How Tariffs Work

This diagram illustrates the mechanics of and intent behind tariffs imposed on goods imported from overseas.

Follow the step-by-step explanation, then use the red Registers (boxes) to modify the key parameters that influence how firms, consumers and governments behave.

A tariff is a tax on the profits made by an overseas firm (i.e. a company or individual from another country) when they sell goods in the country where the tariff applies. For example, a 20 percent tariff imposed by the USA would mean that another country selling goods to the USA would have 20 percent of those profits acquired by the US government.

One of the primary reasons to impose a tariff is to make domestic goods and the firms that produce them more attractive when compared to foreign alternatives. By taxing away the profits of an overseas firm, the firm is incentivised to raise the price at which they sell their goods, lest they operate at a loss.

If this rise in price of foreign goods makes domestic goods comparably cheaper, domestic consumers will shift more towards buying domestic goods. This can serve to stimulate domestic growth and bolster the economic independence of a country.

There are also downsides to imposing tariffs, which may or may not outweigh the benefits. For example, imposing tariffs on necessity goods like food can raise the burden on the average consumer by making the foreign goods they previously purchased more expensive.

Though in the long-term, tariffs may allow domestic firms (and the government) to invest in more productive and less costly business practices, and thus outcompete foreign goods on a more permanent basis, some industries are too reliant on international trade and cannot shift to purely domestic activity. Such industries, even if primarily based in the country imposing tariffs, may suffer supply chain inefficiencies due to the inextricably higher costs of imports, and/or because they are forced to rely on cheaper but less efficient goods and services.