The instruments of protectionism

Overview

Countries increasingly rely on non-tariff barriers rather than tariffs.

What you need to know

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Questions from this subtopic

Each one with the model answer underneath.

1. 1

   What is protectionism?

   Model answer

   Protectionism is the use of government policy to shield domestic producers from foreign competition, by raising the price of imports, limiting their quantity, subsidising domestic rivals, or imposing rules that foreign suppliers find harder to satisfy. Its effect is to move domestic prices above world prices and shift production and consumption away from the pattern free trade would produce.

2. 2

   What is a tariff and how does it affect the domestic market for an imported good?

   Model answer

   A tariff is a tax on imports, usually a percentage of value or a fixed sum per unit. On a diagram with price on the vertical axis and quantity on the horizontal, the world supply line shifts upward by the amount of the tariff, so the domestic price rises from the world price to the world price plus the tariff. At the higher price domestic producers move up their supply curve and supply more, domestic consumers move up their demand curve and buy less, and the gap between the two, which is imports, narrows on both sides.

3. 3

   In a small open economy the world price of a good is 10 pounds. At that price domestic demand is 100 units and domestic supply is 30 units. A tariff of 2 pounds per unit raises the price to 12 pounds, at which domestic supply is 50 units and demand is 90 units. Calculate the change in imports and the government's tariff revenue.

   Model answer

   Before the tariff imports are 100 minus 30, which is 70 units. After the tariff imports are 90 minus 50, which is 40 units, so imports fall by 30 units. Tariff revenue is the duty per unit multiplied by the units still imported, that is 2 multiplied by 40, which is 80 pounds.

4. 4

   Using the same market, where the world price is 10 pounds with domestic supply 30 and demand 100, and a 2 pound tariff gives a price of 12 pounds with supply 50 and demand 90, calculate the gain in producer surplus, the loss of consumer surplus and the net welfare loss.

   Model answer

   Producer surplus rises by the area of a trapezium of height 2 pounds and parallel sides 30 and 50, that is 2 multiplied by the average of 30 and 50, which is 2 multiplied by 40, giving 80 pounds. Consumer surplus falls by a trapezium of height 2 pounds and parallel sides 100 and 90, that is 2 multiplied by 95, which is 190 pounds. Government revenue is 80 pounds, so the net welfare loss is 190 minus 80 minus 80, which is 30 pounds. This equals the two deadweight triangles: a production distortion of one half multiplied by 20 multiplied by 2, which is 20 pounds, plus a consumption distortion of one half multiplied by 10 multiplied by 2, which is 10 pounds.

5. 5

   Explain in words what the two deadweight loss triangles created by a tariff actually represent.

   Model answer

   The production triangle is the extra real resource cost of making units at home that could have been bought more cheaply abroad; society uses up more labour and capital than necessary to obtain those units. The consumption triangle is the value lost by consumers who valued the good at more than the world price but less than the tariff-inclusive price and therefore go without; the satisfaction they would have gained exceeds the cost of supplying them, but the trade does not happen. Neither loss becomes anyone else's gain, which is why they are described as deadweight.

6. 6

   What is an import quota and how does its effect differ from that of a tariff?

   Model answer

   A quota is a legal limit on the physical quantity of a good that may be imported in a given period. Like a tariff it raises the domestic price and expands domestic production, but the price rise comes from the restricted supply rather than from a tax, and the difference between the world price and the domestic price is captured as extra profit by whoever holds the right to import rather than as revenue by the government. A quota also fixes the quantity regardless of what happens to costs abroad, whereas under a tariff a fall in foreign costs still feeds through into more imports.

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