Price Effects of a Tariff :
by Steven Suranovic ©1997-2004
The small country assumption means that the country's imports are a very small share of the
world market. So small, that even a complete elimination of imports would have an imperceptible
effect upon world demand for the product and thus would not affect the world price. Thus when
a tariff is implemented by a small country, there is no effect upon the world price.
To depict the price effects of a tariff using an export supply/import demand diagram, we must redraw the export supply curve in light of the small country assumption. The assumption implies that the export supply curve is horizontal at the level of the world price. From the perspective of the small importing country, it takes the world price as exogenous since it can have no effect upon it. From the exporters perspective, it is willing to supply as much of the product as the importer wants at the given world price.
When the tariff is placed on imports, two conditions must hold in the final equilibrium; the same two conditions as in the large country case. Namely,
However, now PTUS remains at the free trade price. This implies that in a small country case, the price of the import good in the importing country will rise by the amount of the tariff. As seen in the adjoining diagram, the higher domestic price reduces import demand and export supply to QT.
International Trade Theory and Policy
Lecture Notes: ©1997-2004 Steven M. Suranovic