A Strong Dollar, A Weak Assumption: What U.S. Tariff Models Gets Wrong

Written By Angela Gibson

By Angela Gibson

4/5/2025

Tariffs are often presented as a simple lever to protect domestic industries or penalize foreign competition. But beneath the headlines, the way tariffs are calculated and justified can feel wildly disconnected from the complex global economy we live in today. That disconnect becomes obvious when you look at the formula often used to justify tariff adjustments

Δτᵢ = (xᵢ - mᵢ) / (ε · φ · mᵢ)

Here, xᵢ is domestic production, mᵢ is import volume, ε is price elasticity of import demand, and φ is the pass-through rate of tariffs into consumer prices. It's neat and mathematical, but it assumes all countries are operating on a level playing field, with equivalent currencies, consumer behavior, and economic resilience.

But that's far from reality.

A Smarter Tariff Adjustment Formula

Δτᵢ* = (xᵢ - mᵢ) / ((εₗᵤₓ · φ · mᵢ) · Cₐdⱼ · θ)

New Terms Explained:

  • εₗᵤₓ = Luxury-adjusted price elasticity of import demand
    This adjusts elasticity based on whether the good is a necessity or a luxury.

    • For luxury goods: elasticity is lower (rich buyers are less price-sensitive).

    • For essential goods: elasticity is higher (people react more to price increases).

  • φ (phi) = Pass-through rate of tariffs into price
    (Same as before)

  • Cₐdⱼ = Currency adjustment factor

    Where FXᵢ is the local currency-to-USD exchange rate. If 1 USD = 10 pesos, then Cₐdⱼ = 10.
    This scales the tariff impact depending on how weak the foreign currency is compared to the dollar.

  • θ (theta) = Wealth segmentation multiplier
    This reflects how much of the import volume is being purchased by the upper class in the importing country.

    • θ = 0.2 means 20% of the population consumes the import.

    • Lower θ = more luxury concentration, so tariff acts more like a tax on the wealthy.

The Currency Imbalance Problem

Imagine a developing country where 1 U.S. dollar equals 10 or even 80 units of the local currency. When they import a product priced in dollars, they're already paying a steep premium just to convert their currency. A 10% tariff in the U.S. may barely nudge prices for Americans, but a similar tariff abroad could feel like a 30% spike for a country with a weaker currency. The current formula doesn't account for this imbalance.

When Tariffs Are a Luxury Tax

Let’s take the iPhone as an example. It’s an American luxury export bought by wealthier consumers around the world. In countries like India, iPhones are often priced out of reach for the majority of the population due to both the dollar exchange rate and local income levels. Tariffs on iPhones in India aren’t about protecting domestic smartphone makers—they're effectively a tax on the wealthy.

If we use our improved formula to calculate how much India should adjust its iPhone tariff, it might look like this:

Where:

• εₗᵤₓ: price elasticity of luxury goods (low)

• Cₐdⱼ: currency adjustment factor (USD to local currency)

• θ: proportion of population actually purchasing the product (low for luxury goods)

In our calculation, India could reduce its iPhone tariff by nearly 89% and still not affect domestic production (because it barely exists). The high cost, weak currency, and limited buyer pool already act as natural barriers.

When Tariffs Hurt the Market Chain

Now contrast that with wheat in Egypt—a basic necessity. Egypt imports millions of tons of wheat yearly and subsidizes bread to maintain social stability. Using the same formula but with high elasticity (people are very sensitive to food price changes), a high currency adjustment factor, and θ = 1 (everyone needs wheat), we found that the optimal tariff adjustment would be around -0.46%.

That means Egypt should reduce or remove tariffs on wheat entirely. Tariffs here don’t just raise prices—they threaten food security.

A More Precise Tariff Strategy

Tariffs shouldn't be treated as a blunt-force policy tool. The economic context matters:

  • What is the good: luxury or necessity?

  • Who is buying it: everyone or just the wealthy?

  • What’s the currency reality?

  • Is there meaningful domestic production to protect?

By adding variables like currency conversion and class segmentation into the formula, we better capture the real-world impact of tariff decisions.

Tariffs should be used like a chef’s knife with precision and deep understanding of what each move means in a global kitchen. In a world of economic imbalance, cutting first and measuring later can distort entire supply chains, punish vulnerable economies, and escalate tensions. We need trade policies that act with surgical intention, not performative force.

Angela Gibson