Two-and-a-half centuries ago, classical economists, such as John Stuart Mill and Robert Torrens noted that a country enjoying market power in trade could improve its terms of trade and potentially improve national welfare, by using protective tariffs. The optimum tariff is defined as tariff that maximizes national welfare. For a small economy, it is zero; for a large economy, it is positive.

A tariff which maximizes a country’s welfare, trading off improvement in the terms of trade against restriction of trade quantities. For a small economy which cannot affect world prices in the markets in which it trades, the optimum tariff is zero. For a country with monopoly power in its export markets or monopsony power in import markets, the optimum tariff is positive, but not so large as to eliminate trade entirely.

Note:

• In a monopsony, a large buyer controls the market. Because of their unique position, monopsonies have a wealth of power. For example, being the primary or only supplier of jobs in an area, the monopsony has the power to set wages.
• In addition, they have bargaining power, as they are able to negotiate prices and terms with their suppliers.
• There are several scenarios where a monopsony can occur. Like a monopoly, a monopsony also does not adhere to standard pricing from balancing supply-side and demand-side factors.
• In a monopoly, where there are few suppliers, the controlling entity can sell its product at a price of its choosing because buyers are willing to pay its designated price. In a monopsony, the controlling body is a buyer. This buyer may use its size advantage to obtain low prices because many sellers vie for its business.