ChainWhat it assumes · how to break it
Start
The government imposes a tariff on imported steel, as the US did in 2018 when it placed a 25% tariff on most steel imports.
1
As a result, the price of imported steel in the domestic market rises by up to the amount of the tariff.
tariff · world price
tariff · world price
Assumes: Importers pass the tariff on in full.
But: Foreign exporters facing price-elastic demand may cut their own prices and absorb part of the tariff to keep their market share.
2
This means domestic steelmakers face less price competition and can raise their own prices towards the new import price.
price competition · domestic supply
price competition · domestic supply
Assumes: Domestic firms use the protection to raise prices rather than to win market share.
But: If several domestic producers compete hard with each other, home prices may rise by much less than the tariff.
3
Consequently, firms that use steel, such as car, machinery and construction firms, face higher costs of production.
costs of production · raw materials
costs of production · raw materials
Assumes: These firms cannot easily switch to cheaper untaxed suppliers or materials.
But: Some firms can switch to steel from countries exempted from the tariff, or substitute aluminium or other materials.
4
Therefore, these firms pass the higher costs on to consumers, shifting SRAS to the left and causing cost-push inflation.
cost-push inflation · SRAS
cost-push inflation · SRAS
Best link to attack
Assumes: Steel is a large share of the cost of final goods and firms can pass cost rises on.
Assumes: Steel is a large share of the cost of final goods and firms can pass cost rises on.
But: Steel is often a small share of the cost of a finished good such as a car, and firms facing strong competition may absorb the rise in lower profit margins.
End
The price level rises through higher import prices and higher costs for steel-using firms, causing cost-push inflation.
Evaluation chain
- E1However, the effect on inflation depends on how large a share of costs and of the consumer basket the taxed goods make up.
- E2Because steel reaches consumers mainly as a small part of the cost of cars, appliances and buildings, a higher steel price adds only a little to the price of each final good.
- E3As a result, firms in competitive markets may absorb much of the cost rather than raise prices.
- E4So a tariff on a single input causes a small, one-off rise in the price level, and inflation rises noticeably only when tariffs cover a wide range of consumer goods.
Another way to attack it: A tariff causes a one-off rise in the price level, which raises the inflation rate only for about a year, unless it triggers higher wage demands or is followed by more tariffs.
The price rise comes quickly for imported steel but feeds through to finished goods over several months as contracts and stocks run down.
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Questions this answers
- Assess the likely impact of a tariff on imported steel on the rate of inflation.
- Discuss the effects of protectionist policies on consumers.
- Explain how a tariff on an imported raw material can lead to cost-push inflation.
Diagram
Tariff diagram: world supply at Pw shifts up to Pw + tariff. Domestic price rises, consumption falls and imports fall. For the macro effect, show SRAS shifting left on an AD/AS diagram, with the price level rising.
Reverse and related
Tariff removed → import prices and input costs fall, so the price level falls for a time.