More potential customers do not guarantee higher profit.
Foreign markets can allow firms to expand sales, spread fixed costs and specialise. Imported components and capital equipment may reduce costs or improve quality; foreign ideas and competition can encourage innovation. At the same time, domestic sellers face stronger rivals and may lose market share. Expansion requires investment, standards compliance and distribution, while innovation is costly and uncertain. A producer can import inputs and export output, so a tariff intended to protect one sector can raise another sector's costs. Assess revenue, costs and rival responses rather than assuming all firms gain or all firms lose.
- Market size
- Foreign customers can help a firm sell more and spread fixed costs, such as design work, over more units. Average cost means cost per unit; it falls through this channel only if sales expand.
- Competition
- Foreign rivals can encourage better products and methods, but domestic firms may also lose sales. More potential customers do not guarantee that extra revenue exceeds extra costs.
- Imported inputs
- Inputs are resources used to produce other goods. A tariff, or import tax, on components can help domestic component suppliers while raising costs for the firms that use them, including exporters.
Trace both sides of the profit calculation
Demand and scale
Larger accessible markets can spread fixed costs only if the firm wins sales and can organise expansion.
Competition and innovation
Rivalry can reward better products and methods, but investment needs finance and success is uncertain.
Production networks
A restriction on imported inputs can raise costs for domestic exporters. Follow the chain beyond the protected industry.
Worked example: A tariff on an exporter's components
A furniture maker can sell abroad after delivery links improve. It imports specialist fittings. A proposed tariff protects local fitting producers but raises the furniture maker's input bill.
- Export access can raise potential sales and help spread design and machinery costs.
- Imported fittings support the maker's production; a tariff on them can raise costs and reduce export competitiveness.
- The protected fitting sector may expand, while downstream producers, such as the furniture maker using those fittings, face higher costs.
- Compare sales and the amount left after costs, along with firms' ability to adapt and evidence of any claimed benefit from domestic production capability.
Watch out for this
Protecting domestic suppliers always helps other domestic firms.
Domestic firms can buy the protected product as an input. Higher input prices can harm their competitiveness.
Check your understanding
A tariff raises the price of an imported component used by exporters. What is a plausible consequence?
- Exporters' costs rise unless they can substitute or improve productivity.
- All exporters' costs necessarily fall.
- Exports must rise because imports fall.