Trade and tariffs | APⓇ Microeconomics | Khan Academy

In this video, we're going to think about how trade affects the total economic surplus in a market, and we're also going to 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, it's 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. 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. 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. 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 price. 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. The world market lets say that sugar is trading at a dollar fifty per pound. So this right over here is the world price, a dollar fifty per pound. Let me write it right over there— so this is 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 a dollar fifty, 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 a 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 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 can 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. 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 bloc. So I am going to enact a tariff."

Once again, a tariff is a per-unit charge— it's oftentimes a per unit charge. Let's say the tariff is fifty cents 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 a dollar fifty, they would have to pay fifty 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. 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're 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. We have increased the domestic producer surplus. It has increased to this right over here.

But what about this region 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? What's going to be the amount of the tariff times the quantity? So the amount of the tariff is going to be that fifty 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 just becomes dead weight loss. Now you have this region right over here that is now dead weight loss and this region right over here that is dead weight 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 are cases where it can have consequences on the users of whatever, or the people who are the buyers in this market. 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 dead weight loss.

Another idea that a government might sometimes do is the 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.