chapter 5 Flashcards
is levied as a fixed charge for
each unit of imported goods.
For example, $1 per kg of cheese
specific tariff
is levied as a fraction of
the value of imported goods.
For example, 25% tariff on the value of imported
cars.
ad valorem tariff
the difference
between the quantity that foreign producers
supply minus the quantity that foreign
consumers demand, at each price.
export supply curve
is the difference
between the quantity that domestic
consumers demand minus the quantity that
domestic producers supply, at each price.
import demand curve
In equilibrium,
import demand = ?
domestic demand – domestic supply = ?
world demand = ?
export supply
foreign supply – foreign demand
world supply
acts as an added cost of transportation,
making shippers unwilling to ship goods unless the
price difference between the domestic and foreign
markets exceeds the tariff.
tariff
If shippers are unwilling to ship wheat, there is WHAT for wheat in the domestic market and WHAT in the foreign market.
excess
demand
excess
supply
If shippers are unwilling to ship wheat, there is excess
demand for wheat in the domestic market and excess
supply in the foreign market.
what happens to the price of wheat?
The price of wheat will tend to rise in the domestic market.
The price of wheat will tend to fall in the foreign market.
a tariff will make the price of a good _
in the domestic market and will make the price
of a good _ in the foreign market, until the
price difference equals the tariff.
PT – P*T = t
PT = P*T + t
rise
fall
THIS raises the price in Home while lowering the price in Foreign
tariff
The price of the good in foreign (world) markets
should _ if there is a significant drop in the
quantity demanded of the good caused by the
domestic tariff.
fall
Because the price in domestic markets rises
(to PT), domestic producers should _ and domestic consumers should
_.
The quantity of imports falls from QW to QT
supply more
demand less
Because the price in foreign markets falls (to
P*T), foreign producers should _ and
foreign consumers should _.
The quantity of exports falls from QW to QT
supply less
demand more
The quantity of domestic import demand
equals the quantity of foreign export supply
when
PT – P*T = t
the increase in the price of the
good in the domestic country is less than the
amount of the _
tariff.
t or f
Part of the tariff is reflected in a decline of the
foreign country’s export price, and thus is not
passed on to domestic consumers. But this effect is often not very significant.
t
When a country is “small”, it has no effect on
the foreign (world) price of a good, why?
because its
demand for the good is an insignificant part of
world demand.
measures how
much protection a tariff or other trade policy provides
domestic producers.
effective rate of protection
It represents the change in value that an industry adds to the
production process when trade policy changes.
effective rate of protection
The change in value that an industry provides depends on
the change in prices when trade policies change.
Effective rates of protection
often differ from tariff rates
because tariffs affect sectors other than the protected sector,
a fact which affects the prices and value added for the
protected sector.
Effective rates of protection
raises the price of a good in the
importing country, so we expect it to hurt
consumers and benefit producers there.
tariff
How to measure these costs and benefits of tariff?
We use the concepts of consumer surplus and
producer surplus.
t or f
the government gains tariff
revenue from a tariff.
truelalu
measures the amount
that a consumer gains from a purchase by the
difference in the price he pays from the price
he would have been willing to pay.
Consumer surplus
The price he would have been willing to pay
is determined by WHAT
a demand (willingness to
buy) curve.
When the price increases, the quantity demanded
decreases as well as the WHAT
consumer surplus.
measures the amount that
a producer gains from a sale by the difference
in the price he receives from the price he
would have been willing to sell at.
Producer surplus
The price he would have been willing to sell at is
determined by a WHAT
supply (willingness to sell) curve.
When price increases, the quantity supplied
increases as well as WHAT
the producer surplus.
tariff raises the price of a good in the
importing country, making its consumer
surplus ___ and making its producer surplus ___
decrease (making its consumers
worse off)
increase (making its producers better off).
For a “large” country that can affect foreign (world)
prices, the welfare effect of a tariff is WHAT
ambiguous.
T OR F
The terms of trade increases because the tariff lowers foreign
export (domestic import) prices.
T
The tariff distorts production and consumption decisions:
producers produce too much and consumers consume too
little compared to the market outcome.
efficiency loss.
the
tariff rate times the quantity of imports.
Government revenue from the tariff
Part of government revenue (rectangle e)
represents the WHAT, and part
(rectangle c) represents part of the value of
WHAT.
terms of trade gain
lost consumer surplus
T OR F
If the terms of trade gain exceeds the
efficiency loss, then national welfare will
decrease under a tariff, at the expense of
foreign countries.
f
increase
“If the terms of trade gain exceeds the
efficiency loss, then national welfare will
increase under a tariff, at the expense of
foreign countries.”
t or f
An export subsidy can also be specific or ad valorem
t
is a payment per unit exported.
A specific subsidy
is a payment as a proportion of the
value exported.
An ad valorem subsidy
raises the price of a good in the
exporting country, making its consumer surplus
decrease (making its consumers worse off) and
making its producer surplus increase (making its
producers better off).
export subsidy
t or f
through export subsidy, government revenue will increase.
false; decrease
t or f
An export subsidy raises the price of a good in
the exporting country, while lowering it in
foreign countries.
t
In contrast to a tariff, an export subsidy
worsens the___ by lowering the
price of domestic products in world markets.
terms of trade
t or f
An export subsidy unambiguously produces a
positve effect on national welfare.
f; negative
The tariff distorts production and consumption decisions:
producers produce too much and consumers consume too
little compared to the market outcome.
efficiency loss.
a restriction on the quantity
of a good that may be imported.
import quota
This restriction is usually enforced by issuing
licenses to domestic firms that import, or in
some cases to foreign governments of
exporting countries.
import quota
t or f
A binding import quota will push up the price
of the import because the quantity demanded
will exceed the quantity supplied by domestic
producers and from imports.
t
t or f
When a quota instead of a tariff is used to
restrict imports, the government receives
revenue.
false - no revenue
“When a quota instead of a tariff is used to
restrict imports, the government receives no
revenue.”
the revenue from selling imports at high
prices goes to quota license holders: ?
either
domestic firms or foreign governments.
extra revenues are called
quota rents.
works like an
import quota, except that the quota is imposed
by the exporting country rather than the
importing country.
voluntary export restraint
these restraints are usually
requested by the importing country.
voluntary export restraint
The profits or rents from this policy are earned
by foreign governments or foreign producers.
voluntary export restraint
is a regulation
that requires a specified fraction of a final
good to be produced domestically.
local content requirement
It may be specified in value terms, by
requiring that some minimum share of the
value of a good represent domestic valued
added, or in physical units.
local content requirement
From the viewpoint of domestic producers of
inputs, a _____ provides
protection in the same way that an import
quota would.
local content requirement
t or f
From the viewpoint of firms that must buy
domestic inputs, however, the LOCAL CONTENT requirement place a strict limit on imports, but
allows firms to import more if they also use
more domestic parts.
f - does not
From the viewpoint of firms that must buy
domestic inputs, however, the requirement
“does not” place a strict limit on imports, but
allows firms to import more if they also use
more domestic parts.
provides neither
government revenue (as a tariff would) nor
quota rents.
Local Content Requirement
t or f
Local Content Requirement
Instead the difference between the prices of
domestic goods and imports is averaged into
the price of the final good and is passed on to
consumers.
t
t or f
The tariff-rate quota is a one-tiered tariff
f - two-tiered
t or f
A specified number of goods (up to the
quota limit) may be imported at one (lower)
tariff rate, while imports in excess of the
quota face a higher tariff rate
t
Other Trade Policies
Export credit subsidies
Government procurement
Bureaucratic regulations
A subsidized loan to exporters
Export credit subsidies
Government agencies are obligated to purchase from
domestic suppliers, even when they charge higher prices
(or have inferior quality) compared to foreign suppliers.
Government procurement
Safety, health, quality or customs regulations can act as
a form of protection and trade restriction.
Bureaucratic regulations
The practice of selling a product at a
lower price in export markets than at
home (or exporting at prices below
production cost)
Dumping
clear unwanted
inventories or cope with excess capacity
Sporadic dumping
to undermine foreign
competitors
Predatory dumping
reaping greater profits
by engaging in price discrimination
Persistent dumping
Types of non-tariff barriers
Dumping
Government procurement policies
Social regulations (health,
environmental and safety rules can also
restrict trade)
Sea transport and freight restrictions
t or f
The first case for free trade is the argument
that producers and consumers allocate
resources most efficiently when
governments do not distort market prices
through trade policy.
t
National welfare of a small country is highest
with WHAT
free trade.
With WHAT, consumers pay higher
prices and consume too little while firms
produce too much.
restricted trade
T OR F
because tariff rates are already
low for most countries, the estimated
benefits of moving to free trade are only a
small fraction of national income for most
countries.
T
Free trade allows firms or industry to take
advantage of
economies of scale.
Protected markets limit gains from external
economies of scale by inhibiting the
concentration of industries:
Too many firms to enter the protected
industry.
The scale of production of each firm
becomes inefficient.
Free trade provides _ AND _
competition and
opportunities for innovation (dynamic
benefits).
Free trade avoids the loss of resources
through
RENT SEEKING
says that free trade is the best feasible
political policy, even though there may be
better policies in principle.
political argument for free trade
T OR F
Any policy that deviates from free trade would
be quickly manipulated by political groups,
leading to decreased national welfare.
T
For a “large” country, a tariff lowers the
price of imports in world markets and
generates a WHAT
terms of trade gain.
t or f
A large tariff will lead to an increase in
national welfare for a large country.
f - small tariff
A tariff rate that completely prohibits
imports leaves a country worse off, but
tariff rate tO may exist that maximizes
national welfare: an _
optimum tariff.
An __ (a negative export subsidy)
that completely prohibits exports leaves a
country worse off, but an export tax rate
may exist that maximizes national welfare
through the terms of trade.
export tax
t or f
export subsidy lowers the terms of trade for
a large country; an export tax raises the terms
of trade for a large country.
t
t or f
export tax may raise the price of exports in
the world market, increasing the terms of trade.
t
A second argument against free trade is
that ___ may exist
that cause free trade to be a suboptimal
policy.
domestic market failures
The economic efficiency loss calculations using
consumer and producer surplus assume that
markets __
function well.
Types of market failures include
Persistently high underemployment of workers
Persistently high underutilization of structures,
equipment, and other forms of capital
Property rights not well defined or well enforced
technological benefits for society discovered
through private production, but from which
private firms cannot fully profit
environmental costs for society caused by
private production, but for which private firms
do not fully pay
sellers that are not well informed about the
(opportunity) cost of production or buyers that
are not well informed about value from
consumption
Economists calculate the __
to represent the additional benefit to society from
private production.
marginal social benefit
With a market failure, __ is not
accurately measured by the producer surplus of private
firms, so that economic efficiency loss calculations are
misleading.
marginal social benefit
t or f
It’s possible that when a tariff increases domestic
production, the benefit to domestic society will
decrease due to a market failure.
f - increase
It’s possible that when a tariff increases domestic
production, the benefit to domestic society will
increase due to a market failure.
The domestic market failure argument
against free trade is an example of a more
general argument called the
theory of the
second best.
t or f
Government intervention that distorts
market incentives in one market may
increase national welfare by offsetting the
consequences of market failures elsewhere.
t
t or f
If the best policy, fixing the market failures, is not
feasible, then government intervention in another market
may be the “third-best” way of fixing the problem.
f; second-best
a domestic policy aimed
directly at the source of the problem.
“first-best” policy:
Government policies to address market
failures are likely to be manipulated by WHAT
politically powerful groups.
Due to distorting the incentives of
producers and consumers, trade policy may
have ___ that make a
situation worse, not better.
unintended consequences
Models of governments maximizing
political success rather than national
welfare:
- Median voter theorem
- Collective action
- A model that combines aspects of collective
action and the median voter theorem
predicts that
democratic political parties pick their
policies to court the voter in the middle of
the ideological spectrum (i.e., the median
voter).
median voter theorem
Assumptions of the Median Voter model:
- There are two competing political parties.
- The objective of each party is to get elected by
majority vote.
What policies will the parties promise to
follow?
Both parties will offer the same tariff policy to
court the median voter (the voter in the middle
of the spectrum) in order to capture the most
votes.
implies
that a two-party democracy should enact
trade policy based on how many voters it
pleases.
median voter theorem
A policy that inflicts large losses on a few people
(import-competing producers) but benefits a
large number of people (consumers) should be
chosen.
median voter theorem
Political activity is often described as a
collective action problem:
T OR F
While consumers as a group have an incentive
to advocate free trade, each individual
consumer has incentive because his benefit
is not large compared to the cost and time
required to advocate free trade.
F - While consumers as a group have an incentive
to advocate free trade, each individual
consumer has “no incentive” because his benefit
is not large compared to the cost and time
required to advocate free trade.
T OR F
for groups who suffer large
losses from free trade (for example,
unemployment), each individual in that
group has a strong incentive to advocate
the policy he desires.
T
was
begun in 1947 as a provisional international agreement
and was replaced by a more formal international
institution called the World Trade Organization in
1995.
General Agreement of Tariffs and Trade
T OR F
Multilateral negotiations mobilize exporters
to support free trade if they believe export
markets will expand.
T
THIS also help avoid a
trade war between countries, where each
country enacts trade restrictions.
Multilateral negotiations
In 1930, the United States passed a remarkably
irresponsible tariff law,
the Smoot-Hawley Act.
In 1995, the ____, was established as a formal organization
for implementing multilateral trade negotiations
(and policing them).
World Trade Organization, or
WTO
WTO negotiations address trade
restrictions in at least 3 ways:
- Reducing tariff rates through multilateral
negotiations. - Binding tariff rates: a tariff is “bound” by
having the imposing country agree not to raise it
in the future. - Eliminating nontariff barriers: quotas and
export subsidies are changed to tariffs because
the costs of tariff protection are more apparent
and easier to negotiate.
tariff is “bound” by
having the imposing country agree not to raise it
in the future.
Binding tariff rates:
quotas and
export subsidies are changed to tariffs because
the costs of tariff protection are more apparent
and easier to negotiate.
Eliminating nontariff barriers:
The World Trade Organization is based on a
number of agreements:
General Agreement on Tariffs and Trade:
covers trade in goods.
General Agreement on Tariffs and Services:
covers trade in services (ex., insurance,
consulting, legal services, banking).
Agreement on Trade-Related Aspects of
Intellectual Property: covers international
property rights (ex., patents and copyrights).
a formal
procedure where countries in a trade dispute
can bring their case to a panel of WTO experts
to rule upon.
dispute settlement procedure:
are trade
agreements between countries in which they lower
tariffs for each other but not for the rest of the
world.
Preferential trading agreements
There are two types of preferential trading
agreements in which tariff rates are set at or
near zero:
- A free trade area:
- customs union:
an agreement that allows
free trade among members, but each member
can have its own trade policy towards
non-member countries.
An example is the North America Free Trade Agreement
(NAFTA).
- A free trade area:
an agreement that allows
free trade among members and requires a
common external trade policy towards
non-member countries.
An example is the European Union.
customs union:
Are preferential trading agreements necessarily
good for national welfare?
No, it is possible that national welfare decreases
under a preferential trading agreement.
How? Rather than gaining tariff revenue from
inexpensive imports from world markets, a
country may import expensive products from
member countries but not gain any tariff revenue.
T OR F
Preferential trading agreements increase national
welfare when new trade is created, but not when
existing trade from the outside world is diverted to
trade with member countries.
T
occurs when high-cost domestic production is replaced by
low-cost imports from other members.
Trade creation
occurs when low-cost imports from nonmembers are
diverted to high-cost imports from member nations.
Trade diversion
