Question

Suppose Canada imposes a 10% ad valorem tariff on imported clothing but no tariff on imports of fabrics or other inputs to the manufacture of clothing. Suppose that under free trade, the cost of imported materials is $32 for a $40 item of finished clothing

1. Calculate the effective rate of protection. (3 marks)

2. Now, suppose that in addition to the current 10% tariff on imported clothing, a tariff of 5% is also imposed on imported inputs. What is the new effective rate of protection for clothing manufacturers? (3 marks)

3. Finally, suppose that the tariff on clothing inputs is raised to 10%, so that the nominal tariff’s on clothing and on inputs to clothing are all equal to 10%. Calculate the effective rate of protection for clothing manufacturers. What does this tell you about the relationship between nominal and effective tariff rates when all nominal rates are equal to each other and the tariff structures are not escalated?   (4 marks)

Answer 1

Effective Rate of Protection (ERP)= ( V' - V ) / V

V' = domestic value added with tariff

V = Domestic value added in free trade.

Cost of imported material =$32

Cost of imported cloth= $40

a) V= 40 -32 =$8

With tariff Price of cloth is 40+ 40 (0.1) =$44

V' = 44 -32=$12

So ERP =( V' - V ) / V =( 12-8)/8 = 0.5

ERP = 0.5x100= 50 %

b) with 5% tariff...cost of imported fabrics = 32 (1.05)= $33.6

V' = 44 - 33.6 =$ 10.4

ERP = (10.4-8)/8=0.3 or 30 %

C) with 10 % tariff , cost of imported fabric = 32(1.1)=$ 35.2

V' = 44-35.2 = 8.8

ERP =(8.8-8)/8=0.1 or 10 %

When all nominal rates are equal to each other and tariff structures are not escalated, Nomainal rate of protection is equal to effective rate of protection