I’m reading for a quiz and I just ran into this point by an author:
“For a large country that can affect world price through trading, a tariff lowers the price of imports and generates a terms of trade benefit.”
How is this possible? How does it lower the price of imports?
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A tariff on imports increases the price of imports in the tariff nation. This decreases demand for the imported product in the tariff nation.
If that country is large and provides a substantial fraction of global demand, the decline in global demand will lead to a lower global price.
Since terms of trade refers to the ratio of export prices to import prices, and the tariff nation is a net importer of the tariffed good, the lower price on the global market of the tariffed good means that the overall ratio of export price to import price rises. That’s a terms of trade benefit.
My understanding of a Tariff is that it is a tax (additional cost) on imported goods. It is usually used to protect domestic production. If a large country did this it might make those products cheaper for the rest of the world, but the entire point of a tariff is to make the imported product more expensive so that the same domestic product has a price or profit advantage, there by encouraging the domestic production of that product.
If foreign products have to pay a fee when imported, they have to reduce their price to be able to compete with the domestic products.
It may force suppliers (exporters) to reduce the price in order to maintain demand. If the tariff is for goods that have high price elasticity of demand and the tariff imposing country is a major buyer of that good.
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