Chapter 45: The Optimal Tariff
Murray Kemp Any trading country, whatever its size, can move world prices in its favour by imposing restrictive tariffs (or quotas) on its imports or exports. That was recognized long ago by Torrens (1821, 1844) and J.S. Mill (1844, 1848). However, tariffs may be set at such high levels that trade disappears altogether. The task of any country is to choose tariffs not just to improve its terms of trade but to choose them optimally to maximize its wellbeing. It was left to Bickerdike (1906, 1907) and Edgeworth (1908) to provide governments with the necessary formulae. From the foundation laid by Bickerdike and Edgeworth emerged the basic diagram, reproduced as Figure 45.1 and on display in nearly every modern textbook on the theory of international trade. The diagram is based on the assumption that just two countries, G and H, trade in just two commodities. Under free international trade, the world trading equilibrium is at point P, where the two offer curves, GOG9 and HOH9, intersect. The equilibrium terms of trade are represented by the slope of OP. However, by restricting its imports by means of an optimal import duty, country G can move the equilibrium to the preferred point P9, where one of its trade indifference curves uu’ is tangential to country H’s offer curve. (Bickerdike, 1907, recognized that if there are two traded commodities then only one tax is needed.) At P9, country G enjoys improved terms of trade (represented by the slope of OP9) and an improved...
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