Ppt 3 Trade Policy

8/13/2019 Ppt 3 Trade Policy

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It has been seen that international flows of goods & services are

beneficial for all countries involved It leads to higher efficiency

in the classical model based on technological differences and in

neoclassical based on differences in technology and factor

endowments

Yet this view of benefits & increased efficiency to the society

stands in sharp contrast to the varirty of views from different

pressure groups blaming international economics, globalization,international trade flows for its adverse impact on

macroeconomic variables such as employment, wages,

environment, level of development, competition etc.

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Tries to reason out to some extent the existence of such

pressure groups

It analyses the consequences of imposing trade

restrictions/protection for production, consumption &

international trade flows.

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It means unrestricted flow of goods & services between countries

It requires complete absence of government intervention in

international trade

It does not require removal of all duties on imports; but if duties are

imposed on imports, they should be exclusively for revenue & not

for protection of home industries

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Restriction placed on free movement of commodities across national

borders with a view to safeguarding domestic industries constitute

the policy of protection

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Free trade means government of each trading country do not make

any distinction between domestic & foreign commodities & so

neither imposes additional burdens on the later, nor grants any

special favours to the former

Protection implies discrimination against the foreign commodities

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Optimum allocation of resources

Maximization of world output

Expansion of consumption possibilities beyond internal productionpossibilities for the trading countries

Lower prices of goods & services

Widen size of markets

Encourages competition & prevents monopolistic tendencies

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Results in economic dependence of a country on other countries forsome essential commodities

Results in lopsided economic development in a country

May lead to dumping sale of a product in foreign market at a pricewhich is lower than the selling price of the product at home

May give rise to international monopolies

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Infant industry argument an industry in its infancy requires

protection till it acquires strength & maturity & is set to face fierce

foreign competition

Diversification of industry argument it is necessary to diversify the

industrial base of a country for the attainment of national self

sufficiency & balance growth of the economy. This requires

protection.

Employment argument

Key industry argument .

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Endless list of policy options available Mostly of the form:

Tariff

i. Specific a tax of certain amount for each unit of good imported

ii. Ad valorem a certain percentage of tax per unit of good imported

Quota

Production subsidy

Export subsidy

NTBs: saniatry & phytosanitary requirements, standard

requirements

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All these policy measures affect production, consumption &

other related economic variables in different ways.

We illustrate the case of two such policy options:

imposition of tariff

Imposition of quota

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Tariff is the most common instrument of protection

It is a tax or duty levied by the state on a commodity when it crosses

the national boundary

Examples : import dutytax imposed on an imported commodity

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Yes in as much it is a duty levied by the state on a commodity when

it crosses the national boundary

But it is not a protective tariff they are levied by the state either to

raise revenue or to raise the prices of the exported goods in the

market

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effects: Protective effect (production effect)

Consumption effect

Revenue effect

Redistribution effect

Balance of payments effect

Terms of trade effect

Competitive effect

Income effect

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A tariff raises the domestic price of importables increase in

domestic production of importables while the consumption of thesame falls. The former is the production effect& the second is theconsumption effectof tariff

The increase in government revenue due to the tariff is the revenueeffect The increase in price of importables as a result of imposition of the

import duty lowers consumer surplus & raises producers surplus.This is redistribution effect

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Imposition of import duty makes import expensive lowers imports

improves the BOP of the country this is the BOP effect

Imposition of import duty leads to a movement of the terms of trade in

favour of the tariff imposing country the terms of trade effect

Tariff imposed on a import to protect an infant industry enables the later

to gain sufficient competitive strength to withstand foreign competition

after sometime competitive effect of tariff

Imposition of import duty multiplier effect of a fall in imports on real

national income of the country income effect

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Dd

Sd

EP

P1

Po

U

F T

Sw

J

K H G C

M N A B

5

1 2 3 4} t

R

Quantity

Price


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Dd domestic demand schedule for the commodity & Sd domestic supply schedule for the commodity. In autarky equilibrium

occurs at E at which price of the commodity OP

Let OPo be the world price of the commodity at which the foreignsupply curve for the commodity facing the country is perfectlyelastic.

Under free trade domestic price of the commodity would also beOPo at which domestic consumption of the commodity is OB &domestic production is OM. Thus import of the commodity is KC

Now suppose an import duty of t per unit is imposed rise indomestic price of the commodity from OPo to OP1 & shifts theforeign supply curve upward by the amount of the tariff t from theposition PoSw to P1T increases domestic production by MN(production effect) & lowers domestic consumption by AB(consumption effect)

Import falls from MB to NA trade effect18


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Tariff revenue collected by imposing this tariff = HJFG revenueeffect of the tariff

Under free trade consumer surplus is = P0RC but after tariff = P1RF.So consumer surplus falls by P0P1FC (=1+2+3+4). Producers surpluson the other hand increase from P0UK to P1UJ i.e. by area 1 in figure

which is transferred from consumers to producers redistributioneffect

1 goes to producers from consumers & 3 from consumers to thegovernment. But 2 & 4 though lost by consumers do not goanywhere & represents the deadweight loss imposed by the tariff. Of

this 2 represents the production cost & 4 the consumption cost oftariff

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zero

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One of the several instruments of protection

Refers to the fixation of certain maximum limit beyond which the

import of a commodity cannot go during a period of time

Limit may be fixed either in physical units or in value terms

Is enforced through the licensing of imports

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Refer to the same figure as for import tariff

In the figure an import tax of t per unit (i.e. P0P1per unit) on the

quantity imported of the commodity is equivalent to an import quota

equal to NA all effects are same

Only difference: in case of tariff govt. collects tariff revenue = 3 (=

HJFG) there will be no such revenue from the fixation of quotas.

Note: govt can raise same revenue by auctioning off import licences

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Ppt 3 Trade Policy

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