Microeconomic Analysis of Each Government Intervention
- US government intervention through tariffs
The US government has opted to be actively controlling their country’s balance of payments through the use of tariffs aiming at discouraging importation of Chinese solar panels. This intervention has been established with a common goal to protect the US local industry and the manufactures of solar panels and the related products. As a result, the US government has levied custom duties on the Chinese products ranging from 2.9% to 4.73%.
Although, this intervention comes with many advantages, particularly in protecting the domestic market and increasing government revenue, microeconomic analysis shows that there are shortfalls that are associated with the tariffs on the imported goods. Such benefits that are associated with the tariffs, in many cases do not offset the losses experienced by the consumers as a result of increased prices (Nicholson, & Stapleton, 2002). The tariffs imposed on the Chinese products results to an upward shift of the solar panels curve as illustrated on the diagram bellow.
As shown in the diagram above, the importers, United States are forced to pay higher prices of the imported products from China. The price charged on the products increases from PE to PW. As a result, the cost of production incurred by the solar cell installers will increase due to increase of the solar panels. The solar cell installers may be forced to raise the price of their services in order to maintain their profit margin, implying that the fundamental consumers, such as US citizens will be forced to experience the price rise.
As a result of the increase of the solar panel’s price, the consumers will be forced to consume less of these products or less of other goods. Therefore, this rise in price can be viewed as the reduction of the consumer income. Since the consumers are now consuming less, the consumers in the local industry may suffer this impact by selling less products in the market (Nicholson, & Stapleton, 2002). This might lead to a decline in the United States economy.
However, the exporting country, in this case China, also suffers a big impact of the tariffs on their products. The US tariffs will raise the cost of Chinese producers which will forces them to sell their product at a higher price hence sell less in the foreign market. The fall of the solar panel quantity will fall from QE to QW as illustrated in the diagram above.
- Chinese government intervention
On the other hand, the Chinese government may counter the US government intervention by interfering with the free flow of their exports. This involves payment by the Chinese government to the manufacturers and suppliers of the solar panels with an aim to reduce their production cost and enhance them to increase output.
As illustrated in the diagram below, subsidies to the producers cause the supply curve of the solar panels to shift downward/ to the right. Consequently, the producers are able to sell their product at a lower price that may attract more consumers, hence higher output produced. The price of the produced product falls from p1 to p2 while the quantity produced and demanded increases from Q1 to Q2. This implies that the subsidies imposed by the government will boost the demand of the solar panels in the United States since the price is conducive to the consumers. The Chinese solar panels will tend to offer favorable deal to the US citizens, hence buying less of the domestic products but buying more of the imported products from China.
However, according to microeconomic analysis, the effect of the subsidy is greatly influenced by the price elasticity of the product. The consumer’s gain from subsidy is grater to those products that have more inelastic demand curve. In cases where the product is perfectly inelastic, the consumer benefits greatly from the subsidy since all the subsidy is passed on to the consumer in terms of lower prices. On the other hand, when the product has a relative elasticity of demand, the major implication of the subsidy is to increase the quantity traded rather than lowering much market price. This is illustrated on the diagram below.
Therefore, since the solar panels have a relative inelastic demand curve, the impact of subsidy to the Chinese exports will be greatly influence more decrease in the market price, rather than the increase in the quantity traded. As a result, this effect may adversely affect the Chinese economy since the increase in the quantity traded will not cover the price of the product decreased. In other words, the effect of subsidy may result to lower marginal profit. Therefore, the effect of the tariffs on the Chinese solar panels may leave the Chinese Economy worse off.
Deadweight Loss to US from Protective Tariff
The export subsidy increases the price in the exporting country while it lowers the prices in the importing country. This indicates that the export subsidy worsens the terms of trade between the two trading partners as illustrated in the diagram below.
As shown above, the subsidy by the Chinese government shifts the export supply curve from S1 to S2. This reflects the lower marginal cost of the exporters. Consequently, the market price decreases from P1 to P2. The importing country, United States, gains the consumer surplus indicated by area e, so that the deadweight to china from subsidization is indicated by area f + a. the extra deadweight loss f is a due to the importer’s gain as a result of the home term of trade loss. Therefore, the effect of subsidy is a reverse of tax in a sense that it increases supply because fundamentally, the cost of supplying the goods has decreased.
Deadweight Loss to China from Subsidization of Solar Panels for Export
Area “b” is also known as the production effect, which means it is an efficiency loss that is caused by the shift of consuming expensive domestic solar panels, rather than the imported panels. Area “d” represents the consumption effect which is a loss to consumer due to decrease of total consumption of the solar panels that have unfavorable price. Therefore, the net deadweight loss that is as a result of tariffs is presented in area “b + d”.
Deadweight Loss to China from Tariff
The protective tariffs imposed by the United States government will intend to increases the marginal cost of the importers goods making it challenging for the importers to trade with the domestic country. On the other hand, the protective tariff does not change the marginal cost of domestic products. The protective tariff results to an upward shift of the supply curve from S1 to S2. The quantity demanded for solar panels falls from Q1 to Q2 implying that DQ amount of solar panels will not be demanded in the US market. The consumers in the US market may opt to keep the money (DP) they could have spent on the Chinese solar panels. This results to a loss in consumer surplus, also known as welfare dead weight loss. In other words, the United State economy may experience turbulence as solar panel consumers fails to purchase the products due to price increase.
When the United State government imposes tariffs on the Chinese product, it implies that the solar panels are produced domestic firms which are relatively inefficient compared to china firms. This may result to loss of producer efficiency, since more resource s will be used in the production than necessary (Allain, Mullally, & Zhang, 2006). Hence, another deadweight loss of welfare is developed as indicated in the diagram above. The total deadweight loss, that is a + b, is considered as the dead weight loss to US protective tariff.
Higher price of solar panels due to combined effect of tariffs and higher price of inputs to producing solar panels
As discussed above, the tariffs imposed by the US government on the Chinese product will definitely result to an increase in price of the Chinese products. These interventions favors the domestic producers in sue to fact that they are able to sell their product at higher prices, sell more quantity, and hence receive more producer surplus. On the other hand the Chinese producers suffers from the loss of consumer surplus since their products becomes expensive, hence less attractive to the consumers.
However, with the addition to the increase in the inputs used to produce the solar panel, the solar panel producers will be left worse off. This is because, the higher prices inputs increases the cost of production that results to shift of the supply curve upward. In other words, the total production of the solar panels declines hence less quantity produced and high prices of that produce (Rodrik, & Princeton University 1984). Consequently, the solar panel produced in china become unfavorable products in the market since the consumers has to dig deeper into their pockets to afford the product.
Conclusion
According to the microeconomic analysis carried out on this paper, it is clear that the introduction of the tariffs by the US government to the Chinese solar panels has negative effect on both countries. However, if the Chinese government would not intervene, the Chinese producers are the one to face the greater impact. This is because the producers would be not being in a position to produce desirable products with the high prices of the inputs and the tariffs.
References
Allain, J., Mullally, S., & Zhang, X. (2006). International Trade Regulation in China: Law and Policy. China and International Economic Law Series. Hart Publishing.
Hubbard, R. G., & O'Brien, A. P. (2006). Microeconomics. Upper Saddle River, N.J: Pearson Prentice Hall.
Nicholson, W., & Stapleton, D. C. (2002). Microeconomic theory: Basic principles and extensions. Cincinnata, Ohio: South-Western/Thomson Learning.
Northrup, C. C., & Turney, E. C. (2003). Encyclopedia of tariffs and trade in U.S. history: Volume 2. Westport, Conn: Greenwood Press.
Rodrik, D., & Princeton University (1984). Tariffs, subsidies, and welfare with endogenous policy. Princeton, N.J: Woodrow Wilson School, Princeton University.
