What it is:
How it works (Example):
There are generally two types of tariffs.
Ad valorem tariffs are calculated as a fixed percentage of the value of the imported good. When the international price of a good rises or falls, so does the tariff.
A specific tariff involves a fixed amount of money that does not vary with the price of the good.
In some cases, both ad valorem and specific tariffs are levied on the same product.
For example, Company XYZ produces cheese in Scotland and exports the cheese, which costs $100 per pound, to the United States. A 20% ad valorem tariff would require Company XYZ to pay the U.S. government $20 per pound to export the cheese. A specific tariff would involve charging $30 dollars per pound of cheese whether cheese sold for $100 or $200 per pound.
Why it Matters:
Tariffs make foreign goods more expensive to domestic consumers, causing a decline in imports, a decline in the supply of the good, and a resulting increase in the price of the good. The price increase usually motivates domestic producers to increase their output of the product.
Some economists argue that the resulting higher consumer prices, higher producer revenues and profits, and higher government revenues make tariffs an effective way to transfer money from consumers to government treasuries.
Economists also argue that tariffs interfere with free market ideals by diverting resources to domestic industries that are less efficient than foreign producers.