A tariff is a tax on imports, and in a simple supply and demand model it raises the domestic price, increases home production, reduces consumption and cuts imports. It also earns the government revenue.
This lesson builds on tracing effects on importers and exporters and is part of international trade and exchange rates. It uses a table of numbers, which you can turn into a diagram.
How does the model work?
The model has a domestic demand curve, a domestic supply curve and a world price. With free trade, the domestic price equals the world price. At that price, domestic firms supply some of the quantity and imports fill the gap between demand and domestic supply.
A tariff adds a tax per unit, so the domestic price becomes world price plus tariff. Then you read the new quantities at that price.
Worked example
Kesland has a market for bicycles, measured in thousands. Domestic demand is Qd = 160 − 2P and domestic supply is Qs = 2P − 60, with P in kesa per bicycle. The world price is 40.
Free trade, P = 40
- Demand: 160 − 80 = 80
- Domestic supply: 80 − 60 = 20
- Imports: 80 − 20 = 60
With a tariff of 10, P = 50
- Demand: 160 − 100 = 60
- Domestic supply: 100 − 60 = 40
- Imports: 60 − 40 = 20
- Government revenue: 10 × 20 = 200
| Free trade | Tariff of 10 | |
|---|---|---|
| Price | 40 | 50 |
| Quantity demanded | 80 | 60 |
| Domestic supply | 20 | 40 |
| Imports | 60 | 20 |
| Tariff revenue | 0 | 200 |
The explanation in words: the tariff raises the domestic price by 10. Consumers buy 20 fewer bicycles, domestic producers sell 20 more, and imports fall by 40. The government gains 200 in revenue.
Who gains and who loses: domestic producers and the government gain, domestic consumers lose, and foreign exporters sell less. Whether the result is worthwhile depends on aims and judgement, so evaluation should weigh both sides.
The mistake to watch for
The usual slip is to say the tariff “makes the foreign firm pay” and to forget the effect on domestic buyers.
Mistaken answer: “A tariff punishes foreign firms and has no effect at home.”
The student missed that the domestic price rises and consumers buy fewer bicycles.
The correction is to read all four quantities from the table: price, quantity demanded, domestic supply and imports. Then say what happens to each group.
Check yourself
Use the same demand, supply and world price.
1. A tariff of 5 is set. Find the price, domestic supply, quantity demanded and imports.
Show answer
P = 45. Qd = 160 − 90 = 70. Qs = 90 − 60 = 30. Imports = 70 − 30 = 40. Revenue = 5 × 40 = 200.
2. Name one group that gains and one that loses from a tariff.
Show answer
Gains: domestic producers (higher price, more output) or the government (revenue). Loses: domestic consumers (higher price, less quantity bought) or foreign exporters (fewer sales).
3. A quota limits imports to 20 thousand. What happens to the domestic price in the model compared with the tariff of 10?
Show answer
Imports of 20 leave domestic demand and supply to meet at a price where Qd − Qs = 20. At P = 50: 60 − 40 = 20. So the price is 50, the same as with the tariff. The difference is that the government earns no tax revenue unless it sells the licences.
Where this leads next
The last lesson in the module zooms out to the whole trading record of a country: describing trade-account components. The ratios tool helps compare before and after figures.
Models make most sense when you can build them from your own questions. A teacher on our online one-to-one Economics tuition can sit with you while you draw and explain each step.