Protectionism:Trade Barriers
Every year there is some version of this on the test
FREE TRADE or PROTECTIONISM?
Free trade = no trade barriersTrade is allowed to be conducted w/o any restrictionsAbsence of artificial barriers (government imposed)
Protectionism = imposing trade barriers to protect the income of domestic producers
Overview of Types of Protectionism
Direct forms of Protectionism
EmbargoTariffsQuotasubsidies
Alternative forms of Protectionism
VERExchange ControlsImport LicensesAdministrative Barriers
• Health and safety• environmental
Complete Free TradeDue to comparative advantage, imports flow in at P2, as foreign merchants can undercut domestic production.
Pric
e
Quantity
P1,domestic
Q1
D
S domestic
1
Pt. 2 trade benefits consumers because prices are lower (fromp1 to p2) and they have more goods available, Q0 to Qw.
Domestic producers lose because they sellless, A to Q0 and at a lower price, p2 insteadOf p1.
S world 2
P2, world
WA0
Embargo: Total ban or lack of tradeMay be self-imposed by a domestic government
Self-imposed embargos on illegal drugs, endangered animals etc
Imposed from outside for political or military reasons.Most effective when country can’t produce embargoed goods by themselves, or at a very high cost.
Pric
e
Quantity
P
Q1
D
S domestic
1
Pt. 1 is equilibriumfor domestically produced goods.
Tariff: tax on importsad valorem
A tax on a good whose amount depends on the value of the good or service, eg. 15% sales tax
Pric
e
Quantity
P2
P1
Q1
D
S domestic
S world
TariffP3
C WA
S
B0
1
2
45
3
Tariff - Domestic ImpactProducers benefit- A to B and those producing at 0 to A get higher price (0P3 rather than 0P2) Consumers lose- higher prices at P3 and fewer goods at C rather than W.Government gains
Pric
e
Quantity
P2
P1
Q0
D
S domestic
S world
Tariff
Gov. Revenue
P3
C WA
S
B0
1
2
4443
5
CountryTariffs as a % of
Government Revenue
U.K. 0.1%Japan 1.2U.S. 1.5
Costa Rica 16.1Ghana 31.2
Dominican Republic
44.2
Lesotho 55.1
Tariffs as a percentage of total government revenue
Source: World Bank
Quotas- A physical limit on the amount of goods which may be imported in a set period of time
Pric
e
Quantity
P2
P1
Q0
D
S domestic
S world
Equilibrium with quota
P3
C Qw
Quota
Equilibrium with freetrade. At P2
0 A B
Quota- Domestic ImpactProducer Benefits – Better than free trade but not as good as an embargo Consumer Result – Increased P but decrease Q compared to free trade but lower P and higher Q than without free trade.
Pric
e
Quantity
P2
P1
Q0
D
S domestic
S world
Equilibrium with quota at P2 the free trade allows certain goods in up to the max of B and then no more M allowed so supply =Sd
P3
C Qw
Quota
Equilibrium with freetrade. At P20 A B
Subsidies – applied to domestic goods to make them cheaper and more competitive with imports.
Pric
e
Quantity
P1
P
Q0
D
S domestic
S domestic w/subsidy
P2
C Qw
2 S world
0
Subsidies – Domestic Impact Domestic producers – this decreases costs for domestic producers so they can compete with imports.Consumers – pay same p as with free trade and receive same Q
Pric
e
Quantity
P1
P
Q0
D
S domestic
S domestic w/subsidy
P2
C Qw
2 S world
0
0-Q0 produceddomestically
Q0-QW imported
Alternative Forms of Protection Voluntary Export Restraints (VER)
Exporting country agrees to a voluntary quota of exports into a second country
Exchange ControlsGovernment limits amount of foreign currency available to importers, or citizens traveling abroad, or companies investing abroad
Import LicensingForm of rationing where the importer must obtain a license, or permission to import
Administrative BarriersSafety, health or environmental requirementsOther forms of “red-tape” obstacles
Arguments for Protectionism
Military self-sufficientInfant Industry
Protect developing industry in LDCs
Declining IndustriesAllow firms a period of protection
Protecting EmploymentAnti-Dumping
Dumping: product exported at a price below production costs
Arguments Against Protectionism
HIGHER PRICES
Poor Resource Allocation
What else? (see text)
IndustryCost to Consumers
Per Job Saved
Autos $105,000
Color TVs 420,000
Motorcycles 150,000
Athletic Footwear 30,000
Apparel 37,000
Specialty Steel 1,000,000
Glassware 200,000
Sugar 60,000
Ball Bearings 90,000
Costs of protecting U.S. jobs from foreign competition
Source: Coughlin, et al. (1988) and Hufbauer, et al. 1986.
Effect of tariffs and quotas on imports, domestic production, and prices
•PW is the world price—that is, the price of the good that world be established in a global market without trade barriers.
•Pd is the domestic price—that is, the price in the domestic market if imports were equal to zero.
•Qd is the domestic output of a good if imports are zero.
•T is a tariff (measured in dollars, yen, lira, peseta’s, etc.) per unit, ton, pound, etc.
•Pq is the domestic price under the imposition of a quota.
Figure 8.8a: Effect of an embargo on Japanese watches
(a)
12.50
$15.00
Price
Quantity of Digital Watches252015
E
U.S. importsD
U.S. supply
U.S. demand
A
B C
•World price is $12.50
•Embargo pushes price paid by domestic buyers to $15.00
•Loss of CS = BDEA
•CDE is the “dead weight loss (welfare loss)”
effect of a tariff on oranges
0
Price ($)
Quantity (tons)
D
S
PW
PW + T
Pd
Free trade imports
Imports with tariff
q1 q5q4qdq2
•Domestic production increases from q1 to q2.
•The domestic price of oranges increases.
effect of a Quota on oranges
0
Price ($)
Quantity (tons)
D
S
PW
Pq
PdImport quota = 100 tons
100 400300250200
•Domestic production increases from 100 to 200 tons..
•The domestic price of oranges increases.
Free trade imports = 300 tons
S + Quota