# _Effects when there is product differentiation_

The choice of the modeling framework determines how the imposition of import tariffs in a particular sector affects its output prices. When users decide to simulate effects with the product homogeneity framework, the average import tariff across all the products in a particular sector represents the percentage increase in the sector’s output prices. A full pass‐through on domestic prices is therefore assumed under this framework. By contrast, if the product differentiation framework is chosen, UTAS calculates the following three effects: (i) the increase of import prices on account of the tariff, (ii) the pass‐through of the tariff on imports on the goods’ domestic equivalent, and (iii) an overall price effect that combines (i) and (ii). While (i) is calculated simply as the average import tariff on products of a particular sector, (ii) and (iii) depend on user‐defined substitution and supply elasticities as well as a sector’s domestic consumption share (i.e. how much of a sectors’ total consumption is sourced domestically).

UTAS considers first by how much the demand for the imported variety of the sector’s output would increase, if all tariffs were to be abolished. This depends on the sector’s elasticity of substitution. It then calculates by how much the hypothesized increase in the import demand would lead to lower demand for the sector’s domestic output variety. This is done by assuming a Leontief production framework, where the increase in the demand for the imported variety at zero tariffs is exactly offset by an equivalent reduction in the demand for the domestic variety. Next, UTAS calculates how the demand shift from the domestic to the imported variety would translate into a lower output price for the domestic variety. The size of this effect is mediated by the sector’s elasticity of supply. Last, the overall effect of the tariffs in the sector is calculated as a weighted average of the change in the output price for the imported and the domestic variety, where the hypothesized consumption shares of domestic versus imported sector produce at zero‐tariffs are used as the respective weights.

Figure 20 and Figure 21 below illustrate these calculations for a few selected sectors based on Pakistan’s pre‐2019 reform duty rates. Imports of vegetables, fruit and nuts, for example, accrue a tariff of 10.5 percent. The pass‐through of the tariff on domestic prices in this sector is relatively small, amounting to only 2.3 percent. This is because UTAS predicts only a small difference in the domestic consumption share on account of the tariff. By contrast, the pass‐through effect on domestic prices is much larger in the textiles and motor vehicles sectors, where UTAS attributes a much larger increase in domestic consumption shares due to the prevalence of tariffs.

_Figure 20: Price pass‐through of tariffs in selected sectors under product differenciation_ _Figure 21: Domestic consumption share in selected sectors_ <!-- Start of picture text --> 30% 90%<br>80%<br>25% 70%<br>60%<br>20% 50%<br>40%<br>15% 30%<br>20%<br>10% 10%<br>0%<br>5%<br>0%<br>Vegetables, Vegetable Textiles Motor<br>fruit, nuts oils and vehicules<br>fats and parts<br>Imported prdct. Domestic prdct. Overall with tariff without tariff<br><!-- End of picture text --> Source: Authors’ calculations using UTAS 20