Free trade refers to the elimination of barriers to international trade. The most common barriers to trade are tariffs, quotas, and nontariff barriers.
A tariff is a tax on imports, which is collected by the federal government and which raises the price of the good to the consumer. Also known as duties or import duties, tariffs usually aim first to limit imports and second to raise revenue.
A quota is a limit on the amount of a certain type of good that may be imported into the country. A quota can be either voluntary or legally enforced.
A tariff is a tax on imported goods, while a quota is a limit on the amount of goods that may be imported. Both tariffs and quotas raise the price of and lower the demand for the goods to which they apply. Nontariff barriers, such as regulations calling for a certain percentage of locally produced content in the product, also have the same effect, but not as directly.
You may wonder why a nation would ever choose to use a quota when a tariff has the added advantage of raising revenue. The major reason is that quotas allow the nation that uses them to decide the quantity to be imported and let the price go where it will. A tariff adjusts the price, but leaves the post-tariff quantity to market forces. Therefore, it is less predictable and precise than a quota.
The effect of tariffs and quotas is the same: to limit imports and protect domestic producers from foreign competition. A tariff raises the price of the foreign good beyond the market equilibrium price, which decreases the demand for and, eventually, the supply of the foreign good. A quota limits the supply to a certain quantity, which raises the price beyond the market equilibrium level and thus decreases demand.
Tariffs come in different forms, mostly depending on the motivation, or rather the stated motivation. (The actual motivation is always to limit imports.) For instance, a tariff may be levied in order to bring the price of the imported good up to the level of the domestically produced good. This so-called scientific tariff—which to an economist is anything but—has the stated goal of equalizing the price and, therefore, “leveling the playing field,” between foreign and domestic producers. In this game, the consumer loses.
A peril-point tariff is levied in order to save a domestic industry that has deteriorated to the point where its very existence is in peril. An economist would argue that the industry should be allowed to expire. That way, factors of production used by that inefficient industry could move into a new one where they would be better employed.
A retaliatory tariff is one that is levied in response to a tariff levied by a trading partner. In the eyes of an economist, retaliatory tariffs make no sense because they just start tariff wars in which no one—least of all the consumer—wins.
Nontariff barriers include quotas, regulations regarding product content or quality, and other conditions that hinder imports. One of the most commonly used nontariff barriers are product standards, which may aim to serve as “barriers to trade.” For instance, when the United States prohibits the importation of unpasteurized cheese from France, is it protecting the health of the American consumer or protecting the revenue of the American cheese producer?
Other nontariff barriers include packing and shipping regulations, harbor and airport permits, and onerous customs procedures, all of which can have either legitimate or purely anti-import agendas, or both.
Excerpted from The Complete Idiot's Guide to Economics © 2003 by Tom Gorman. All rights reserved including the right of reproduction in whole or in part in any form. Used by arrangement with Alpha Books, a member of Penguin Group (USA) Inc.