Transcript Government Intervention in International Trade Activity 51

Government Intervention in
International Trade
Activity 51
by
Advanced Placement Economics Teacher Resource Manual.
National Council on Economic Education, New York, N.Y
Objectives
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Define tariffs, quotas and regulations to
limit trade.
Describe policies that are intended to
protect the domestic economy from the
effects of international trade.
Explain the effects of tariffs, quotas and
subsidies on domestic production and the
prices domestic consumers pay.
Government Intervention in
International Trade
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The last lesson demonstrated the benefits
of trade among nations, showing that total
output increased. Nevertheless, most
nations attempt to create barriers to trade
using tariffs, quotas or regulations.
Trade barriers limit the gains from trade
and tend to reduce competition and
economic efficiency.
Government Intervention in
International Trade
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Tariff – “a tax levied on imports”
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Example: The United States imposes a tariff of more than 10% on
imports of textiles and shoes.
Quotas – “a proportional part or share of a fixed total
amount or quantity.” (“Quota”)
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(Krugman 450)
A good example of a quota is the voluntary export restraint (VER) Japan
agreed to in the 1980’s limiting the number of cars it exported to the
U.S.
Import quota – “a legal limit on the quantity of a good
that can be imported” (Krugman 452)
Example of a regulation to limit trade is the Federal Drug
Administration’s test requirements on pharmaceuticals
imported into the United States
PRICE
Domestic and Foreign Supply
Domestic Supply
Total Supply with Tariff
Total Supply
P
P2
P1
Domestic Demand
q
q2 q1
QUANTITY
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For domestic consumers, the price is
higher and the quantity available is
smaller than under free trade.
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Arguments in support of limitations on trade:
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the national defense argument
the infant industry argument
the “dumping” argument
preservation of domestic jobs
maintenance of diverse and stable economy
prevention of exploitation
Most of these arguments do not stand up to
scrutiny.
Limitations on trade fundamentally allow
domestic producers to be inefficient and
increase the costs to domestic consumers.
History of Tariffs in U.S.
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The Smoot-Hawley Act of 1930, tariffs reached a
high average rate of 20%
Over time, the United States has attempted to
reduce tariffs using trade agreements such as
the North American Free Trade Agreement
(NAFTA)
In the Uruguary Round (1986 to 1994) of World
Trade Organization negotiations, the U.S.
negotiated its lowest rate ever.
Barriers to Trade
Activity 51
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The free trade movement started about 200
years ago. Previously, it appears that one of the
goals of governments was to stifle international
trade, presumably for the benefit of their own
economies.
Over the last 50 years, there have been efforts
to reduce trade barriers, with significant success
during the 1990s.
Examples of these efforts include the North
American Free Trade Agreement (NAFTA), the
World Trade Organization (WTO), the European
Union (EU) and the Asia-Pacific Economic
Cooperation (APEC) forum.
Barriers to Trade
Activity 51
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We want to be able to investigate the economic effects
of various barriers to trade that a nation might impose to
protect domestic industries.
In Fig. 51.1, the demand curve represents the demand
by the domestic economy for a commodity that is
produced domestically and also imported.
The domestic supply curve indicates what the domestic
suppliers are willing and able to produce at alternative
prices.
If there were no international trade or a complete ban
on imports, the equilibrium price would be P, and the
equilibrium quantity, Q, would be produced only by
domestic firms.
Fig. 51.1
PRICE
Domestic Supply
Total Supply
P
P1
Domestic Demand
q2
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q
q1
QUANTITY
If there is free international trade, the Total Supply curve
represents the production by domestic and foreign
producers. Domestic consumers would pay p1 and
consumer q1:
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They are able to consume more of the commodity at a lower price.
Also, at p1 , domestic firms are producing q and foreign producers are
producing (q1 – q2).
Thus, domestic firms are producing less under free trade than they
would if the nation did not import the commodity.
Part A: Quotas
Instead of permitting free trade or imposing
a complete ban, a nation may decide to
set a quota to limit the number of imports.
Import quotas are sometimes referred to
as voluntary export restraints (VERs)
because the two countries have agreed
that the exporting nation will not export
more than a certain amount.
We can see the effect of an import quota by looking at Fig. 51.2. Here
the domestic price would be ‘p’ and the quantity would be ‘q’ if
there were a complete import ban, If there were free trade, the
price would be p1 and the quantity demanded by domestic
consumers would be q1.
Notice that under free trade, the entire market is supplied by foreign
producers as the market is drawn. This does not have to be the
case; it depends on the costs of the domestic industry and the
domestic industry’s ability to sell at the lower price.
Fig. 51.2
PRICE
Domestic Supply
Total Supply
P
P1
Domestic Demand
q
q1
QUANTITY
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Suppose the importing nation imposes a quota, or VER,
of X amount; the Total Supply with Quota curve
represents the new supply curve. Total Supply with
Quota is the domestic supply curve plus X amount at
every price level (X = q2 – q3 ).
The domestic price has risen from p1 to p2 and
consumers are able to purchase less of the commodity.
Equilibrium quantity has decreased from q1 units to q2
units. However, domestic producers are now producing
q units, and foreign producers are supplying X = q2 – q3.
PRICE
Fig. 51.2
Domestic Supply
Total Supply with Quota
Total Supply
P
P2
P1
Domestic Demand
q3
q
q2 q1
QUANTITY
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Use Fig. 51.3 to demonstrate what will happen to the
domestic price, domestic production and the amount of
imports if a quota is removed. The Domestic Supply and
Total Supply curves on the graph are without any
barriers to trade imposed. Be sure to show on the graph
the supply curve with quota. It is not on the graph now.
Domestic Supply
PRICE
Fig. 51.3
Total Supply
P
P1
Domestic Demand
q
q1
QUANTITY
PRICE
Fig. 51.3
Domestic Supply
Total Supply with Quota
Total Supply
P
P2
P1
Domestic Demand
q3
q
q2 q 1
QUANTITY
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If there were a complete import ban, the equilibrium domestic price
would be ‘p’ and the equilibrium quantity would be ‘q’ with the
commodity completely produced by the domestic industry.
If there were a partial quota, the supply curve labeled Total Supply
with Quota would be the relevant curve. The domestic price and
quantity would be p2 and q2. The amount of the quota would be (q2
– q3). Domestic production will be q3. Removing the quota and
moving to the free trade equilibrium, the domestic consumers will
pay p1 and purchase q1.
Removal of a quota has led to a decrease in price and an increase in
the quantity consumed. In the case illustrated, there will be zero
domestic production under free trade.
2.
Write a paragraph summarizing the advantages and
disadvantages of a quota to the domestic economy.
Be sure to discuss the impact on domestic consumers,
domestic producers and foreign producers.
The advantage of a quota are that the domestic industry will be
able to produce more and receive a higher price for the commodity
relative to the free trade equilibrium, and employment in that
industry is greater with quota than without a quota. The
disadvantage are that consumers pay a higher price and cannot
consume as much of the commodity as at the free trade
equilibrium. Foreign producers receive a higher price but produce
less with a quota than under free trade.
3.
If a quota is imposed, explain the methods people
would use to circumvent the effects of the quota.
An underground market may develop for the commodity. Foreign firms
may open factories or assembly plants in the domestic nation and
produce the commodity there so that production won’t be subject to the
quota.
Part B: Tariffs
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A tariff is a tax on an import. The
imposition of a tax increases the cost of
each unit, which is represented by a
decrease in supply. This would result in
an increase in equilibrium price and a
decrease in equilibrium quantity.
Modify Fig. 51.4 to show the effect of an import
tariff of $7 per unit. Be sure to show on the graph
the amount of the tariff. Add one curve to the
graph, and label it Total Supply with Tariff. After the
imposition of the tariff, label the new equilibrium
price ‘pT’ and the equilibrium quantity ‘qT’.
Domestic Supply
Total Supply with Tariff
Total Supply
Fig. 51.4
PRICE
4.
P
PT
Tariff = $T
P1
Domestic Demand
q2
q
qT q1
QUANTITY
The imposition of a tariff causes the total supply to decrease because the
tariff has caused the price to increase at every level of output. Q2 is the
amount of domestic production after the tariff. The tariff is the vertical
distance between the total Supply and the Total Supply with Tariff curves
indicated by an arrow on the graph.
PRICE
Domestic Supply
Total Supply with Tariff
Total Supply
P
PT
P1
Domestic Demand
q2
5.
q
qT q1
QUANTITY
What is the effect of the tariff on the
equilibrium price and quantity for domestic
consumers compared with the free trade
levels?
The equilibrium quantity decreases to ‘qT ‘, and the
equilibrium price increases to ‘pT ‘. Note that domestic
industry is not producing. How far the curve shifts (how
large the tariff is) determines whether domestic firms are
producing any output.
6.
What are the similarities between the
effects of a quota and those of a tariff?
Both a quota and a tariff raise the price and
limit the quantity to domestic consumers
relative to the free trade equilibrium. Foreign
firms produce less under either a quota or a
tariff.
7.
8.
What is the primary difference between the
effects of a quota and those of a tariff.
With a quota, all of the revenue generated by the price
increase goes to the producers. With a tariff, the
government receives the tax revenue.
Suppose a country can impose either a quota
that raises the domestic price to ‘p₂’ as in Fig.
51.2 or a tariff that raises the domestic price
‘p₂’. Explain whether domestic consumers
would prefer a tariff or a quota and why.
Domestic consumers would prefer a tariff because the domestic
government receives the revenue as opposed to the producers
(domestic and foreign.). Consumers might expect that the
overall level of taxes would then decrease. The tariff tax
revenue would substitute for other tax revenue.
Part C: Export Subsidies
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Nations may choose to assist domestic
industries by providing subsidies to an
industry. The subsidies would lower the
costs and permit the industry to sell at a
lower price. This assistance is called an
export subsidy because the industry can
now compete on the world market and
export some of its product to other
nations.
9.
Modify Fig. 51.5 to show the effects of an export
subsidy on domestic producers. Indicate as ‘pS ’ and
‘qS’ the equilibrium price and quantity for domestic
consumers after an export subsidy. Add two curves to
the graph: a Domestic Supply with Subsidy curve and
a total supply with Subsidy curve.
Domestic Supply
PRICE
Fig. 51.5
Total Supply
P
P1
Domestic Demand
q
q1
QUANTITY
Domestic Supply without Subsidy
Fig. 51.5
Domestic Supply with Subsidy
PRICE
P
Total Supply without Subsidy
Total Supply with Subsidy
P1
PS
Domestic Demand
q2
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q3
q
q1 q S
QUANTITY
The equilibrium without subsidy would result in a price
of P1 and a quantity of Q1 and the domestic economy
would be producing Q2. With the subsidy to the
domestic industry, the equilibrium would result in a price
of PS and a quantity of QS, and the domestic economy
would be producing Q. The quantity supplied by foreign
producers is (QS – Q3).
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(B)
(C)
According to Fig. 51.5 with your
modifications, what would be the
equilibrium price and quantity for
a completely closed economy (no
imports and no subsidy)? ____________
P and Q
An open economy (completely free trade
with no export subsidy? _____________
P1 and Q1
An open economy with a domestic
export subsidy? ____________
PS and QS
10.
11.
What is the effect of an export subsidy on the
equilibrium price and quantity for domestic
consumers relative to the free trade
equilibrium without a subsidy?
The price is lower and the quantity is greater.
If an industry receives a subsidy, what will
happen at the equilibrium to domestic
production and the amount of imports?
Fig. 51.5 – The free trade equilibrium without subsidy would result in a
price of P1 and a quantity of Q1 and the domestic economy would be
producing Q2. With the subsidy to the domestic industry, the
equilibrium would result in a price of PS and a quantity of QS, and the
domestic economy would be producing Q3. With the subsidy, domestic
production increases. The exact impact on imports depends on the
extent of the subsidy and the demand curve for the commodity.
Part D: Applications
12.
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One of the goals of the European Union
is the elimination of trade barriers
among the member nations.
Consumers who buy the commodity will benefit by
having lower prices and a greater quantity of the
commodity. Domestic producers of imported
commodities will lose since the price will decrease as
trade barriers are reduced and domestic producers will
produce less at the lower price. A second result of the
reduced production is that employment in this industry
will decrease. However, the economy will be more
efficient, and the standard of living will increase.
13.
Identify the arguments frequently used to impose
some type of trade barrier. Discuss the pros and cons
of three arguments.
Protection of specific industries from foreign competition: An industry may argue
that it cannot compete with foreign producers and that this competition will have
an impact on wages and employment. The costs to domestic consumers are the
higher prices and restricted quantity. Most governments that favor unrestricted
trade will offer short-term protection to allow the industry to adjust.
National defense and other noneconomic considerations: Some industries produce
defense items and thus should not be driven out of business by foreign competition.
This is a noneconomic reason for protecting an industry. The problem with this
argument is that the number of industries to which protection is extended may be
quite large. The U. S. restricts endangered-species imports for noneconomic
reasons.
Infant Industry: Start-up industries argue that, to develop, they need protection from
foreign competition. Support for this argument is valid only if the expected future
benefits exceed the up-front costs of protectionism. Another argument against
infant industry protection is that the industry may “never grow up.”
Wage or employment protection: With low prices on imports, domestic workers will
lose their jobs and unemployment will rise. The economy as a whole benefits from
low prices and increased quantity of goods. The government response could be to
retrain the affected workers and to provide adequate monetary and fiscal policies
to maintain domestic growth and employment.
Works Cited
Krugman, Paul and Robin Wells.
“Macroeconomics.” New York. Worth
Publishers. 2006.
“Quota.“ Dictionary.com Unabridged (v 1.1)
Based on the Random House
Unabridged Dictionary, © Random
House, Inc. 2006.
http://dictionary.reference.com/browse
/quota