International Trade Policy

Free Trade Protectionism

Free TradeO Free trade is the absence of

government intervention of any kind in international trade, therefore there

are no restrictions between countries.

O According to the law of comparative advantage, free trade is the pathway

to increased output and efficient allocation of resources

ProtectionismO Protectionism is the imposition of barriers to trade to prevent the free

entry of imports into a country in order to protect the domestic

producers from foreign competition. O The debate between free trade and

protectionism has been raging for hundreds of years and remains a

controversial subject

To import or to export..?

O If a country is producing a particular product but not engaging in

international trade, how will the domestic price be determined?

O Now let’s assume this country decides to adopt a free trade policy. How will this country decide whether to import more of the good from the

world supply, or export their production of this good?

Suppose the domestic price of the good is $10, but the world price is $12. What situation do

we have in the domestic market at the $12 price? What would be the wise trading

decision to make?

The decision to exportO Because this country has an excess

supply of the product at the world price of $12, it has a surplus that can

be sold abroad. O The wise move to make would be to

export the good and pocket the profits. So when the world price is above the domestic price, the good

should be exportedO Does the country have a

comparative advantage in this product?

Suppose the domestic price of the good is $10, but the world price is only $8. What

situation do we have in the domestic market at the $8 price? What would be the

wise trading decision to make?

The decision to importO Because this country has excess demand of the product at the world

price of $8, the shortage can be resolved with foreign purchases.

O The wise move to make would be to import the good. So when the world price is below the domestic price, the

good should be importedO Does the country have a comparative

advantage in this product?

Protectionist policiesO Which of the two scenarios typically

lead to protectionist policies by government? Why would the government choose this policy?

Tariffs

OTariffs, (aka customs duties), are taxes on imported goods

and are the most common form of trade restriction.

O Can you identify the two reasons tariffs are sometimes

used as economic policy?

Tariffs can…Protect

domestic producers

Be a source of revenue

Effects of Tariff

Impacts of a tariffO As you saw on the graph, the tariff raises the price of the good from the world price to the world price plus the tariff. Let’s see how different stakeholders fare in this situation

StakeholdersO Domestic consumers are worse off.

They now pay a higher price and they buy less quantity

O Domestic producers are better off. They sell more quantity and receive a higher price.

StakeholdersO What effects does a tariff have on

domestic employment?O What happens to government revenue?

O How do tariffs effect income distribution?

O What is the effect on domestic society?O What effect does the tariff have on

foreign countries?O What happens to the global allocation of

resources?

Consumer and Producer Surplus

O The imposition of a tariff changes the consumer and producer surplus. As

we will see on the next slide, consumers, producers and the government will all see their

surpluses change after a tariff is put in place

Let’s take a closer look…

Consumer and Producer Surplus

O Before the tariff, consumer surplus was

(a + b + c + d + e + f)O Before the tariff, producer surplus

was (g)

O So the total surplus to society was equal to

(a + b + c + d + e + f + g) before the tariff was placed

Consumer and Producer Surplus

O After the tariff, consumer surplus is (a + b), so consumers are worse off

O After the tariff, producer surplus is (c + g), so producers are better off

O The government gains area (e)O Total surplus to all of the above is

equal to (a + b + c + g + e)

O Deadweight loss exists at (f + d)

Final word on tariffsO Consumers lose some of their surplus to producers and some to

government. O Consumers are worse off, producers

and government is better off. O The deadweight loss demonstrates

that the social losses are greater than the gains, due to inefficient firms producing too much of the

good

Ready for Import Quotas?

O An import quota is a legal limit to the quantity of a good that can be imported over a particular time

period. It has a similar effect as a tariff, but may or may not create

revenue for government

Yikes!

Effects of Import Quotas

O Domestic production increases because there is a limit on imports, but domestic consumption falls and

so does the quantity of imports.O Domestic consumers are worse off, they pay a higher price and buy less

quantityO Domestic producers are better off,

they receive a higher price and sell more quantity

Effects of Import Quotas

O Domestic employment increasesO Quota revenues go to either government or

importers, depending on government policyO Domestic income distribution worsens, as

the quota has the effect of a regressive taxO Domestic society is worse off, as less is

consumed and inefficient domestic producers overproduce

O Exporting countries are worse off as they sell less quantity

O Global misallocation of resources results

Consumer and Producer Surplus

O Import Quotas result in deadweight loss due to inefficiencies in

production. Government has picked up a small piece, at the expense of

consumers. O Very similar effects to that of tariffs

Subsidies

Two types of SubsidiesO Production

subsidies

O These are payments by

government to domestic producers

competing with cheap imported

goods

O Export subsidies

O These are payments by

government to domestic

producers who export certain

goods

Production subsidies

Production SubsidiesO As we can see from the previous slide, the world price is way below

the domestic price, therefore domestic suppliers produce only Q1

output, while imports capture a much greater part of the market (Q1-

Q3). O A government subsidy will shift the

domestic supply curve to the right, allowing domestic suppliers to

increase quantity to Q2

Results of production subsidies

O Imports fall from Q1-Q3 to Q2-Q3O Consumption of the good is

unchanged. Consumers simply buy a greater quantity of domestic output

and less foreign outputO Price is unchanged

O Taxpayers are worse off, because their money goes to subsidizing

producers and not to more beneficial purchases by government

Results of production subsidies

O Domestic producers are better off as they sell more quantity

O Domestic jobs are createdO Domestic society is worse off (too

much produced by inefficient producers) but at least consumption

doesn’t fallO Exporting countries are worse off

O Global misallocation of resources is seen

What if……O Government gave an enormous

subsidy to domestic producers? Could they create a situation where the country could actually become an exporter of a good that it has a

comparative disadvantage in?

O Maybe we should draw a graph….

Voluntary Export restraints

Voluntary export restraints

O Another form of protectionism. Essentially, a country that is being hurt by too many imports coming into their country threatens the exporting country with harsher

treatment if they do not “voluntarily” restrict their exports.

O So it’s not as voluntary as the name suggests, and again the WTO is

opposed to these deals.

Voluntary export restraints

O They have almost identical effects as import quotas, the only exception

being that exporting countries receive additional revenue from the

higher resulting price. O Most stakeholders are worse off after

VERs are imposed.

Other trade disruptionsO Governments may require a great

deal of paperwork to make selling imported goods inconvenient

O Regulations requiring certain health, safety and environmental standards may restrict the amount of imported

goods coming into a country

Last words on protectionism

O Domestic producers and workers are the main beneficiaries

O Consumers typically loseO Inefficiencies in production result

O Income distribution worsensO Foreign producers suffer

O Society suffers (misallocation of resources)

O Trade wars may result

Wake up! It’s Over!