The REAL Tariff Problem, Explained in 6 Minutes

I want to explain the real impact of import tariffs, and I'm going to show you in a way that you haven't seen before. It's only been a few weeks and President Trump is already making serious economic waves. One of those waves is his goal of bringing manufacturing back onto US soil. I want to see the day when Apple will make their iPhones in this country. He wants America's trade partners to start bringing more to the table. Mexico and Canada have never been good to us on trade. They treat it as very unfairly on trade. And he's even floated the idea of eliminating federal income tax entirely. Did you just float out the idea of getting rid of income taxes? Our? Yeah, sure. But why not? And Trump's weapon of choice to achieve all of this? Tariffs. I always say tariffs is the most beautiful word to me in the dictionary. This time he's vowing 25% tariffs on automobiles, semiconductors and pharmaceutical drugs. Meanwhile, the European Union triggering the first phase of retaliation. Tariffs are a tax the government can levy on the goods being imported or exported from the country. In this case, Trump has been laying down a lot of import tariffs. It started with 25% tariffs on imports from Canada and Mexico, although they've now been paused. A 10% tariff on all Chinese imports, threatening to go as high as 60%. A week later, he announced a 25% tax on steel and aluminium worldwide. He has ordered federal agencies to explore retaliatory tariffs, matching US tariff rates to those that other countries have imposed on the US. Just this week, he also floated the idea of 25% tariffs on auto, pharma and chip imports. And you've probably heard it a million times by now. Tariffs will raise prices for Americans. But a possible resurgence of inflation for consumers isn't the only major impact. Arguably, it's not even the biggest downside. So I'm going to do what no one else is doing and explain the full picture for the Trump tariff impacts. And I'm going to do it all in under 6 minutes. Let's start with an imaginary world where only the United States exists, and the only product being traded are bananas. The American growers produce bananas, and Americans buy and consume them. The more expensive the bananas are, the less quantity people want to buy. So a graph representing banana demand would look like this. For the producers, it's the opposite. The higher the selling price, the more quantity of bananas will be produced. So the banana supply line would look like this. So who sets the prices? Well, while the banana producers are the ones putting the price tag on them when they offer them to consumers, they don't actually set the price. It's the market forces between both the producers and the consumers that drive the price towards a balance point called the equilibrium price. In our USA-only world, this price is currently $15. This of course is just theory. In the real world, there are types of businesses that can be price makers. And there are goods that just don't behave like this. But the model does very much help explain the full impact of tariffs. In our imaginary world, if we want to see what happens when tariffs are imposed on imported goods, we first need another country to trade with. The foreign producer sells bananas for a much lower price than the US domestic producers. We can represent it with this horizontal line here. And this is where things get messy. At this new lower price that's available to US consumers, a higher quantity of bananas are demanded than before. Instead of 100 bananas, demand is now 140. At the same time, domestic producers can only supply fewer bananas at the new lower price, just 60 instead of the previous 100. In the real world, this might look like businesses exiting an industry because the new price point no longer makes the business profitable. Most of the demand in this global trade of bananas is now being supplied by the foreign low-cost producer. Of the 140 bananas demanded by consumers, 60 are being supplied by domestic producers and 80 are being imported. And we can actually use this chart to see who benefits from this kind of market. By shading the area above the price line but below the demand curve, we get the size of the consumer surplus. Take someone at this point on the curve. They're willing to buy 60 bananas at a price of $19. But the current price is just $11, so that consumer is getting their bananas for way less than they'd be happy to pay. That gap between the price and the price they're willing to pay is the consumer surplus. It's one way in economics that we can measure the excess benefit enjoyed by consumers. In a world with a cheap foreign producer with much lower prices, consumers are significantly better off. But take a look at the producer surplus. Again, it's basically the opposite of the demand side, the difference between the price a domestic producer is willing to sell bananas for and the price they actually receive. Or in other words, having a foreign producer supply bananas at a much lower cost makes American producers significantly worse off. If a country wants to make their domestic producers more competitive, they can adopt protectionist policies. And the most popular choice is of course import tariffs. The tax is levied on goods bought by domestic consumers and so it raises the price of bananas. Now there is an important clarification here. Domestic consumers in this model effectively means buyers. And in the US, there are lots of businesses that import goods from overseas to sell in America. So those businesses are the ones that directly pay the tax. But it is an increased cost that is passed on to the end consumer. The new higher price for bananas means a smaller quantity of bananas are consumed. It also means US domestic producers can sell their bananas at a new higher price. And that higher selling price causes an increase in domestic production. So the combination of lower demand and higher domestic supply means there are less bananas being imported. The tariff also has an impact on the consumer and producer surpluses. Domestic surplus shrinks because prices are higher, meaning consumers are worse off. At the same time, domestic producers now selling products at higher prices enjoy an increase in their surplus and are better off. But this market also isn't just one between buyers and sellers anymore. There's a third participant now, the federal government. This shaded area reflects the taxes received by the government from the tariffs. If I haven't put you to sleep yet, you'll notice there's actually two other new shaded areas as well. Before the tariff, these areas were a part of consumer surplus. Now it represents the benefit to society that is completely lost. Taxes like import tariffs create what's called deadweight loss. Yes, the tax did result in producer and government surplus increasing, but it also resulted in consumer surplus decreasing to a bigger effect. So the social benefit overall declined. So why on earth is Trump so hell bent on tariffs if they have an overall negative effect? Well, there's a few reasons. Firstly, while it's true that tariffs are a net negative to social surplus, they can also have a negative effect on the country that it's imposed on. The tariff lowers overall demand and increases the quantity of goods supplied by US producers. So they usually lead to a decrease in capital flowing into the foreign country, meaning tariffs can be a good way to inflict economic pain on another country. Hence the term trade war. The problem of course is that it can create a tit for tat fight that is good for nobody. Two countries going back and forth, raising tariff rates on each other just means more and more deadweight loss on both ends. The other point is that while they do reduce the overall benefit, they still generate new benefits for the government in the form of tax revenue. Part of the decline in consumer surplus is in essence the consumers paying a new tax through higher prices. Whether or not you think that's a good thing depends on your view of taxation, but generally it's seen as undesirable because it's a regressive tax. Lower income households are burdened with a higher cost as a percentage of their income than wealthy households. And maybe the most important thing to remember is that this is economics, so things never play out as simply as the theory suggests. We can really only just watch and observe as things play out over the coming months and years. Subscribe if you enjoyed and check out one of these videos next.