Trade Policies and Negotiations

Question 1

What is a tariff?

Answer 1

A tax imposed on imported goods, raising the price of these goods, reducing domestic demand and increasing domestic supply, causing imports to fall.

Question 2

Why is the global supply of the good perfectly elastic in the tariff diagram?

Answer 2

Because it is likely there will be several countries producing this good, so even if for some reason one countries production of this good depletes, there are other suppliers.

Question 3

Where are suppliers in the global market more likely to be able to charge a lower price than domestic producers?

Answer 3

The global suppliers most likely are from countries that have a comparative advantage in producing this good, so they can produce it more efficiently and face lower costs of production which is then reflected I the market price.

Question 4

Explain the deadweight welfare loss to society through consumer surplus that tariffs cause.

Answer 4

By raising the price, demand contracts as consumers consume a smaller amount of the good, what was previously consumer surplus goes to the government in taxation revenue.

Question 5

Explain the deadweight welfare loss to society through loss of world efficiency

Answer 5

Through the increase in supply from domestic suppliers, what was previously being produced by efficient world suppliers with a comparative advantage, is now being produced by less efficient domestic suppliers. Every extra unit the domestic suppliers produce, is produced at a higher cost than what global producers would have faced. (Remember Supply = MC)

Question 6

What are the benefits of a tariff?

Answer 6

The government are successful at protecting domestic producers as they have reduced imports.

They have an improved the current accounts position, as they have reduced imports.

The government receive taxation revenue.

There is an increase in producer surplus.

Question 7

What are the disadvantages of a tariff?

Answer 7

Through imposing a tariff on a countries imports, this country may respond by putting a tariff on the countries exports, worsening their current account position and reducing AD.

The deadweight welfare loss to society through consumer surplus being reduced

The deadweight welfare loss to society through loss of efficient production.

Tariffs may protect domestic industries, but this may prevent structural change that is needed for economic development. For countries to develop new specialisms old industries need to contract and new ones expand.

The protection of these domestic firms may cause them to become complacent increasing x-inefficiency and making them unable to compete in the world
market.
Government need good knowledge as to what level the tariff should be set to.

Question 8

What is a voluntary export restraint?

Answer 8

Also known as a quota, a country agrees to limit its exports to another country to a given amount (quota).

Question 9

How are the benefits of quotas different to that of tariffs

Answer 9

Rather than the government receiving tax revenue the foreign producers receive additional income as they have agreed to limit their supply of the good, causing the market price to rise.

Question 10

What are non-tariff barriers?

Answer 10

An obstacle t free trade other than a tariff, often this comprises rules and regulations on the standard of products that can be sold in the country.

Question 11

What is a free trade area?

Answer 11

A group of countries that agree to remove tariffs, quotas and other barriers for trade among member countries, but haven’t set out a common tariff for non-members e.g. European Free Trade Area (EFTA) North American Free trade Association (NAFTA) includes USA, Canada, Mexico

Question 12

What is the problem with free trade areas.

Answer 12

They haven’t set out a common tariff or quotas level for non-members.
This can cause problems between member countries if one imposes a lower tariff level on non-member countries, it is more likely that imports will be received through this country and then resold to other member countries.

Question 13

What is the benefit free trade areas.

Answer 13

It allows countries to specialize and produce according to their pattern of comparative advantage, reducing their production costs as they can produce efficiently.
This prices to fall.

Question 14

What is a customs union?

Answer 14

It is a step further in economic integration to free trade areas as although tariffs quotas and other free trade barriers are removed amongst members, unlike with free trade areas, a common external tariff is set for non-member countries.
E.g. European Union customs union, East African Community

Question 15

What is trade creation?

Answer 15

More expensive goods produced domestically or imports are replaced by cheaper imports from a partner in a trading bloc.

Question 16

Why are imports often cheaper within a customs union or free trade area as opposed to trading with countries that are not economically integrated.

Answer 16

Tariffs are removed, so foreign producers don’t have to pay a tax to import so there is no need for them to raise the price.
Producers can specialise and exploit their comparative advantage, producing what they can the most efficiently.

Producing in such a large market means economies of scale are available, lowering the average cost and price as a whole.

Question 17

What is trade diversion?

Answer 17

The replacement of cheaper imported goods with imports from a less efficient producer within a trade bloc.

Question 18

What are the benefits of trade diversion?

Answer 18

The price of the good from the less efficient producer in the bloc is still lower than the non-member as unlike the member they are not facing a tariff.

This means there is an increase in consumer surplus.

Question 19

Why is the increase in consumer surplus that occurs when trade diversion takes place not a pure gain?

Answer 19

Part of the consumer surplus is gained through the loss of tax revenue from the tariff that was placed on imports before the country joined the bloc.

Question 20

What are the costs of customs unions

Answer 20

They can cause trade diversion.

There may be traditional rivalries between members that need to be overcome, this may reduce the free working of the union.

There may be growing inequality between firms in the region as firms may try to locate near the centre of the union to reduce transportation costs, or they may try to locate near the richest part of the market, excluding countries that are in a more remote location or have a lower average income.

Question 21

What are the benefits of customs unions

Answer 21

Possibility of trade creation
Allowing countries to specialise in what they have a comparative advantage in.

Arguably smaller countries have the most to gain from the union as they have access to economies of scale that wouldn’t be possible if they were selling in only their domestic market.
By joining a customs union, a country is opening up its domestic market to international competition forcing it to lose x-inefficiency and instead adopt the best practice techniques and technologies.

Question 22

What is a common market?

Answer 22

The next stage up from a customs union, it includes trade agreements where countries establish common tax rates and laws to create an environment for production, employment and trade amongst member countries.
This includes the free movement of factors of production, mainly labour and capital.

Question 23

Give an example of a common market

Answer 23

The Single European Market

Question 24

What is a monetary union?

Answer 24

(A currency union) Where countries share the same currency, but do not cooperate to the extent of which is done in a free trade area or customs union.

Question 25

What is economic and monetary integration?

Answer 25

It combines the requirements of a common market, with the adoption of a common currency, or a permanently fixed exchange rate between members.

Question 26

Why are some governments wary to take part in full economic and monetary integration and permanently fix their exchange rate between members?

Answer 26

This means monetary variables must be mainly used to ensure that the exchange rate is maintained.

The government can no longer set independent targets for the bank rate or money supply and such variables can no longer be used primarily to achieve macroeconomic objectives.

Question 27

Why is economic and monetary union bad for a country that is facing a recession especially when the majority of members are in a boom period?

Answer 27

The country cannot set interest rates independently as it must focus on maintain the exchange rate, while the union is setting interest rates high to encourage saving, it would be most beneficial for this country to lower interest rates to boost AD, but it is unable to do so.

Question 28

Why can free trade negatively effect certain sectors in the economy?

Answer 28

Free trade allows countries to alter their pattern of comparative advantage. This means certain sectors will be allowed to expand, while others must contract, which can be painful. This is especially difficult as these contracting sectors were most likely protected, but now they are exposed to competition and workers must be retrained in order to be ready for employment in expanding sectors in the economy.

In the UK the manufacturing sector is contracting and the financial sector is expanding.

Question 29

What is the Single European Market?

Answer 29

A common market amongst member countries of the EU and several other European countries where there are very few barriers to trade, and there is the free movement of factors of production.
Passport and custom checks have been abolished at most EU internal borders.

Question 30

How does being a member of the EU reduce transaction costs for producers in the bloc?

Answer 30

Tariff barriers are abolished as well as non-tariff barriers being reduced.

Question 31

How does being a member of the EU allow firms to benefit from economies of scale?

Answer 31

Firms will find that trade is increasing, meaning they are operating in a larger market, allowing them to exploit the economies of scale from operating on a large scale.
This should benefit consumers through trade creation (as long as it exceeds trade diversion)

Question 32

What is the benefit of intensified competition that firms are exposed to when they join the EU?

Answer 32

Domestic firms are in a larger market so they seek more efficient production techniques and eliminate x-inefficiencies, in order to remain price competitive.

Question 33

What type of countries gain the most from membership of the Single European Market?

Answer 33

Relatively labour abundant countries in southern Europe have a very different pattern of comparative advantage to the other advanced industrial nations in the EU that specialise in capital services this means they can specialise in labour intensive sectors and benefit from trade.

Countries that would be subject to high tariff barriers otherwise would gain a large amount by joining the SEM as these are removed.

Question 34

What is the European Monetary System?

Answer 34

This was the first step to closer integration of many EU countries, it meant that capital controls were removed progressively so financial capital could be moved across borders easily.

The EMS also included the Exchange Rate Mechanism.

Question 35

What was the drawback of the removal of financial capital controls under the European Monetary System?

Answer 35

The financial markets of countries were integrated with the European Central Bank, that set a common interest rate across the union, meaning the interest rate could no longer be used as a means of monetary policy for an individual country.

They couldn’t use financial capital independent of other countries either, or other areas of monetary policy.

Question 36

What is an optimal currency area?

Answer 36

The idea that a group of countries are better off in a single currency area.

Question 37

What are the benefits of a single currency are?

Answer 37

Encourages more trade between member countries allowing them to exploit comparative advantage and reap from economies of scale.

Question 38

What is a monetary efficiency gain (in terms of a single currency area)?

Answer 38

When trade increases once a country joins a single currency area so they can specialise and exploit their comparative advantage, also benefiting from economies of scale so producing at a lower cost.

Question 39

What causes monetary efficiency gains in the single currency area?

Answer 39

It reduces transaction costs as there is no need to convert from one currency to another when trading.

Gains due to a reduction in uncertainty as there is no need to predict the future movements of the exchange rate as they are all fixed to each others.

Question 40

Why might the benefits of a single currency area not be fully experienced ?

Answer 40

If most of the trade is done with countries that are outside of the are the benefits are unlikely to be felt.

If the countries are not closely integrated

Question 41

What Is the exchange rate mechanism?

Answer 41

Members choose to maintain their exchange rate within +/- 2.25% against the average of member countries.

This is seen as a stage before a single currency.

Question 42

Why was it agreed under the Treaty of Maastricht (1992) that countries need to have similar economic characteristics?

Answer 42

If the countries had too diverse economic conditions the transition to a single currency would be too costly.

Strong countries would be dragged down and weak countries would be unable to cope.

Question 43

What was the Maastricht criteria?

Answer 43

It set out the similar monetary and fiscal conditions that countries had to adhere to before they could join the Eurozone.

Question 44

What was the Maastricht criteria that had to be met for fiscal policy before a country could join the Eurozone?

Answer 44

Low and similar inflation rates, no more than 1.5% higher than the average of the three countries in the European Monetary System with the lowest exchange rate.

Budget deficit no larger than 3% of GDP
National debt no larger than 60% of GDP.

Question 45

What was the Maastricht criteria that had to be met for monetary policy before a country could join the Eurozone?

Answer 45

Countries with high interest rates attract flows of financial capital so diversity of interest rates in the union was undesirable and the long term interest rate of a country could be no more than 2% above the average of the three EMS countries with the lowest rate.

Question 46

What was the European Economic and Monetary Union (EMU)

Answer 46

Exchange rates between countries are permanently locked together meaning everyone’s exchange rate was kept at the average of each others currency.

Question 47

What are the costs of being part of a single currency area e.g. Eurozone?

Answer 47

Individual countries can’t use monetary policy to stabilise their monetary policy e.g. if an individual wants to lower interest rates to reduce demand-deficit unemployment, but the other countries are experiencing inflation, the individual may be forced to experience an increase in interest rates, worsening its situation.

It is even more important now that the economic cycles of participating countries are synchronised.

Question 48

How did Paul Krugman suggest that cost-benefit analysis can be used to determine whether it is beneficial for a country to join a single currency area?

Answer 48

He argues that the more closely itegrated a country was with the member countries of the area, the more benefits it would gain from joining, but the less integrated, the more costs would be incurred.

he showed this on a cost (demand ) and benefits (supply) diagram. If a country was to the right of the equilibrium , t where benefits exceeded costs it would be more beneficial for them to join.

Question 49

What is MERCOSUR?

Answer 49

‘the common market of the south’-is a regional trade agreement , it is South America’s largest trading bloc and is a customs union.

Question 50

What are the issues concerning trade in MERCOSUR?

Answer 50

‘the common market of the south’
Argentina imposed tariffs on imports from brazil, despite them both being member countries of this customs union.

MERCOSUR members agreed to raise the external tariff barrier to 35% on certain products limiting freer global trade.

Question 51

Name 2 regional trade agreements

Answer 51

MERCOSUR - ‘the common market of the south’ ( biggest trading bloc in South America )

NAFTA- Canada, USA, Canada
ASEAN- the association of Southeast Asian Nations

Question 52

Why are some nations cautious towards free trade?

Answer 52

There are transitional costs of structural change.
It can cause uncomfortable effects on the domestic job market as in order for countries to be able to specialise and produce what they have a comparative advantage in, sectors have to contract in order for others to expand, meaning these people need to be retrained

Deregulation of financial markets allows financial capital to go across borders more easily but can cause recession to spread more quickly.

Question 53

What is the basis for critics of globalisations concern about potential damage to the environment?

Answer 53

Fragmenting production across countries means goods have to be transported all over the world, using up valuable resources.

Nations have the incentive to lower production costs to attract MNC’s by enabling low cost production

Question 54

Why do some critics of globalisation argue that it’s the rich countries that have the most benefits from global trade?

Answer 54

They have the market power to ensure that trading conditions work in their favour
Most MNC’s come from developed nations

Question 55

Why was there a lot of opposition against the WTO Doha Agenda?

Answer 55

This would have worked to provide freer global trade in the agricultural sector howevet the USA, EU and Japan have large scale policies in place o protect their sectors.

Question 56

Why do some hold the WTO responsible for environmental damage due to globalisation

Answer 56

As an international agency, some argue they should do more to monitor global environmental standards