1. Free Trade vs. Protectionism
Frederick University
2009

2. Free Trade vs. Protectionism
“If there were an Economist’s Creed it would surely contain the affirmations: ‘I understand the principle of comparative advantage’ and ‘I advocate free trade’”
Paul Krugman

3. Free Trade vs. Protectionism
Trade Protection (Protectionism) - Policies that limit imports, usually with the goal of protecting domestic producers in import-competing industries from foreign competition

4. The Gains from trade } Oz widget market Local consumer's
extra gains = d+e
Local producer’s
extra gains = -d S P a a 4
Po= 4 d e b
Pw = 2 } c
Imports = 28 D
Qo =16
Q = 44
Qo = 30
Trade: world price = 2; Qo= 16,
Q imports = 28, Q = 44
Consumer surplus = a+d+e
Producer surplus = c Q
No trade: Oz price = 4; Q = 30
consumer surplus = a
producer surplus = b

5. The Gains from trade } Zo widget market Zo consumer’s extra gain = -i
Producer’s extra gains = i + j
Zo widget market P
Exports = 28 S S h }
P = 2 j i f
1.5
Pz = 1.5 D g D g Q 50 78
Qz = 60
Trade: P = 2; Q = 78
Consumer surplus = h = f – i
Producer surplus = g + i + j
No trade: P = 1.5; Q = 60
Consumer surplus = f
Producer surplus = g

6. The Gains from trade Total: + e + j Surplus before trade a c + d h + i
Oz consumers
Oz producers
Zo consumers
Zo producers
Surplus before trade a
c + d
h + i g
Surplus after trade
d + e + a c h
g + i + j
Total: + e j

7. Free Trade vs. Protectionism
Showing that free trade is better than no trade is not the same thing as showing that free trade is better than sophisticated government intervention

8. Trade Restrictions
Tariffs - taxes levied basically on imported goods. They are imposed as an attempt to raise foreign exchange revenue and increase the welfare at the expense of other nations.
Nontariff barriers - all forms of trade restrictions other than tariffs.

9. Tariffs
ad valorem import tariff - expressed as a percentage of the invoice value of the imported good
specific tariff - a fixed sum levied on a physical unit of the good no matter what its invoice price is
compound duty - a combination of ad valorem and specific duties
variable levy - calculated daily
official prices - a basis for ad valorem duty calculations

10. } } The Effect of a Tariff S a – producer gain
a + b + c + d – consumer loss Pd
c – government collection Pt a
} t b } c d Pw D }
b + d – deadweight loss M Dt
b – consumer loss due to the
demand shift to domestic supply
- production effect Sd St Q Dd
d –consumer loss due to the reduction in consumption
consumption effect

11. Nontariff barriers quantitative restrictions technical regulations
Quotas - numerical limits for a specific kind of good that a country will permit to be imported without restriction during a specified period
Voluntary export restraints
Tariff quotas -permit a stipulated amount to enter the country duty free or at a low rate, but when that quantity is reached, a much higher duty is charged for subsequent importations
technical regulations
administrative regulations
other regulations of imports

12. The Import Quota } a – producer gain Sd Dd
a + b + c + d – consumer loss Sq
c – transfer from domestic
consumers to someone else Pq
b + d – a loss to the country a b c d Pw } q Qs Qd
Qdq
Qsq Q

13. Arguments for trade restrictions
The need of protection of domestic labour markets against cheap foreign labour
The desire to reduce domestic unemployment
The need to counteract dumping in international trade
The need to protect the infant industries
Protect industries important for national defence
Decrease the national balance of payments deficit
Improve the nation’s terms of trade and welfare
Strategic trade policies
The scientific tariff
The need to protect national health and safety standards

14. Strategic Trade Policies
economies of scale justify the operation of just one firm in the world market as a whole
lucky firms in the industry may be able generate returns higher than the opportunity costs of the resources they employ
the country can raise its national income at other countries’ expense if it can somehow ensure that the lucky firm that gets to earn excess returns is domestic rather than foreign

15. Strategic Trade Policies – an example
Assumptions:
Two companies from two countries are capable of producing a good
Neither country has any domestic demand for the good – the good is intended solely for export
The producer surplus coincides with the national interest
Each firm faces only a binary choice – either to produce or not to produce
The market is profitable for either firm if it enters alone, unprofitable for both if both enter

16. Strategic Trade Policies – an example
The good is a 150 – seat passenger aircraft
The firms are Boeing and Airbus
The countries are the U.S. and the EU
The Payoff Matrix
Airbus P N -5
Boeing
100

17. Strategic Trade Policies – an example
Boeing has some kind of head start that allows it to commit itself to produce before Airbus’s decision
Boeing earns 100 while deterring entry by Airbus
The EU decides to subsidize Airbus at a point before Boeing is committed to produce
The EU pays a subsidy of 10 to Airbus if it produces the plain, regardless of what Boeing does

18. Strategic Trade Policies – an example
The Payoff Matrix after European Subsidy
Airbus P N 5
Boeing
- 5
100
110