Optimal Tariffs

Nuno Limão, New Palgrave Dictionary of Economics, ed. by Steven N. Durlauf and Lawrence E. Blume, Palgrave Macmillan 2, January .


Optimal tariffs allow a country to exploit its market power in international trade. A country can improve its terms of trade by unilaterally restricting its exports if it faces a downward-sloping demand for them or restricting its imports if it faces an upward-sloping foreign export supply. This argument against unilateral free trade is over 150 years old but it remains central to modern theories that explain trade agreements and their rules. This, along with recent evidence that prior to such agreements countries exploit their market power in trade, shows that optimal tariffs may be an important positive theory of protection.

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