1. Restrictions on free trade

2. 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

3. 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

4. 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

5. 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.

6. 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

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

9. 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

10. 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.

12. 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

13. 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?