How Do Import Tariffs Work?
A tariff is a tax on imported units. Assume a small price-taking economy, competitive sellers and no transport costs. Pw is the world price in dollars per unit. With a 5-dollar tariff on a product costing 20 abroad, importers need 25 to cover both the product and tax. Domestic sellers can also charge 25 while imports continue.
Builds on: What Is Trade Protection?
What you will learn
- A tariff raises the domestic price while imports continue, encouraging domestic production and reducing purchases.
- Distinguish government revenue from an efficiency loss
Essential definitions
- Tariff
- A tax on imported goods, expressed here as dollars per imported unit.
- Deadweight loss
- A loss of total surplus that is not received by another group.
Explain the price change
A tariff is a tax on imported units. Assume a small price-taking economy, competitive sellers and no transport costs. Pw is the world price in dollars per unit. With a 5-dollar tariff on a product costing 20 abroad, importers need 25 to cover both the product and tax. Domestic sellers can also charge 25 while imports continue.
The higher price encourages domestic firms to produce more and consumers to buy less. Imports are domestic consumption minus domestic production, so both responses shrink the import gap. A tariff large enough to eliminate imports needs a different price calculation; Pw plus tariff is not always the resulting market price.
Read quantities and welfare areas
In the diagram, price per unit is vertical and quantity per month horizontal. D and S are domestic demand and supply. Read their quantities at Pw first, then at Pw plus tariff. Move from each intersection down to the quantity axis. The gap between demand and supply at each price gives imports.
Consumers lose surplus; domestic producers gain. Government revenue = tariff per unit × remaining imports. A rectangle measured in dollars per unit times units per month gives dollars per month. The revenue is not itself a deadweight loss. The production-loss triangle measures extra domestic units costing more than imports; the consumption-loss triangle measures purchases forgone despite being worth more than world cost. Under the model's assumptions these triangles are net losses, while transfers between domestic groups cancel.
Import tariff: transfers and welfare loss
A tariff raises the domestic price, increases domestic output and reduces consumption and imports. The rectangle is government revenue; the two triangles are production and consumption losses.
How to read this diagram
- Put price vertically and quantity per month horizontally. Draw D and S; mark E1 where D meets the world-price line.
- Add Pw + tariff above it and mark E2 where it meets D.
- Mark old and new quantities. Shade tariff × remaining imports, then the two loss triangles.
Blue: policy revenue, rent or fiscal cost. Orange: efficiency loss. D: Qd = 120 − 2P. S: Qs = 2P. Values are illustrative; calculations are HL.
- Consumer price / producer receipts
- 25 / 25 dollars per unit
- Domestic output / consumption
- 50 / 70 thousand units
- Imports
- 20 thousand units
- Government net revenue (negative = cost)
- 100 thousand dollars
- Efficiency loss
- 50 thousand dollars
On a small screen, scroll the graph horizontally to read all labels.
Assumptions and limits: Small price-taking country; tariff passed fully into price; imports remain positive. Numerical welfare calculations are HL.
Apply and evaluate
- This model holds the world price fixed and excludes externalities and retaliation.
- If a tariff eliminates imports, revenue from this good becomes zero.
Common misconceptions
- Government revenue is a transfer in national welfare accounting, not the entire welfare loss.
Knowledge check
Why is tariff revenue calculated using remaining imports?
What to remember
A tariff raises the domestic price while imports continue, encouraging domestic production and reducing purchases. Revenue is a transfer; extra high-cost production and lost consumption create separate efficiency losses.
Completion records your reflection, not a test score.
Lessons in this section
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