revenue effect and distributive effect of tariff in partial equilibrium framework.

Understanding Tariffs in a Partial Equilibrium Framework

The partial equilibrium analysis of tariffs simplifies the complex interactions within an economy by focusing on a single market. Key assumptions for this framework include:

• The country imposing the tariff is "small," meaning its demand for imports does not affect the world price of the good.
• The supply and demand curves for the commodity remain constant.
• There are no changes in consumer tastes, incomes, or prices of other goods.
• Absence of technological advancements or externalities that alter cost conditions.
• Imported and domestically produced goods are perfect substitutes.
• No transport costs.

1. Price Effect

The most immediate and fundamental effect of an import tariff in a partial equilibrium framework is the price effect. When a tariff is imposed on an imported good, the domestic price of that good increases. For a small country, this increase in the domestic price will be by the full amount of the tariff, as the world price remains unaffected. This means that consumers in the importing country now face a higher price for both imported goods and, due to competition, often for domestically produced substitutes as well.

For example, if the world price of a good is $100 and a $10 tariff is imposed, the domestic price will rise to $110. This higher price directly impacts consumer purchasing power and producer incentives.

2. Protective Effect (or Production Effect)

The protective effect, also known as the production effect or import substitution effect, refers to the increase in domestic production of the import-competing good as a result of the tariff. The rise in the domestic price, caused by the tariff, makes domestic production more profitable. This encourages domestic producers to increase their output, as they can now sell their goods at a higher price (world price + tariff) than before. This effectively provides a "protective shield" for domestic industries against cheaper foreign competition. However, this increased domestic production may come at a higher cost compared to imports, leading to inefficiencies.

Mechanism: Higher domestic price leads to an expansion along the domestic supply curve.

3. Consumption Effect

The consumption effect describes the reduction in the total quantity of the good consumed domestically due to the tariff. As the domestic price of the good rises, consumers face a higher cost, leading to a decrease in their willingness and ability to purchase the good. This reduction in consumption signifies a loss of consumer welfare or consumer surplus. Consumers either reduce their overall consumption of the good or substitute it with other, potentially less preferred, goods.

Mechanism: Higher domestic price leads to a contraction along the domestic demand curve.

4. Revenue Effect

The revenue effect refers to the income generated for the government from the imposition of the tariff. This revenue is calculated by multiplying the tariff rate per unit by the quantity of the good that is still imported after the tariff is imposed. While a primary objective for some tariffs is revenue generation, particularly in developing countries, in many cases, protection is the main goal, and revenue generation is a secondary outcome. The revenue effect is a direct transfer of income from consumers (who pay higher prices) to the government.

Calculation: Tariff revenue = Tariff per unit × Quantity of imports after tariff.

5. Distributive Effect (or Redistribution Effect)

The distributive effect, also known as the redistribution effect, highlights how the imposition of a tariff reallocates income and welfare among different groups within the domestic economy. Specifically:

• Consumers lose: They face higher prices and reduced consumption, leading to a decrease in consumer surplus.
• Domestic producers gain: They receive higher prices for their output and can expand production, leading to an increase in producer surplus.
• Government gains: It collects revenue from the tariff.

Thus, tariffs redistribute income from domestic consumers to domestic producers and the government. This redistribution often comes with a net welfare loss for the nation as a whole, known as "deadweight loss," which represents the inefficiency arising from reduced consumption and inefficient domestic production.

The following table summarizes these effects:

Effect	Description	Impact on Domestic Economy (Small Country)
Price Effect	Increase in the domestic price of the imported good by the amount of the tariff.	Higher prices for consumers, increased profitability for domestic producers.
Protective Effect	Increase in the quantity of the good supplied by domestic producers.	Expansion of domestic import-competing industries.
Consumption Effect	Decrease in the total quantity of the good consumed domestically.	Reduction in consumer welfare/consumer surplus.
Revenue Effect	Collection of tax revenue by the government from imported goods.	Increased government income.
Distributive Effect	Transfer of welfare from domestic consumers to domestic producers and the government.	Changes in income distribution, potential deadweight loss.