Economic theory predicts that, except in certain special cases, tariffs will increase the domestic price of a country’s imported goods and services. The way economists present the effects of tariffs to students is generally through simple demand and supply models (see, for example, this discussion of tariffs, which is fairly representative of textbook presentations). This model assumes direct exchange of goods between buyers and producers (foreign and domestic).
One logical consequence of this model is that the tariff burden is shared between buyers and producers, with each burden determined by how sensitive each party is to changes in prices. Therefore, if consumers do not pay the full amount of customs duty, some of it will be borne by foreign producers, and if the sum of producers’ surplus profits and the government’s tariff revenue from foreign producers is greater than welfare , there may be net welfare benefits. Consumer loss.
This so-called “optimal tariff” model has many practical problems, which lead many economists to reject its usefulness for policy purposes. I do not intend to rehash these discussions (interested readers may find a useful summary here). Rather, I would like to emphasize that while the textbook supply and demand model is very useful, it is limited in important ways when discussing the practical effects of some policies. Not understanding these limitations can lead to incorrect conclusions.
The main drawback of the model for discussion here is that it flattens the trade process too much. A simple supply and demand model assumes direct exchange between consumers (end users) and producers. A literal translation of this model means that each consumer goes to the factory/farm etc. where the product is produced, buys directly from the producer, and transports the product himself. The reality is not so simple. Transaction costs are incurred during the exchange process and various intermediaries exist to reduce those costs. For example, I don’t buy coffee directly from coffee companies, but from grocery stores, wholesalers, importers, and roasters. There is not one exchange between me and the producer, but four exchanges. Each producer becomes a consumer at different stages of the process.
The presence of these intermediaries makes conversations about customs duties (in fact, most taxes) a little more complicated. We need to find out how much the price changes at each stage of the exchange (called “pass-through”). If some parties on the exchange are more sensitive to price changes, the price is less likely to rise. Those who are insensitive to price changes will see prices rise. Therefore, we do not want to look at just one set of prices (e.g. consumer price index, producer price index, etc.), but rather we want to look at the entire price schedule of an exchange.
Looking at just one price can lead to incorrect conclusions. For example, suppose an imported widget is subject to a 10% tariff. Widgets are common items with many alternatives. Widget end users have many options and are therefore very sensitive to price changes. Widget retailers, on the other hand, are very price insensitive. Furthermore, for the sake of argument, let’s assume that the widget’s importer is price insensitive. In this scenario, the burden of customs duties would be borne by retailers and importers. Their profits will shrink. Consumers will see little price increase. Looking only at consumer prices would lead us to mistakenly conclude that tariffs have no effect on prices. In fact, it can be concluded that the customs duties are paid by foreigners. What they don’t realize is that those fees are paid by other domestic members of the exchange.
A recent Wall Street Journal article demonstrates this problem (“U.S. Comparator Companies Stock Up to Get Ahead of Trump’s China Tariffs,” November 20, 2024). Two American business owners discuss the issue of increasing prices for consumers and how it affects their business.
In addition to tariffs on Chinese goods, President Trump has proposed imposing tariffs of 10% to 20% on imports from all countries. For Leah Dirk Fleury, co-founder of San Francisco natural stone and porcelain wholesaler Stone Fleury, that would be the worst-case scenario. She has been buying natural stone from the same supplier in China for 20 years, and imports most of her other materials from Europe. When President Trump imposed tariffs on Chinese natural stone during his first term, Dirk Fleury continued to buy from China as usual. The company raised prices to compensate, but tried not to charge the full price increase to remain competitive.
Toni Norton, owner of Fine Fit Sisters in Charlotte, North Carolina, sources body oils from China that are popular among her customers during the summer. She typically doesn’t stock up until the new year, but is looking to order about 20,000 units by the end of the year.
If tariffs on Chinese products actually reach 60%, Norton said she may have to stop selling body oils and focus more on her fitness coaching services. She said she doesn’t think there’s much room to raise the price of the body oil, which she promotes primarily on TikTok and sells for about $13. This is because “people like cheap things.”
The Trump/Biden tariffs are characterized by such pass-through effects. A 2021 paper by Cavallo et al. found that nearly all of the tariffs were borne by U.S. companies. Merely looking at retail prices (adjusted for inflation) is not enough to determine whether tariffs are harmful. The entire replacement process must be considered.
P.S.: This just-published paper looks at the long-term effects of China’s tariffs. The authors conclude, “While there is no consistent evidence of reshoring, there is evidence of nearshoring to border countries. Despite significant restructuring, China remains the largest direct importer to the United States in 2022. continued to be a supplier of
John Murphy is an assistant professor of economics at Nicholls State University.
