Lecture 4 - Protectionism
from last time
effective rate of protection
indifference curve analysis of a tariff
other barriers to trade
costs of trade barriers
arguments for protection
From Last Time
- Firms that lose profits due to imports may indeed shut down.
- Imperfect competition is a generic term encompassing monopoly, monopolistic competition, and oligopoly
- Exporters gain from trade while import-competing firms lose profits. So, those hurt by imports often seek trade protection.
- Trade, whether with perfect competition or economies of scale, benefits the nation as a whole. The impact on particular groups differs under the 3 cases.
- The important thing about trade with external economies is that an expansion of output due, say, to the opening of an export market, lowers average costs. This, in turn, lowers the price. Consumers in both the exporting and importing country gain
from the lower price.
- In the short run, the wages, interest, rent, and profits paid to the resources in the export sector do rise following a move to free trade. The payments to factors in the import-competing sector fall in the short run. In the long run, the payments
to factors of production used intensively in the export sector rise and payments to the factors used intensively in the import-competing sector fall. This is the Stolper-Samuelson theorem.
- Total demand is equal to home demand, the demand of domestic consumers, plus foreign demand, demand from foreign consumers.
- The assumption of free entry drives economic profits for monopolistic competitors to zero. As long as there are economic profits available, firms will enter the market and steal existing firms' customers.
A tariff is a tax on imports.
The tariff raises the domestic price above the world price. Consumers are losers
because they pay a higher price and buy less of the product. Since the domestic
price rises, domestic firms increase output and see their profits rise.
Effective Rate of Protection
Tariffs also have an effect on industries that sell material inputs to the protected industry, and firms in the protected industry are affected by tariffs on their inputs. This complicates looking at who is being protected by a set of tariffs.
The effective rate of protection is the percentage by which the entire set of a nation's trade barriers raises the industry's value added per unit of output.
Suppose that under free trade, the input costs of a bicycle are $220 and the world price is $300. Value added equals $80.
Suppose a 10% tariff is imposed on bicycle imports so the domestic bicycle price rises to $330 and a 5% tariff is placed on its inputs so that input costs rise to $231. Value added now equals $99.
The effective rate of protection for the bicycle industry equals (99-80)/80 or 23.8%, not the 10% nominal tariff. This tells us that income rises by 23.8% in the bicycle industry.
Indifference Curve Analysis of a Tariff
A tariff distorts consumption so we end up on a lower indifference curve. Production of the import good rises and that of the export good falls.
A quota is a limit on the amount of imports. For example, the U.S. allows 1
million tons of sugar to be imported but no more than that.
||The tariff has the same effects on producers and consumers as a tariff. The domestic price rises above the world price.|
Other Barriers to Trade
- regulatory barriers: health & safety standards; government procurement policies
- export barriers: quotas & duties
- exchange controls
Costs of Trade Barriers
|industry||consumer losses per
Arguments for Protection
- optimal tariff
- spillover effects
- creation of domestic jobs
- infant industries
- infant government
- national pride
- income redistribution
- national defense
- balancing the balance of trade
- creation of a "level playing field"
- strategic trade policy