Free Trade vs.

Protectionism

Frederick University 2009

Free Trade vs. Protectionism

If there were an Economists Creed it would surely contain the affirmations: I understand the principle of comparative advantage and I advocate free trade Paul Krugman

Free Trade vs. Protectionism

Trade Protection (Protectionism) Policies that limit imports, usually with the goal of protecting domestic producers in import-competing industries from foreign competition

The Gains from trade

Oz widget market
P S Local consumer's extra gains = d+e Local producers extra gains = -d

a
Po= 4

a
4

d b
D Qo = 30
No trade: Oz price = 4; Q = 30 consumer surplus = a

Pw = 2

}
Imports = 28 Qo =16 Q = 44

Trade: world price = 2; Qo= 16, Q imports = 28, Q = 44 Consumer surplus = a+d+e Producer surplus = c

The Gains from trade

Zo widget market
S Zo consumers extra gain = -i Producers extra gains = i + j Exports = 28 S

Pz = 1.5

f g
D

P=2 1.5

i g

}
j
D 50 78

Q Qz = 60 No trade: P = 1.5; Q = 60 Consumer surplus = f Producer surplus = g

Trade: P = 2; Q = 78 Consumer surplus = h = f i Producer surplus = g + i + j

The Gains from trade

Oz consumers Oz producers Zo consumers Zo producers

Surplus before trade Surplus after trade

c+d

h+i

d+e+a c

g+i+j

Total:

+e

+j

Free Trade vs. Protectionism

Showing that free trade is better than no trade is not the same thing as showing that free trade is better than sophisticated government intervention

Trade Restrictions
Tariffs - taxes levied basically on imported goods. They are imposed as an attempt to raise foreign exchange revenue and increase the welfare at the expense of other nations. Nontariff barriers - all forms of trade restrictions other than tariffs.

Tariffs

ad valorem import tariff - expressed as a percentage of the invoice value of the imported good specific tariff - a fixed sum levied on a physical unit of the good no matter what its invoice price is compound duty - a combination of ad valorem and specific duties variable levy - calculated daily official prices - a basis for ad valorem duty calculations

The Effect of a Tariff

S
P

a producer gain Pd Pt Pw }t a b c a + b + c + d consumer loss c government collection

M Sd St Dt Dd Q b consumer loss due to the

demand shift to domestic supply

d consumer loss due to the reduction in consumption

D b + d deadweight loss

- production effect

Nontariff barriers

quantitative restrictions
Quotas - numerical limits for a specific kind of good that a country will permit to be imported without restriction during a specified period Voluntary export restraints Tariff quotas -permit a stipulated amount to enter the country duty free or at a low rate, but when that quantity is reached, a much higher duty is charged for subsequent importations

technical regulations administrative regulations other regulations of imports

The Import Quota

P

Sd Dd

a producer gain

a + b + c + d consumer loss
Sq c transfer from domestic

consumers to someone else

Pq

b+d a b c d

a loss to the country

Pw q Qs Qsq Qdq Qd
Q

Arguments for trade restrictions

The need of protection of domestic labour markets against cheap foreign labour The desire to reduce domestic unemployment The need to counteract dumping in international trade The need to protect the infant industries Protect industries important for national defence Decrease the national balance of payments deficit Improve the nations terms of trade and welfare Strategic trade policies The scientific tariff The need to protect national health and safety standards

Strategic Trade Policies

economies of scale justify the operation of just one firm in the world market as a whole lucky firms in the industry may be able generate returns higher than the opportunity costs of the resources they employ the country can raise its national income at other countries expense if it can somehow ensure that the lucky firm that gets to earn excess returns is domestic rather than foreign

Strategic Trade Policies an example

Assumptions: Two companies from two countries are capable of producing a good Neither country has any domestic demand for the good the good is intended solely for export The producer surplus coincides with the national interest Each firm faces only a binary choice either to produce or not to produce The market is profitable for either firm if it enters alone, unprofitable for both if both enter

Strategic Trade Policies an example

The good is a 150 seat passenger aircraft The firms are Boeing and Airbus The countries are the U.S. and the EU

The Payoff Matrix Airbus

P N

-5 -5 100 100

Boeing

0 0

Strategic Trade Policies an example

Boeing has some kind of head start that allows it to commit itself to produce before Airbuss decision Boeing earns 100 while deterring entry by Airbus The EU decides to subsidize Airbus at a point before Boeing is committed to produce The EU pays a subsidy of 10 to Airbus if it produces the plain, regardless of what Boeing does

Strategic Trade Policies an example

The Payoff Matrix after European Subsidy Airbus
P N

5 -5 110 100

Boeing

0 0