The Economic Effects of Tariff Changes
The following post is from Yuchen Dong, Senior Financial Application Engineer.
The code presented in this blog can be found here.
This example demonstrates a practical tool for modeling the economic effects of tariff changes. We run simulations of hypothetical tariff changes using illustrative data inputs. Suppose there are three imported products, and the tariffs increase to different levels: 20%, 15%, and 10%. We apply the Multi-step Euler method to a non-linear model. Due to domestic substitution products, the price and quantity of imported products decrease, while the revenue of domestic products increases. Consequently, the Consumer Price Index (CPI) rises due to the impact of the tariffs. In this example, we implement a non-linear Constant Elasticity of Substitution (CES) Tariff model.
The CES demand curve for products from source country j: 
,
,where:
: the quantity demanded of the product from source j
: the producer price of this product.- k: a demand shift term
: a preference asymmetry term specific to the product from source j- P: the CES industry price index across all sources j
: a trade cost factor for product from source j- σ: the elasticity of substitution between products within the industry.
The CES price index from the industry: 
.
.The CES supply curve for the products from source country j is defined as 
, where
, where
: a supply shift parameter,
: the price elasticity of supply from source j.
Parameter Inputs and Industry Economic Variables
Assume that there are 3 import products. The inputs include the inital expenditures on the products from each source country to the market, initial and revised tariff rates, and estimates of the price responsiveness of demand and supply. The elasticity of substitution is set to be 5.
|
Imported from A
|
Imported from B
|
Imported from C
|
Domestic Shipments from D
|
|
|
Supply Elasticity
|
10
|
10
|
10
|
2
|
|
Initial Tariff
|
0%
|
0%
|
0%
|
0%
|
|
Revised Tariff
|
20%
|
15%
|
10%
|
0%
|
|
Initial Expenditure
|
25%
|
25%
|
25%
|
25%
|
Non-Linear Multi-step Euler Method Model with Four Sources of Supply
Set the number of iteration steps as 3000. The simulations divide the total percent change in the trade factor on imports from c into many steps. If the total percentage change 
is divided into 3000 steps with a constant step-to-step growth rate of g. Then 
and 
. We iterate the percentage changes of prices, quantities, product revenue with the impact of tariff.
is divided into 3000 steps with a constant step-to-step growth rate of g. Then and . We iterate the percentage changes of prices, quantities, product revenue with the impact of tariff.
Conclusions
We conduct a simulation of the model using a hypothetical change in tariffs along with illustrative data inputs.
Based on the results, the tariff changes lead to a decrease in the price of the product imported from source A, B and C. Consequently, both the quantity and product revenue of the imported products decline, with product revenue dropping by around 30%. Due to substitution effects, we can quantitatively confirm that the price, quantities, and revenue for alternative sources increase. We can also implement log-linearized CES Tariff model as a comparison.
Reference:
[1] D. Riker, Multinational Production and Employment in an Industry-Specific Model of Trade. U.S. International Trade Commission, Aug. 2018.
[2] D. Riker, S. Schreiber, Practical Tools for Modeling the Economic Effects of Tariff Changes. U.S. International Trade Commission, Nov. 2020.
- Category:
- Econometrics,
- Forecasting
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