The 25% Tariff on Cars

EconEye Admin

1 year ago

The 25% Tariff on Cars

In a Proclamation, “Adjusting Imports of Automobiles and Automobile Parts into the United States” issued on March 26, 2025, President Donald Trump announced the imposition of a 25 percent tariff on imported cars and auto parts to be effective from April 2, 2025.

During a call with the CEOs of major automakers, the president warned against using the tariff as an excuse to raise car prices. On March 31, the president said he “couldn’t care less” if automakers raised prices because of new tariffs.

Which countries are the major producers of U.S. imported cars?

Mexico, Japan, South Korea, Canada, and Germany produce almost all the cars imported by the United States.

Figure 1 shows the data for 2024

Why does the United States import cars?

The United States imports and exports cars, but the value of car imports is more than three times the value of car exports. Comparative advantage is the reason why the United States is a net importer of cars—the opportunity cost of producing many types of cars is lower in Mexico, Japan, South Korea, Canada, and Germany than in the United States. An American car buyer benefits from buying an imported car, and automakers in the rest of the world benefit from selling cars to American buyers.

Figure 2 explains and illustrates the gains from international trade in cars.

The figure is a graph of the market for cars in the United States, with the quantity of cars bought on the x-axis and the price of a car on the y-axis. All the numbers are assumed and chosen to make the analysis as clear as possible.

The curve D_US is the demand for cars in the United States, and in this model economy, buyers don’t care whether a car is made in the United States or another country. The curve S_US is the supply of cars produced in the United States, and S_US + M is the supply of cars produced in and imported into the United States.

Equilibrium in the U.S. car market determines the price and quantity of cars. In equilibrium, the price is $40,000 and 5 million cars a year are bought. The quantity produced in the United States is 1.5 million, and 3.5 million are imported.

Car buyers enjoy a consumer surplus shown by the green triangle, A, and U.S. automakers get a producer surplus shown by the blue triangle, B. Automakers in the rest of the world enjoy a producer surplus shown by the orange triangle, R.

How will a 25 percent tariff on car imports change the price of a car and the volume of U.S. car production and imports?

A 25 percent tariff on cars will raise the U.S. price of a car, decrease the volume of cars imported, and increase the quantity of cars produced in the United States.

Figure 3 explains and illustrates these effects.

A U.S. tariff on imported cars decreases the supply of foreign cars in the U.S. car market and the supply curve becomes S_US + M + T. The vertical gap between S_US + M + T and S_US + M is the tariff.

Equilibrium in the U.S. car market with a tariff determines the new price and quantity of cars. In equilibrium, the price rises to $48,000 and 4 million cars a year are bought. The quantity produced in the United States increases to 2 million, and car imports decrease to 2 million.

The tariff is $10,000 per car and is shared by buyers who pay $8,000 and producers who pay $2,000. (This outcome and shares of the tariff depend on the assumed elasticities of demand and supply.

If the president issues a second proclamation that orders automakers not to raise the prices of cars, how would the U.S. auto market change?

If President Trump imposes a 25 percent tariff on car imports and sets an effective price ceiling at the free-trade price, the quantity of cars produced in the United States will return to its free-trade level, car imports will decrease, and there will be a shortage of cars in the United States. Figure 5 explains and illustrates these effects.

The starting point is Figure 3 with a 25% tariff. The price ceiling PC is $40,000, the free-trade price.

At that price, the quantity of cars supplied by U.S. producers is the free-trade quantity of 1.5 million cars, and the quantity imported decreases to 1.5 million cars. The total quantity supplied deceases to 3 million, but the quantity demanded is 5 million. There is a shortage of 2 million cars.

Car importers will bear the full burden of the tariff, U.S. automakers will have the free-trade producer surplus, and U.S. car buyers will have a smaller consumer surplus, and the deadweight loss will increase. The rest-of-world will become yet further worse off.

Background Reading

The model and analysis in this blog Eye On is an extension of coverage in Parkin 14e, Bade and Parkin 9e, Parkin and Bade, 12e Canadian, Parkin, Powell, and Matthews, 11e European, chapters on Demand and Supply, Efficiency, Taxes, and Global Markets in Action.

Now take a short quiz to ensure you understand what you just read.

Answer the following questions to check your understanding of the story.

Why is the United States a net importer of cars?

a) Because tariffs make imported cars cheaper than domestic cars

b) Because U.S. consumers prefer foreign cars regardless of price

c) Because other countries have a comparative advantage in producing many types of cars

d) Because U.S. automakers are prohibited from exporting cars

Wrong! - Because U.S. consumers prefer foreign cars regardless of price
This is incorrect because consumer preferences alone do not explain net imports. Even if consumers like foreign cars, imports occur mainly because foreign producers can supply cars at lower opportunity cost. Price and efficiency matter, not just preference.

Because U.S. automakers are prohibited from exporting cars
This is incorrect because U.S. automakers are not prohibited from exporting cars. The United States does export cars, but the value of imports is much larger than exports due to comparative advantage.

Because tariffs make imported cars cheaper than domestic cars

This is incorrect because tariffs raise the price of imported cars, not lower them. Without tariffs, imported cars are cheaper due to lower production costs abroad.

Correct! - Countries such as Mexico, Japan, South Korea, Canada, and Germany have a lower opportunity cost of producing many types of cars than the United States. This comparative advantage makes it efficient for them to specialize in car production and export cars to the U.S., while the U.S. specializes in other goods and services.

What is the effect of a 25 percent tariff on imported cars in the United States?

a) It raises car prices, increases U.S. car production, and reduces imports

b) It lowers car prices and increases imports

c) It has no effect on prices or quantities

d) It reduces both U.S. production and imports

Wrong! - It lowers car prices and increases imports
This is incorrect because tariffs increase costs, which raises prices and reduces imports rather than increasing them.

It reduces both U.S. production and imports

This is incorrect because while imports fall, U.S. production rises in response to higher prices. Domestic producers benefit from protection provided by the tariff.

It has no effect on prices or quantities

This is incorrect because tariffs directly affect market prices.

Well Done! - A tariff raises the cost of imported cars, which increases the overall market price of cars. Higher prices encourage U.S. producers to increase production while discouraging consumers from buying imported cars, leading to fewer imports.

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