Business Economics · International Trade

Trade Barriers: Tariffs – Types and Effects (CA Foundation Business Economics)

Updated 1 October 2026 · Fact-checked

A tariff is a tax on imported goods. It can be specific (fixed rupees per unit), ad valorem (a percentage of value) or compound (both). A tariff raises the domestic price, increases domestic output, reduces consumption and imports, and earns the government revenue. Solve questions by adding the tariff to the world price, then reading quantities.

Understand Trade Barriers: Tariffs

A tariff is a tax charged on goods when they cross a border. In exams it almost always means an import tariff, also called a customs duty. It is the most common trade barrier.

Why do governments use tariffs? To protect domestic industries from foreign competition, to earn revenue, to correct a trade deficit, or to respond to unfair practices such as dumping. A tariff meant mainly to shield local producers is a protective tariff. One meant mainly to raise money is a revenue tariff.

There are three main types by the way the tax is charged:

Specific tariff: a fixed amount per unit, such as ₹50 per kg.
Ad valorem tariff: a percentage of the value of the good, such as 10% of its price.
Compound (mixed) tariff: a combination of a specific and an ad valorem duty on the same good.

Now the effects. Think of a country that is a small buyer in the world market, so it takes the world price as given. Before the tariff, the domestic price equals the world price. After the tariff, imports cost more by the amount of the tariff, so the domestic price rises to world price plus tariff.

At the higher price, domestic producers supply more, so domestic output rises. Consumers buy less, so consumption falls. Imports equal domestic demand minus domestic supply, so imports fall. The government collects tariff revenue on the imports that still come in. Consumers lose (consumer surplus falls), domestic producers gain (producer surplus rises), and the government gains revenue. The country as a whole suffers a net loss called deadweight loss, because some production is shifted to higher-cost domestic firms and some consumption is given up.

Key formulas to remember

Domestic price with a specific tariff: Domestic price = World price + Tariff per unit; Applies when the country is a small importer and the tariff is fully passed on to the domestic price.
Domestic price with an ad valorem tariff: Domestic price = World price × (1 + t), where t is the tariff rate as a decimal; A 20% tariff means t = 0.20, so the multiplier is 1.20.
Compound tariff: Total duty per unit = Specific duty + (Ad valorem rate × Value); Add both parts to get the duty on one unit.
Imports: Imports = Domestic demand − Domestic supply (at the prevailing price); Use the quantities at the post-tariff price to get post-tariff imports.
Tariff revenue: Revenue = Tariff per unit × Quantity imported after the tariff; Use post-tariff imports, not pre-tariff imports.
Deadweight loss (linear curves): DWL = ½ × Tariff × (Increase in domestic output) + ½ × Tariff × (Fall in domestic consumption); These are the two triangles. Tariff revenue is the rectangle between them and is not part of the loss.

How to solve Trade Barriers: Tariffs questions

Use this order for any tariff question, numerical or theory. It keeps you from mixing up the pre-tariff and post-tariff positions.

1Identify the tariff type: specific, ad valorem or compound.
2Find the tariff per unit in rupees. For ad valorem, multiply the world price by the rate.
3Add it to the world price to get the new domestic price.
4Read domestic supply and demand at the new price. Output rises and consumption falls compared with the free-trade price.
5Calculate imports as demand minus supply at the new price.
6Calculate revenue as tariff per unit × post-tariff imports.
7For loss questions, find the change in output and the change in consumption, then apply the two-triangle rule.
8Check the direction of each effect against the theory before marking the option.

Quickest way: Direction check, then one calculation

When to use it: Use this in the MCQ paper when time is short. Most tariff options can be removed using direction alone.

Remember the fixed pattern: price up, domestic output up, consumption down, imports down, government revenue up, net national welfare down.
Cross out any option that breaks this pattern. For example, any option saying consumers gain or imports rise.
For numbers, do only the one calculation needed: new price, import quantity or revenue.
Convert percentages straight to a multiplier (25% becomes ×1.25).
For deadweight loss, compute the two triangles and ignore the revenue rectangle.
If you cannot settle between two options after the direction check, move on. A wrong answer costs 0.25 marks.

Common mistakes in Trade Barriers: Tariffs

Calculating revenue on pre-tariff imports.
Students use the larger free-trade import quantity because it is the first number they see.
Fix: Always recompute imports at the post-tariff price. Revenue = tariff × post-tariff imports.
Treating a 20% ad valorem tariff as ₹20 per unit.
The word tariff is linked with a fixed amount in memory.
Fix: Ad valorem means a percentage of value. Multiply the price by the rate to get the rupee duty.
Saying consumers gain from a tariff.
Students mix up producer gain with consumer gain.
Fix: A tariff raises the price consumers pay and lowers consumer surplus. Producers and the government gain.
Including the revenue rectangle in deadweight loss.
The diagram shows several areas and students add them all.
Fix: Revenue is a transfer to the government. Only the two triangles are the deadweight loss.
Confusing a tariff with a quota.
Both restrict imports and both raise domestic prices.
Fix: A tariff is a tax on imports and earns revenue for the government. A quota is a quantity limit. Quotas are covered under non-tariff barriers.
Saying tariffs always make a country better off.
Students remember the protection argument and forget the efficiency cost.
Fix: For a small country, a tariff creates deadweight loss. Protection helps some producers but lowers overall welfare.

Worked examples

Example 1

The world price of a good is ₹200 per unit. A country imposes a 25% ad valorem tariff. Assuming the country is a small importer, the domestic price will be: (a) ₹205 (b) ₹225 (c) ₹250 (d) ₹300

Show the solution

Tariff type: ad valorem at 25%.
Duty per unit = 25% of ₹200 = ₹50.
Domestic price = ₹200 + ₹50 = ₹250.
Check with the multiplier: 200 × 1.25 = 250.

Answer: (c) ₹250

Example 2

A country imposes a specific tariff of ₹10 per unit. At the post-tariff domestic price, domestic demand is 1,000 units and domestic supply is 600 units. Tariff revenue is: (a) ₹400 (b) ₹4,000 (c) ₹6,000 (d) ₹10,000

Show the solution

Post-tariff imports = demand − supply = 1,000 − 600 = 400 units.
Revenue = tariff per unit × imports = ₹10 × 400.
Revenue = ₹4,000.

Answer: (b) ₹4,000

Example 3

A specific tariff of ₹10 per unit raises domestic output from 500 to 600 units and cuts domestic consumption from 1,100 to 1,000 units. The deadweight loss is: (a) ₹500 (b) ₹1,000 (c) ₹2,000 (d) ₹4,000

Show the solution

Increase in domestic output = 600 − 500 = 100 units.
Production triangle = ½ × 10 × 100 = ₹500.
Fall in consumption = 1,100 − 1,000 = 100 units.
Consumption triangle = ½ × 10 × 100 = ₹500.
Deadweight loss = 500 + 500 = ₹1,000.
Note that post-tariff imports are 1,000 − 600 = 400 and revenue is ₹4,000. This rectangle is a transfer and is not counted in the loss.

Answer: (b) ₹1,000

Exam tips

Questions often ask for the effect on one group: consumers, producers, government or the economy. Learn the direction for each group: consumers lose, producers gain, government gains revenue, the economy has a net loss.
Expect definition-style MCQs on specific, ad valorem and compound tariffs. Link each to its key words: fixed amount, percentage of value, both.
In numerical questions, first note whether the question asks about pre-tariff or post-tariff quantities. This is where most marks are lost.
Watch for options that mix tariffs with quotas or subsidies. A tariff is a tax on imports and gives revenue. Quotas and subsidies belong to non-tariff barriers.
Do not spend long on diagram-based questions. Get the direction right, do one calculation, and move on.

Practice questions from International Trade

Trade Barriers: Tariffs: frequently asked questions

What is the difference between specific and ad valorem tariff?

A specific tariff is a fixed rupee amount per unit, such as ₹50 per kg. An ad valorem tariff is a percentage of the value of the good, such as 10% of its price. With an ad valorem tariff, the duty rises when the price rises. With a specific tariff it stays the same.

What is a compound tariff?

A compound tariff, also called a mixed tariff, combines a specific duty and an ad valorem duty on the same good. You add both parts to get the total duty per unit.

How does an import tariff affect domestic price and output?

It raises the domestic price to the world price plus the tariff. At the higher price, domestic producers increase output while consumers reduce their purchases. Imports fall as a result.

Who gains and who loses from a tariff?

Domestic producers gain because of the higher price and output. The government gains tariff revenue. Consumers lose because they pay more and buy less. The country also suffers a net deadweight loss.

Why do governments impose tariffs?

Common reasons are to protect domestic industries, to raise revenue, to reduce imports when the trade deficit is large, and to act against dumping. Whether a tariff is good for the whole economy is debated, and this is covered under free trade versus protection.