Explain how a reduction in tariffs could help to reduce inflation

AQA A-Level Economics Paper 2 June 2022

Extract E (lines 7–9) states: ‘It was hoped that policy measures, including a reduction in tariffs... would help to reduce inflation’.

With the help of a diagram, explain how a reduction in tariffs could help to reduce inflation. (9 marks)

1. A tariff is a tax on imports.
2. Inflation is the rate at which average prices are increasing in the economy.

1. As tariffs are reduced, taxes on imports are reduced, so imports become cheaper.
2. This means that world supply shifts to the right (downwards on the diagram below) from Sworld+tariff to Sworld.
3. This leads to a fall in the price from p1 to p2.
4. This leads to an expansion along the domestic demand curve and a contraction along the domestic supply curve.
5. This means that there is an increase in imports from q1q2 to q3q4.
6. As net exports (X-M) is a component of aggregate demand (AD), there will be a decrease in AD.
7. Additionally, imports are cheaper so it is cheaper for firms to import raw materials from abroad. They might also benefit from cheaper energy bills since it might be cheaper to import oil.
8. This leads to a fall in costs of production, and therefore an increase in short-run aggregate supply.
9. As AD decreases and SRAS increases, the price level and inflation rate in the economy fall.

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