Optimal and threshold tariffs, trade balance and welfare in a small open Ricardian economy

Robert Stehrer

No 280, wiiw Working Papers from The Vienna Institute for International Economic Studies, wiiw

Abstract: This paper draws on a Ricardian model for a small open economy and derives the welfare implications of tariffs. By focusing on three key parameters – (i) the expenditure share on imports, (ii) the degree of tariff pass-through, and (iii) the proportion of tariff revenues spent domestically – the model provides closed-form expressions for welfare, optimal tariff rates, and threshold tariff levels. The analysis explains why the marginal effectiveness of increasing tariff rates declines and might even become negative as well as why real wage income typically diverges from total income when tariff revenues are saved rather than spent. The results indicate that high pass-through of tariffs substantially limits potential welfare gains from tariffs even at the optimal rate. Improvements in the trade balance only arise when tariff revenues are not fully recycled into domestic demand. However, welfare is also lower when the optimal tariff rate is applied in such a case. The framework captures mechanisms consistent with more complex trade models and highlights the narrow range of conditions under which tariff policy can yield positive welfare outcomes.

Keywords: Ricardian trade model; optimal tariffs; pass-through; trade balance (search for similar items in EconPapers)
JEL-codes: F13 F17 (search for similar items in EconPapers)
Pages: 39 pages including 6 Tables and 16 Figures
Date: 2026-09
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