Part B: Political Economy Of Trade Policy

Question 1

Case for free trade (5)

Answer 1

Improved efficiency
E.o.S
Competition encourages
Rent seeking behaviour reduced
Best feasible political policy

Question 2

Cases against free trade (3)

Answer 2

Trade policies can generate terms of trade gains (so don’t do free trade!)

Trade policies are 2nd best option so with market failure

Political arguments e.g protection

Question 3

1st case for FT: Efficiency

A) when is national welfare of a small country highest?

B) under restricted trade, what do consumers face

C) under restricted trade, what do distorted prices cause

Answer 3

A) free trade

B) pay higher prices and consume less

C) overproduction either by existing firms produce more or new firms entering

Question 4

Diagram to show restricted trade effects e.g a tariff

Answer 4

A tariff has producer and consumer distortion

Draw a tariff diagram showing world price+tariff leads to producer and consumer loss.

Question 5

How large are benefits of moving to free trade

B) what does this imply for trade restrictions like tariffs

Answer 5

A move to worldwide free trade would only increase world GDP by 0.93%

B) it implies tariff rates are already low for most countries; estimated benefits of moving to free trade now are only a small fraction of GDP for most countries.

Question 6

So gains of moving to free trade pretty small:

Are they larger for advanced economies or developing economies

Answer 6

Larger gains (more beneficial) for developing countries

Question 7

Cost of protection : name a country with high cost of protection relative to GDP.

Answer 7

High for some countries like Brazil 9.5%.

So free trade clearly would benefit these countries

Question 8

2nd case: EOS

Why?

Answer 8

Protected markets limit gains from external economies of scale i,e too many firms, so scale of production becomes inefficient (produce little so cannot exploit EOS)

Question 9

3rd case for free trade: Competition and innovation encouraged (dynamic benefits)

Answer 9

Offers more opportunities for learning and innovation

Question 10

4th case for free trade: reduces rent seeking behaviour

Answer 10

Quotas result in economic waste as firms spend time and resources seeking quota rights and the profit they will earn

Question 11

5th case for free trade: free trade is the best feasible political policy

Why?

Answer 11

Any policy that deviates from free trade would be quickly manipulated by political groups, leading to decreased national welfare

E.g a tariff on an import may be desirable, but government have to resist pressure from other industries to grant them too

Question 12

1st case against free trade: trade policies (a tariff) can lower the price of imports and generate a terms of trade gain

For which country is this talking about

Answer 12

A large country! I.e benefits exceed losses in producer and consumer distortions

Since small countries always benefit from free trade

Question 13

A small tarifff

Question 14

Optimal tariff diagram

Question 15

Export tax can also create terms of trade gains for a large country

How

Answer 15

Can raise price of exports and increase terms of trade to maximise welfare for the large country (at the expense of other countries)

Question 16

Caveats to this

Answer 16

Retaliation by other countries enacting their own restrictions

Also doesn’t work for small countries

Question 17

2nd case against free trade: domestic market failures may exist that cause free trade to be a suboptimal policy