global economy 4.2- types of trade protection

Question 1

define a tariff

Answer 1

a tax charged on imported goods

Question 2

draw a diagram for a tariff and describe its effects

Answer 2

• S(world) shifts up by the amount of the tariff to S(world)+T
• market price rises from Pw to Pw+T, causing total quantity demanded to fall from OQ2 to OQ4
• domestic producers increase production from OQ1 to OQ3 and so their revenue increases from g to g+a+b+c+h
• foreign producers supply falls from Q1Q2 to Q3Q4. They receive Pw+T but have to pay the tariff to the government, so their revenue falls from h+i+j+k to I+j
• government now receives tariff revenue of d + e
• importers must pay a higher price for the good. for companies that need this good as a raw material this will increase the cost of production, which may be passed onto consumers
• if these companies are exporters, this could reduce international competitiveness
• deadweight loss 1: Q4Q2 is not demanded anymore. consumers keep the amount k they would have spent, but there is a loss of consumer surplus equal to f, because the good is not purchased anymore
• deadweight loss 2: Q1Q3 is now produced by relatively inefficient domestic producers, that need a minimum revenue of h+c, as opposed to more efficient foreign producers that need a minimum revenue of h. so c is a loss of world efficiency.

Question 3

define a subsidy

Answer 3

an amount of money paid by the government to a firm, per unit of output, lowering the firm’s costs

Question 4

why would a government give subsidies?

Answer 4

to make domestic producers ore competitive and shift the domestic supply curve downwards

Question 5

draw a diagram and explain the effects of a subsidy

Answer 5

• S(domestic) shifts downwards by the amount of the subsidy to S(domestic) + subsidy
• market price stays at Pw and so demand remains at OQ2
• domestic producers increase production to OQ3, because they are now receiving Pw+subsidy per unit that they produce
• their revenue increases from a to a+b+e+f+g
• foreign producers supply the rest, which is now Q3Q2
• their revenue falls from b+c+d to c+d
• government pays the subsidy which is e+f+g
• no change in consumer surplus as price does not change
• but consumers indirectly affected as govt uses tax revenues to fun subsidies, leading to higher tax payments and an opportunity cost
• deadweight loss: Q1Q3 is being produced by relatively inefficient domestic farmers as opposed to efficient foreign farmers
• foreign farmers would produce this quantity for a minimum revenue of b but domestic need minimum of b+g
• g represents a misallocation of the world’s resources and inefficiency of domestic consumers

Question 6

define a quota

Answer 6

a physical limit on the numbers or value of goods that can be imported into a country

Question 7

describe how a quota has an effect on the market

Answer 7

before quota is imposed:
- OQ2 of wheat is purchased at a price of Pw
- domestic supply is OQ1 and imports are Q1Q2

govt imposes a quota of Q1Q3

after:
- domestic producers supply OQ1 at a price of Pw and the importers produce their quota of Q1Q3
- however, there is an excess demand of Q3Q2 at the price Pw and so price begins to rise
- foreign producers not allowed to supply more so domestic producers begin to enter the market, attracted by the higher price of wheat
- domestic supply curve has shifted to right above Pw
- eventually, price settles at P(quota), where total quantity of wheat demanded falls to Q4

Question 8

draw a diagram and thus describe the effect of quotas on stakeholders

Answer 8

• domestic producers now supply 0Q1 and Q3Q4 at a price of P(quota)
• revenue rises from a to a+c+d+f+I+j
• foreign producers now supply Q1Q3, their quota, and also receive a price of P(quota)
• their income changes from b+c+d+e to b+g+h
• this is usually a fall in income

deadweight loss 1:
- loss of consumer surplus
- Q4Q2 not demanded anymore; consumers keep amount e they would have spent but there is a loss of CS equal to k as the wheat is no longer purchased

deadweight loss 2:
- Q3Q4 tons of wheat are now produced by relatively inefficient domestic farmers as opposed to more efficient foreign farmers
- foreign farmers would produce this quantity for a minimum revenue of c+d but domestic producers need c+d+j
- j represents the inefficiency of domestic producers and loss of world efficiency

Question 9

state 3 types of administrative barrier that may be imposed by governments

Answer 9

1. red tape
2. health and safety standards and environmental standards
3. embargoes

Question 10

red tape

Answer 10

administrative processes that have to be undertaken. if lengthy and complicated they can act as a restriction to imports, sometimes raising the cost to importers (eg legal paperwork)

Question 11

embargoes

Answer 11

extreme quotas - a complete ban on imports and usually put in place as a form of political punishment
- eg USA has a trade embargo on all products from Cuba