One of the Great ideas of Trump has been to build a wall between Mexico and the USA and make the Mexicans pay for it. He has suggested that this could be done by increasing the tax on imports, tariff, from Mexico to USA to 20%. In reality this proposal does nothing more than prove how Trump lacks the understanding of basic economics.
When tax or tariff is imposed on a product it increases the cost of its production as the producer must pay this extra amount of money to the government in addition to cost of materials, machines and labor. However, what most often happens is that the producer will increase the price to cover this extra cost. This effect is illustrated in the figure below.
The diagram illustrates the impact of setting a tariff on a good. The effect of increase of an already existing tariff would be the same. The primary thing to note is that an increase in the tariff will lead to an increase the price of the goods from ‘Pworld’ to ‘Ptariff’. Furthermore, the quantity imported will decrease.
For producers to be able to make the consumers pay for the tariff, requires the demand for the good in question to be highly inelastic. In other words the consumers must not be able to easily switch to another producer. In theory this means that when there’s an increase in the price of a good, the decrease in demand for that good will be proportionately smaller. This enables the producer to increase the price without losing a lot of customers and therefore revenue. The demand for Mexican imports to the USA are likely to be inelastic, as it depends on Mexico when it comes to goods such as avocados, cars and television sets. Therefore, the consumers in the USA would be forced to keep buying these Mexican imports but at a higher price.
For a simplistic example, let’s say that a producer is importing avocados to the USA currently at the price of $1.1 per avocado at a tariff of 10% (not accurate but a working example). When the tariff increases to 20%, the Mexican producer will increase the price of avocados to $1.2, and so will still get the revenue of $1 while the consumer now pays $0.1 extra. With the risk of this carrying on exponentially, the result for the USA could be disastrous with imports across the board. So, in the end, who would actually be paying for the Wall? The American consumers. One hopes that the White House administration will not enact such a ridiculous policy, else a Californian avocado salad might wind up costing a whole lot more than you bargained for.
Written by: Elina Takala