Knowledge that Transforms

In the presence of a perfectly competitive market, a tariff cannot reverse trade flows. The imposition of a nonprohibitive tariff on an imported commodity merely reduces the volume of imports. The levy of a prohibitive duty eliminates trade; it does not cause the good to be exported. However, in the presence of a single domestic producer, the levy of a tariff on an imported commodity may lead the economy to begin exporting the commodity. In this paper I explore this latter case, examining also the welfare implications of such a tariff. Consider an economy which, under free trade, imports a given commodity that is also supplied domestically by a single producer. All other markets are assumed to be perfectly competitive. The economy is assumed to be a price taker in the world market for this good; hence, the domestic producer is confronted with international competition in perfectly elastic supply. In Figure 1, Pw is taken to be the world price of the good;' D represents the (real income constant) domestic demand for the good; MR represents the marginal revenue derived from D; and MC depicts the producer's marginal cost. Under free trade, the domestic price equals the world price. The producer's output Of 0Q2 units is sold domestically, and imports are Q2Q6 units. If a tariff rate of t, is imposed on imports, the domestic price increases to (1+t,)PW. The producer's output increases to oQ3 units and domestic consumption declines to oQ5 units. The government is the recipient of tariff revenue equal to t,Pw multiplied by Q3Q5. Although the profits of the producer's increase and additional revenue accrues to the government, together they are less than the loss in consumers' surplus. Accordingly, domestic welfare declines as a consequence (1 + t4)PPw MC

This paper suggests that conventional economic theory has tended to ignore the inflation transmission process, and sketches some of the reasons why that is so. Harvey Leibenstein's paper in this session is intended as companion piece; it outlines an unconventional theoretical approach to the inflation process.' Inflation just means rising prices. Conventionally, however, economists mean something more. Robert Solow, for example, has defined it as a substantial, sustained increase in the general level of prices (p. 31). But when inflation is sustained at steady rate for long enough to be anticipated, those affected adversely begin protecting themselves against its consequences. Moreover, general inflation implies an absence of relative price changes and their consequent allocative and distributional effects. As economists we agree that inflation has no real consequences once sufficiently long-lived and general,2 yet we definitionally preclude short-run and relative price changes from the purview of inflation theory! For present purposes, the transmission stage is defined as inflation before it is universally anticipated and compensated for. Only in its transmission stage is inflation of practical consequence to anyone, but extant theory has little systematic to say. The one aspect of the transmission process that economists do try to analyze is the macroeconomic price/output problem: how is macro shock to demand or supply divided over time between price change and output change? This problem is far from solved, and is perhaps the central bugbear of modern macroeconomics. Underlying our ignorance of the inflation transmission process are inadequacies inherent in microeconomic theory. Section I briefly discusses some of these inadequacies. Section II illustrates them by looking at conventional treatments of the price/output problem. For space reasons much of what follows consists of bald assertions, and most references have been deleted. The reader is referred for elaboration to the manuscripts listed at the end.

This paper was presented at the American Economic Association meetings in Denver in September 1980. The research reported here is part of the NBER's research program in Economic Fluctuations. Any opinions expressed are those of the author and not those of the