Restrictions on free trade

Advantages and disadvantages of free trade Specialisation leading to increased output Trade allows economies of scale (larger market to sell to) Lower price and increased choice Competition and innovation Risk – interdependence, over- reliance on trade, loss of control Unemployment (perhaps) Income inequality Environmental impact Culture

Welfare Gain From Trade S domestic P domestic A B C S world P world D domestic Q S domestic Q D domestic Imports Consumer surplus gain = A + B + C Producer surplus loss = A Total welfare gain = B + C

Trade Protection Options Tariffs: taxes on imports Quotas: quantity restrictions on imports Subsidies: given to domestic firms to help them compete in foreign markets Regulations: can make it very difficult or expensive for foreign products to comply

Tarrifs A tax on imported goods (aka import duty/ customs duty) designed to raise the price to the level of, or above the existing domestic price. http://youtu.be/qiDE20UG0xE

Tariffs – A Loss of Welfare S domestic P tariff A B C D S world P world D domestic Q S1 free trade Q S2 with tariff Q D2 with tariff Q D1 free trade Lower Imports Consumer surplus reduced by A + B + C + D Producer surplus increased by A (domestic producers expand production at ↑ price) Gov’t tax revenue = C Total loss of welfare = B + D

Quotas A physical limit on the quantity of the good imported. Increases the share of the market available for domestic producers.

Welfare loss from quota Quota amount decided, added to domestic production Loss in consumer surplus is A+B+C+D SD1 Price Gain in producer surplus is A PW +q Who receives C? A B C D PW SW Generally importers, so welfare loss is B+C+D D If the government sold licences to import, welfare loss is between B+D and B+C+D So tariffs are better than quotas QS1 QS2 QD2 QD1 Quantity

Subsidies Can be used to increase exports and reduce imports. Export subsidies to increase exports and support industries Subsidies to reduce imports – subsidising firms that compete with imports.

Welfare loss from subsidy Original producer surplus is A SD1 Price New producer surplus is A+B+C+D SD2 Gain in producer surplus is B+C+D PW SW S A C Subsidy costs taxpayers A+B+C+E B E D PW - S So loss from subsidy is A+B+C+E minus B+C+D Which is A+E-D D QS1 QS2 QD1 Quantity Since A is the same as D the loss is E

Why have trade restrictions? If countries specialise according to comparative advantage there are major gains from trading Tariffs, quotas and other restrictions lead to welfare loss, so why do some countries have protectionist policies?