Microeconomics → International Trade → Tariffs | Part 1 of 4
Part 1 of our four-part tariff learning pathway. Follow Joanne, a supermarket buyer, to discover who pays a tariff, who ultimately bears its cost and why the distinction matters.
To see how a tariff works in practice, we’re going to follow one through a supermarket buying decision.
Joanne is 23 and has just started her first job as an assistant buyer for a large supermarket. She works on the salads team, and one of the products she will be working on is tomatoes.
During her first week, her manager takes her around one of their stores. He points out the tomatoes. At this time of year they come from Spain, although in summer the supermarket also sells British ones.
“They’re £1.60 a kilo,” he tells her. “We buy them for about £1.”
The 60p difference isn't all profit. The supermarket has other costs to pay.
Now suppose the government introduces a 20% tariff on Spanish tomatoes. Since the supermarket is paying £1 a kilo, we'll assume that means a 20p tax on each kilo imported.
Joanne knows that a tariff is a tax on imports. But what does that mean in practice? Who pays the 20p? Where does it go? And does the £1.60 shop price automatically become £1.80?
The tariff in this example is hypothetical. Spanish tomatoes that meet the relevant rules of origin can currently be imported tariff-free under the UK–EU trade agreement.
Who pays the 20p?
The Spanish supplier is still charging £1 for a kilo of tomatoes. The 20p tariff does not go to the supplier. It goes to the UK government.
So if nothing else changed, the supplier would still receive £1, while it would now cost the supermarket £1.20 to import a kilo of tomatoes.
But Joanne and the rest of the buying team don't have to accept that extra cost without doing anything about it.
They have several options. They could raise the shop price and pass some or all of the extra cost on to customers. They could keep the price down and accept a lower margin. They could negotiate with the Spanish supplier for a lower price. Or they could look for tomatoes from another supplier, perhaps in a country where the tariff is lower or doesn't apply.
In practice, they might do a combination of these things.
Who actually bears the cost?
Suppose the Spanish supplier agrees to reduce its price from £1 to 95p. The supermarket decides to absorb another 5p itself, while passing the remaining 10p on to customers by raising the shop price from £1.60 to £1.70.
The 20p tariff still goes to the UK government. But its economic cost is now being shared.
The Spanish supplier is receiving 5p less for its tomatoes. The supermarket is absorbing 5p through a lower margin. And the customer is paying 10p more.
Those numbers are only an example. The actual outcome could be very different.
If Joanne can easily find another supplier, the Spanish supplier may have more reason to cut its price. If suitable tomatoes are difficult to obtain elsewhere, it may refuse. Similarly, if customers are very sensitive to the price of tomatoes, the supermarket may find it difficult to pass much of the tariff on to them.
Later, ideas such as elasticity will help us analyse these possibilities more precisely. For now, the important distinction is this:
Paying a tariff to the government and bearing the economic cost of the tariff are not necessarily the same thing.
The tariff may be collected from the importing side, while its economic cost ends up being shared between the overseas supplier, the supermarket and its customers.
That is the real-world process a tariff diagram is trying to simplify. In the next article, World Price and Imports Explained: The Economics Before a Tariff, we step back and build the economic model needed to understand what happens when a tariff is introduced.
Continue the Tariffs Learning Pathway
Part 2 → World Price and Imports Explained: The Economics Before a Tariff