INTERNATIONAL TRADE AND AGREEMENTS

Topic 8: The Instrument of Trade Policy

 INTERNATIONAL TRADE AND AGREEMENTS

Topic 8

THE INSTRUMENT OF TRADE POLICY

A. OVERVIEW

This chapter examines the policies that governments adopt toward international
trade, policies that involve several different actions. These actions include taxes on some
international transactions, subsidies for other transactions, legal limits on the value or
volume of imports, and many other measures. The chapter provides a framework for
understanding the effects of the most important instruments of trade policy.

B. OBJECTIVES

1. Define terminologies and understand the concepts of the different instruments of trade
policy.
2. Understand existing instruments of trade policy.
3. Be guided with the content of the succeeding topics.

C. LEARNING OBJECTIVES
Students will be able to:
1. Understand the basic tariff analysis, costs and benefits of a tariff and effects of trade
policy.
2. Understand the supply, demand and trade in a single industry, consumer and producer
surplus and the comparison of a tariff and a quota.

D. INSTRUCTIONS

1. Kindly read and comprehend Topic VIII: The Instruments of Trade Policy.
2. Should you have any questions or concerns, do not hesitate to message me.
3. Enjoy your own pace, ‘cause learning is never a race. In these hard and trying times, I
understand that you are walking on a rough patch. Do not forget to pause, breathe, and
carry on! You got this! ☺
 INTERNATIONAL TRADE AND AGREEMENTS

E. DISCUSSION

THE INSTRUMENTS OF TRADE POLICY

Free Trade – refers to situations where a government does not attempt to restrict what its
citizens can buy from another country or what they can sell to another country.

Trade Policy – collection of rules and regulations which pertain to trade. This is to help a
nation’s international trade run smoothly by setting clear standards and goals which can be
understood by potential trading partners.

BASIC TARIFF ANALYSIS

TARIFFS – tax levied on imports.

• Specific Tariffs – Taxes that are levied as a fixed charge for each unit of goods imported.
(Example: A specific tariff of $10 on each imported bicycle with an
international price of $100 means that customs officials collect the
fixed sum of $10.)
• Ad Valorem Tariffs – Taxes are levied as a fraction of the value of the imported goods.
(Example: A 20% ad valorem tariff on bicycles generates a $20
payment on each $100 imported bicycle.)
GAINERS:
1. The government gains because the tariff increases government revenues.
2. Domestic producers gain because the tariff affords them some protection
against foreign-competitors by increasing the cost of imported foreign goods.
SUFFERERS:
1. Consumers suffer because they must pay more for certain imports.

SUBSIDIES
- Government payment to a domestic producer.
- Takes many forms including cash grants, low-interest, tax breaks and
government equity participation in domestic and government producers in 2
ways:
1. They help producers compete against foreign imports.
2. Subsidies help them gain export markets.
- The main gains from subsidies accrue to domestic producers whose
international competitiveness is increased as a result of them.
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Measuring the Amount of Protection

In analyzing trade policy in practice, it is important to know how much protection a trade
policy actually provides. One can express the amount of protection as a percentage of the price
that would prevail under free trade. Two problems arise from this method of measurement.
1. In the large country case, the tariff will lower the foreign export price.
2. Tariffs may have different effects on different stages of production of a good.

Effective Rate of Protection

One must consider both the effects of tariffs on the final price of a good, and the effects of
tariffs on the costs of inputs used in production. The actual protection provided by a tariff will not
equal the tariff rate if imported intermediate goods are used in the production of the protected
good.

Costs and Benefits of a Tariff

A tariff raises the price of a good in the importing country and lowers it in the exporting
country. As a result of these process changes:

• Consumers lose in the importing country and gain in the exporting country.
• Producers gain in the importing country and lose in the exporting country.
• Government imposing the tariff gains revenue.

To measure and compare these costs and benefits, we need to define consumer and producer
surplus.

Consumer and Producer Surplus

Consumer Surplus- measures the amount a consumer gains from a purchase by the
difference between the price he actually pays and the price he would
have been willing to pay.

Producer Surplus – measures the amount a producer gains from a sale by the difference
between the price he actually receives and the price at which he
would have been willing to sell.

OTHER INSTRUMENTS OF TRADE POLICY
Export Subsidy
Import Quotas
Voluntary Export Restraints
Local Content Requirements
Fig. 1. Effects of Alternative Trade Policies
INTERNATIONAL TRADE AND AGREEMENTS
Payment by the government to a firm or individual that
ships a good abroad. When the government offers an
export subsidy, shippers will export the good up to the
point where the domestic price exceeds the foreign
price by the amount of the subsidy. It raises prices in the
exporting country while lowering them in the
importing country. It also worsens the terms of trade.
It ambiguously leads to costs that exceeds its benefits.
Direct restriction on the quantity of a good that is
imported. The restriction is usually enforced by issuing
licenses to some group of individuals or firms. It raises
the domestic price of the imported good.
Export quota administered by the exporting country. Also
known as a Voluntary Restraint Agreement. These are
imposed at the request of the importer and are agreed to
by exporter to forestall other trade restrictions. It is always
more costly to the importing country than a tariff that
limits imports by the same amount.
Regulation that requires that some specified fraction of a
final good be produced domestically. It has been widely
used by developing countries trying to shift their
manufacturing base from assembly back into intermediate
goods.
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F. REFERENCES

Krugman, Paul R. (2003). International Economics Theory and Policy, 6th Edition. 75
Arlington St., Suite 300, Boston, MA 02116: Pearson Education, Inc.

Mankiw, N. (2012). Principles of Economic. Pasig City: Cengage Learning Asia Pte Ltd.
Philippine Branch.