1. Restrictions on Free Trade

2. This Topic Covers:

3. 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

4. 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

5. 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

6. Tariffs
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.

7. 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. From YouTube – Tariffs and Protectionism

9. We can draw a similar diagram for trade creation
Trade creation from free trade within the trading bloc, ie a welfare gain for countries within the bloc
Bigger market
Economies of scale
Jobs

10. Gains from trade creation
S domestic
P tariff
S EU (France) + tariff A B C D
P world = EU
S EU (France)
D domestic
Q S2 FTA
Q S1 with tariff
Q D1 with tariff
Q D2 FTA
Higher Imports
Eliminate tariffs, consumer surplus increased by A + B + C + D
Producer surplus decreased by A, and government tax revenue falls by C
Total welfare gain = B + D
Imports have increased = trade is created

11. Trade diversion – loss in welfare
And the loss in welfare from Trade Diversion….
Trade diversion – loss in welfare

12. Trade diversion (UK) S domestic P w+tariff S world + tariff (NZ) A B C
P FTA
S FTA (France) E
P W
S world (NZ)
D domestic
Q S2 FTA
Q S1 with tariff
Q D1 with tariff
Q D2 FTA
Starting point is where all countries have tariffs on all imports. Analyse impact on the UK
Cheapest world supplier was not EU but say New Zealand, represented by Sworld + tariff so price is Pw + tariff
Creation of FTA, we now buy at PFTA from eg France, so consumer surplus increases by A+B+C+D
Producer surplus falls by A, and we lose C + E in revenue from the tariff
So welfare gain is B + D - E, so if E is greater than B + D there is an overall loss in welfare
The loss in revenue will be greater the greater the original difference in prices between France and NZ

13. Quotas A physical limit on the quantity of the good imported.
Increases the share of the market available for domestic producers.
Note a quota of zero is an embargo (“an official ban on trade or other commercial activity with a particular country”)
Quota raises no money for the Government

14. 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
(they D
So tariffs are better than quotas
QS1
QS2
QD2
QD1
Quantity

15. 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.