1: Trade Policy Under Imperfect Competition (Welfare Effect Of Trade Policies + Strategic Export Subsidy)

Question 1

Common trade policy for imports (4)

Answer 1

Tariff
Quota
Voluntary export restraint
Others: local content requirement, bureaucracy

Question 2

Common trade policy for exports

Answer 2

Subsidies
Export tariff (tax)

Question 3

IMPORTANT AND GOOD: Import tariff: impact on national welfare for large country vs small

Answer 3

Large: Ambiguous depends on whether tax revenue and added tax revenue (from the gained (since world price falls in diagram) i.e c+e > b+d

Small: falls as CS -abcd, while positive gain for producer is a, and gov rev c. -Abcd - (a+c) = -(b+d)

(Also remember optimal tariff t=1/ε, and ε is infinity in SOE so optimal t is 0)
Eval in imperfect competition, gains can be made if MSB>b+d!!!!

Question 4

Import quota impact on national welfare for large vs small economy

Answer 4

Ambiguous again, same reasoning c+e > b+d for welfare increasing but c+e is instead quota rents

Falls for a small country (however this assumes perfect competition… under imperfect there may be market failures: domestic failure argument… if MSB>b+d (DWL loss)

Question 5

Export subsidy impact national welfare (CS, PS, Gov)
(Hint: Usually CS unchanged, how can it be argued to fall?)

Answer 5

National welfare falls for large and small!

CS unchanged in terms of price, however can be argued to fall since incentive for firms to export increases, can create inefficient allocation of resources if domestic markets require goods more.

PS: gain of a
Government expenditure: (a+b), so export subsidy makes overall national welfare fall!

(NOTE: this assumes perfect comp…we see under imperfect competition strategic export subs can improve welfare)

Question 6

Export tax impact on national welfare on large and small country

Answer 6

Ambiguous, falls for a small country.

Question 7

So most trade policies reduce national welfare:

When is an instance when a country gains…

Answer 7

A large country from a tariff or quota may gain… (if market failure exists, and optimal tariff set! Since gain from ToT improvement as tariff causes their export price to rise and import price to fall, so can consume more (higher CIC)

World lose! - fall in world prices!

(theory of trade policy topic for clarification)

Question 8

Caveat to this idea of most policies being welfare reducing;

Answer 8

This is under our assumption of perfect competition.

In reality, markets are imperfect, so does the effect of policies differ in reality? (As mentioned, under market failure, trade restrictions in a large economy can improve welfare!)

Question 9

So we’ll explore trade under imperfect competition more.

What are trade policies under imperfect competition called

Answer 9

Strategic trade policies

Question 10

What % of Chinese exports were subject to US tariffs by Trump 2019

Answer 10

66% subjected to tariffs by 2019 ($506bn worth)

Question 11

Did the foreign exporters (Chinese) lower prices in response to having to pay tariffs? (did US make ToT gains?)

B) how much more did this cost US households annually?

Answer 11

Barely! Negligible terms-of-trade gains! Import price did not fall, US consumers assumed the burden of the high prices as a result of the tariff!

(Shows reality of imperfect competition differs from assumptions!!!)

B) Additional $300-900 annually for US households

Question 12

US 2018 import tariffs: effect on employment. We’d expect employment to improve since tariffs are protectionist…

Look at the steel sector in particular.
A) How much was the tariff
B) Employment in steel sector by 2020 (2 years later)

Answer 12

25% tariff on imported steel

B) 84,000 to 80,000!!!

(Highlights imperfect competition IRL breaks our beliefs!)

Question 13

So why did employment fall!

Answer 13

Import tariff on steel negative impacted firms that used steel as input, since costs increased, thus let workers go.

(Choose to use less-efficient domestic steel or just pay higher import price)

Question 14

How can large tariffs induce producers to engage in wasteful activities to avoid tariffs, example.

Answer 14

There was a 25% tariff on COMMERCIAL trucks.

To be classified as a PASSENGER vehicle, Ford installed rear windows, rear seats and seat belts to try be subjected instead to 2.5% tariff

Question 15

US 2018 tariff: effect on exports (we mentioned this briefly on previous FC)

Specific export market?

Answer 15

With retaliatory tariffs, US exports negatively impacted.

US was China’s dominant soybean supplier.
Then Brazil benefited from this trade diversion

Question 16

Import quota effect on import price

B) what happens to domestic price (country with the quota)

Answer 16

Increases price of imports less supplied

b) Country with the quota, domestic price increases above world prices (since less supply, so afford to charge more, esp if quota is tiny!)

Question 17

US Sugar quota 2014: what happened to US price of sugar

B) loss to consumers and gain to producers, which outweighed which and so did national welfare increase or fall

Answer 17

High prices of US sugar (since QD>QS) above world prices. (Since limited supply)

B) National welfare fell, as US consumers hurt more ($4.4bn) than US producers benefitted ($3.9bn)

Question 18

How did they overcome this problem

Answer 18

NAFTA (free trade agreements) lifted Mexico’s sugar quota restrictions, and thus lowered US sugar prices. (Since they face Mexican competition so forced to lower prices to remain competitive)

Question 19

How did the US sugar producers react to this alleviating of quota.

B) what happened to US sugar prices 2015

Answer 19

They complained so US reduced sugar imports. Imposed a 64% anti dumping tariff.

B) So US sugar prices rose again (almost double world price in 2015)

Question 20

US sugar quota on employment

Answer 20

Good - improved domestic production. Generated 17-20k new jobs in food producing sugar.

Question 21

Export subsidies diagram: outline the welfare effects (PS, CS, DWL, gov)

Answer 21

Shift right in supply.

CS unchanged

Producer surplus - part a (can now produce more

a+b = gov expenditure (cost of sub)

b is DWL as foreign production is swapped for less efficient domestic producers.

Question 22

Strategic export subsidy example

Answer 22

Boeing (US) and Airbus (EU) compete in game theory

Draw the Pg 35 game theory matrix

Question 23

Nash equilibrium definition

Answer 23

Each strategy is best response to the strategy of other (no incentive to deviate)

Question 24

What is the best strategy for Boeing and Airbus (Nash equilibrium)

Answer 24

2 Nash equilibriums

Don’t produce when the other does produce

Question 25

Thus , who will benefit in this situation

Answer 25

Whoever moves first! First mover advantage (since they will try produce first, since the other one will not produce since payoff -5

Question 26

Scenario 2: what if $25M EU subsidy is provided to Airbus pg 36

Answer 26

Only 1 Nash equilibrium remains since Airbus will always produce, so Boeings best response is to not produce

Thus total EU welfare = +100 since 125 - 25 = 100

Question 27

So under perfect competition, a export subsidy would decrease national welfare (producer gain a<cost to gov a+b) (flashcard 5)

But now we’ve seen under imperfect competition in this game theory, a subsidy will likely increase welfare of that nation.

When is a welfare increase even more likely, and evaluation

Answer 27

If subsidy causes exit of other firm (Boeing in this instance who will never produce)

Eval: unlikely to happen since other country may subsidise their firm. So both firms undeterred from producing, waste taxpayers funds

Question 28

Weaknesses of strategic trade policy (4)

(Like the export subsidy)

Answer 28

Foreign retaliation: respond with own subsidies, so neither firm deterred, just waste funds. (US provided tax rebates for Boeing)

Payoff matrix too simple: Needs more info than likely available and even if so may not be accurate

Giving strategic advantage in one industry can give strategic disadvantage elsewhere.

Can be manipulated by politically powerful groups

Question 29

3nd criticism of strategic trade policy:
Giving strategic advantage in one industry can give strategic disadvantage elsewhere.

How?

Answer 29

Subsidising exports create incentive for firms to export and ditch/draw resources away from domestic markets (explains why CS can actually be seen to fall) see FC5 again

Question 30

Voluntary export restraint

Answer 30

Quota imposed by exporting country rather than the importing country!

Hence why “voluntary” (they benefit from rents by selling a restricted quantity at a higher price)

Question 31

Voluntary export restraint example

Answer 31

US requested Japanese to restrict its car exports 1979.

They agreed (VER) to limit to 1.68M cars. So price of their cars rose and they capture rent from this.

Question 32

Local content requirement (rules of origin) example

Answer 32

EU-UK TCA car components must be 55% from EU/UK