Lecture 4 - Protectionism
From Last Time
Firms that lose profits due to imports may indeed shut down.
Imperfect competition is a generic term encompassing monopoly, monopolistic competition, and oligopoly
Exporters gain from trade while import-competing firms lose profits. So, those hurt by imports often seek trade protection.
Trade, whether with perfect competition or economies of scale, benefits the nation as a whole. The impact on particular groups
differs under the 3 cases.
The important thing about trade with external economies is that an expansion of output due, say, to the opening of an export
market, lowers average costs. This, in turn, lowers the price. Consumers in both the exporting and importing country gain from
the lower price.
In the short run, the wages, interest, rent, and profits paid to the resources in the export sector do rise following a move to free
trade. The payments to factors in the import-competing sector fall in the short run. In the long run, the payments to factors of
production used intensively in the export sector rise and payments to the factors used intensively in the import-competing
sector fall. This is the Stolper-Samuelson theorem.
Total demand is equal to home demand, the demand of domestic consumers, plus foreign demand, demand from foreign
consumers.
The assumption of free entry drives economic profits for monopolistic competitors to zero. As long as there are economic
profits available, firms will enter the market and steal existing firms' customers.
Tariffs
A tariff is a tax on imports.
The tariff raises the domestic price above the world price. Consumers are losers because they pay a higher price and buy less
of the product. Since the domestic price rises, domestic firms increase output and see their profits rise.
Effective Rate of Protection
Tariffs also have an effect on industries that sell material inputs to the protected industry, and firms in the protected industry are
affected by tariffs on their inputs. This complicates looking at who is being protected by a set of tariffs.
The effective rate of protection is the percentage by which the entire set of a nation's trade barriers raises the industry's value added
per unit of output.
Suppose that under free trade, the input costs of a bicycle are $220 and the world price is $300. Value added equals $80.
Suppose a 10% tariff is imposed on bicycle imports so the domestic bicycle price rises to $330 and a 5% tariff is placed on its inputs
so that input costs rise to $231. Value added now equals $99.
The effective rate of protection for the bicycle industry equals (99-80)/80 or 23.8%, not the 10% nominal tariff. This tells us that
income rises by 23.8% in the bicycle industry.
Indifference Curve Analysis of a Tariff
A tariff distorts consumption so we end up on a lower indifference curve. Production of the import good rises and that of the export
good falls.
quotas
A quota is a limit on the amount of imports. For example, the U.S. allows 1 million tons of sugar to be imported but no more than that.
The tariff has the same effects on producers and consumers as a tariff. The domestic price rises above the world price.
Other Barriers to Trade
regulatory barriers: health & safety standards; government procurement policies
export barriers: quotas & duties
exchange controls
Costs of Trade Barriers
industry consumer losses per job saved
orange juice $240,000
textiles 42,000
color TV's 420,000
automobiles 105,000
specialty steel 1,000,000
sugar 60,000
Arguments for Protection
1. optimal tariff
2. spillover effects
3. creation of domestic jobs
4. infant industries
5. infant government
6. national pride
7. income redistribution
8. national defense
9. balancing the balance of trade
10. creation of a "level playing field"
11. strategic trade policy