Dynamics of economic efficiency in tariff and trade

Abstract

When the efficiency losses or gains as a result of an ad valorem import tariff are accounted for, the exisiting literature compares the equilibrium states before and after the tariff. However, after the imposition of an ad valorem tariff, the cost of the foreign producer to sell in the domestic market jumps upwards by the extent of the ad valorem tariff. This affects the quantity of imports, and the market is no longer in the initial equilibrium. The market then adjusts and after some efficiency loss, a new equilibrium state is arrived at. The mechanism of price adjustment has a basis of lack of coordination among buyers and sellers at the exisiting prices. The economic efficiency loss when the market is out of equilibrium is not taken into consideration in the literature, while deriving an optimal ad valorem tariff rate. In this article, an optimal ad valorem tariff schedule has been derived. From optimality, it should be construed that the economic efficiency losses get minimised when the market is adjusting and also during the equilibrium. A revenue constraint has to be met in addition.

Adam Smith’s Perfectly Competitive Market Is Not Pareto Efficient: A Dynamic Perspective

“…The basic model has already been discussed in Nawaz (2017Nawaz ( , 2019aNawaz ( , 2019bNawaz ( , 2020Nawaz ( , 2021Nawaz ( , 2022). Let's assume that there is a perfectly competitive market of a single homogeneous commodity in equilibrium (initial condition is when the market is already in equilibrium).…”

“…There have been a number of ways of modeling paths to equilibrium under different sets of frictions, such as incomplete markets (see Angeletos & Calvet, 2005;Talman & Thijssen, 2006), adjustment costs (see Lucas, 1967;Bertola & Caballero, 1990;Danziger, 1999;Chen, Feng, & Seshadri, 2014), rational inattention (see Chen, Levy, Ray, & Bergen, 2008;Maćkowiak & Wiederholt, 2009, 2011, and search costs (see Wright, 1986), etc. Nawaz (2017, 2019a, 2019b, 2020, 2021, 2022 model dynamic adjustment path for optimal policies.…”