Free Trade and Protection

Question 1

Specialisation

Answer 1

• Specialisation means concentrating all your resources or skills to tasks you are best suited. You then trade the surplus production for other goods and services.
• countries are better at making certain goods and services than other countries.
• This is due to:
• > Quality of resources
• > Population size
• > Climate
• > Labour size
• > Technology
• Therefore countries specialise in what they are more efficient in producing.
• This means they produce goods which have the lowest opportunity cost (goods which they do not have to give up as much for).
• Goods which you have low opportunity cost in will mean a country has a comparative advantage in that good.

Question 2

Absolute Advantage

Answer 2

A situation where a country can produce more of a good with the same amount of resources.

Question 3

Comparative Advantage

Answer 3

• When a country has absolute advantage in both goods, it specialises in the good it has lower opportunity cost in. This is called comparative advantage.
• countries can trade with other countries even if it is better at producing both goods. This is because it’s not about how much you can produce; it’s about how little you have to give up (lowest opportunity cost)

Question 4

Protection

Answer 4

• Refers to any action by the government designed to give the domestic producer an artificial advantage over a foreign producer.
• The goal of protection is to increase domestic production in the protected industries and decrease the consumption of both imported goods and services.

Question 5

Tariffs:

Answer 5

• Increase the price of foreign products to Australians.
• Tariffs are the most widely used protective measure in the manufacturing sector.
• A tariff is a tax placed on an import.
• Designed to increase the price of the foreign good or service so that the competing domestic good receives a price benefit.
• Important source of revenue for the government.

Question 6

Subsidies:

Answer 6

• Lower costs for Australian producers to make their goods cheaper.
• Grants or payments made by the government to domestic producers thus allowing them to reduce the price of their goods which increases their competitiveness against world producers.
• Paid out of taxation revenue from the government.
  Enables domestic firms to lower costs so that they can compete more favourably against imports.
• Consumers supply the revenue that the government uses to pay the subsidies with; economic cost.
• Result in a deadweight loss to the economy.

Question 7

Quotas:

Answer 7

• Restrictions or limits on the amount of imports bought in particular industries.
• Direct quantity restriction on the amount of some product that importers can bring into the country.
• This increases price of imported product and thus decreases relative competitiveness.
• Used extensively in the motor vehicle industry to protect Australian car manufacturers.

Question 8

Arguments for protection:

Answer 8

• Some economists claim that no protection is good protection
• Protection distorts the free flow of trade and negates the benefit a country can gain through specialising in the goods in which they are the best at producing.
• Increases competition, creates high quality goods, economic growth and lowers prices.
• Increases real income and the standard of living.
• Arguments for protection:
• > Infant industry argument:
• ->Argued that junior industries need protection in their early years until they mature and become well recognised in the world market.
• Diversification argument:
  -> Countries like Australia rely heavily on their mineral and mining industries for exports.
  If all industries were protected then we wouldn’t have to put all of our eggs in one basket and only specialise in what we are best at producing.
• Anti dumping argument:
  -> Some large overseas firms can sustain short run losses by selling at abnormally low prices and then increase its price in the long run.
  Protection would prevent this from happening.
• Increased employment argument:
  -> Purchasing imports means increasing foreign employment and decreasing domestic employment.
  Protection increases employment in the protected domestic industries.

Flaws in the argument due to employment in unprotected industries will suffer,
industries that use the products of the protected industries as inputs will face higher production costs

thus decreases employment and also consumers will have less to spend on the output on other industries.

Question 9

Arguments for trade liberalisation:

Answer 9

• Liberalisation increases trade which increases growth.
• When protection falls income and living standards rise.
• Trade liberalisation delivers a more productive, outward looking economy with higher incomes and more job opportunities.
• Does not distort the allocation of resources and create a deadweight loss to the economy.
• According to comparative advantage, it is important to realise that there are gains from importing and exporting.
  Exports add to production while imports add to consumption.
• Free trade helps to increase both exports and imports.
  Exporting leads to more output and production from firms hence more employment and an increase in GDP.
• Importing leads to a greater variety of goods and services at lower prices for consumers.
• Protection costs efficient industries at the expense of inefficient industries. It results in resources being detracted from efficient economies to the less efficient.
• Protection promotes ineffiency as removing protection means industries must increase their efficiency in order to compete in the global market.
• If an industry cannot survive without protection, it is recommended that it is closed down.

Question 10

Preferential trade agreement or free trade agreement (FTA):

Answer 10

• Trade pact between countries that reduces tariffs for certain products to the countries which sign the agreement.
• While the tariffs are not necessarily eliminated they are lower than in those counties not party to the agreement.

Question 11

Trade creation:

Answer 11

• Term used to describe when countries establish free trade amongst themselves and impose tariffs on non-member nations.
• As a result, the member nations establish greater trading ties between themselves now that barriers such as tariffs, quotas and subsidies have been eliminated.
• Results in increase of trade between nations.

Question 12

Trade diversion:

Answer 12

• Term used describe when trade is diverted from a more efficient exporter towards a less efficient one because of a free trade agreement.
• An example of this is the UK always importing lamb from New Zealand, the cheapest lamb producer, however, when Britain joined the EU it made more sense to import lamb from France.
• This is because the European agreement eliminated any tariffs between European countries making it cheaper to import from France.
• In this case, trade has been diverted away from the more efficient country (New Zealand)