Tariffs | A-Level Economics Model Paragraph (AQA, Edexcel, OCR)
A tariff is a tax on imports. It is a form of protectionism. Protectionism is a barrier against free trade. The diagram below shows the effect of a tariff on a market.
The diagram shows the upward sloping domestic supply curve and the downward domestic demand curve, and it shows a perfectly elastic world supply curve. It is perfectly elastic because there are infinite producers around the world, compared to those just from the UK. Before the tariff is imposed, the quantity of goods bought from the UK is Q1 and the quantity of imports is Q1-Q2 - at price P1. The tariff causes world supply to shift to the left. After this, the quantity of goods bought from the UK increases from Q1 to Q4 - and the quantity of imports decreases from Q1-Q2 to Q4-Q3.
Overall. this means that consumer spending (C) in the UK would increase, and the quantity of imports (M) would decrease. Since aggregate demand C + I+ G + (X-M) is the total planned spending on goods and services produced in the UK, this would shift to the right - and the balance of payments on the current account would also improve due to a fall in the value of imports.
AD RIGHT SHIFT DIAGRAM
As a result, output increases from y1 to y2. There would be a decrease in unemployment due to the greater demand fo labor which is derived from the greater demand for goods and services from the UK.
However, a tariff can be problematic because other countries could retaliate by imposing a tariff back on UK goods and services. So this means, whilst UK imports would fall, UK exports could also fall. However, one more point is that the tariff generates a tax revenue shown by the shaded rectangle q3-q4-p1-p2. This tax revenue can be used to fund supply-side policies - for examples. Supply-side policies are policies that are used to increase the productive potential of the economy. For example, investing in infrastructure would allow the UK to produce more goods and services with the same amount of resources due to an increase in productivity. As a result, there would be an increase in competitiveness of UK goods and services, which would make our exports more attractive. So even if other countries retaliate with tariffs, we wouldn't suffer as much of a fall in exports.