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