International trade, protectionism and globalisation

Step 1. Calculate the government's tariff revenue. Revenue = tariff per tonne x quantity imported after the tariff = $100 x 35,000 = $3,500,000.

Step 2. Calculate the extra cost to consumers on imports. Consumers now pay $500 rather than $400 on each of the 35,000 tonnes imported, which is $100 x 35,000 = $3,500,000 extra. This is exactly the tariff revenue, transferred from consumers to the government.

Step 3. Identify the effect on domestic producers. Domestic output rises from 20,000 to 30,000 tonnes and domestic producers now receive $500 rather than $400 per tonne. They gain both from selling more and from a higher price on every tonne, so producer surplus rises substantially.

Step 4. Identify the losers. Consumers lose twice: they pay $100 more on every tonne they still buy, whether imported or domestic, and total consumption falls from 70,000 to 65,000 tonnes because some buyers are priced out. Foreign producers lose 15,000 tonnes of sales.

Step 5. State the net effect. Part of the consumer loss is transferred to the government as revenue and part to domestic producers as higher profit, so those are transfers rather than losses to the economy. But the extra 10,000 tonnes are now produced domestically at a higher cost than the world price, and 5,000 tonnes of consumption have been given up entirely. Those two elements are pure welfare loss, benefiting nobody.

Step 5 is the analytical payoff. Transfers move value between groups; the welfare loss destroys it. A candidate who identifies which parts are which is doing economics rather than describing a policy.

Step 1. Identify absolute advantage. Country A produces more wheat (40 against 30), so it has an absolute advantage in wheat. Country B produces more cars (30 against 20), so it has an absolute advantage in cars. Neither is better at both here, but comparative advantage would still determine specialisation even if one were.

Step 2. Calculate Country A's opportunity costs. A gives up 20 cars to produce 40 wheat, so 1 wheat costs 20/40 = 0.5 cars. Conversely 1 car costs 40/20 = 2 wheat.

Step 3. Calculate Country B's opportunity costs. B gives up 30 cars to produce 30 wheat, so 1 wheat costs 1 car, and 1 car costs 1 wheat.

Step 4. Determine comparative advantage. Wheat costs A 0.5 cars and costs B 1 car, so A has the lower opportunity cost in wheat. Cars cost A 2 wheat and cost B 1 wheat, so B has the lower opportunity cost in cars. A should specialise in wheat and B in cars.

Step 5. Find the range of gainful terms of trade. A will only export wheat if it receives more than 0.5 cars per tonne, since that is what wheat costs it domestically. B will only import wheat if it pays less than 1 car per tonne. So any rate between 0.5 and 1 cars per tonne of wheat benefits both. A rate of 0.75 cars per tonne would split the gain roughly evenly.

Step 6. Confirm the gain. At 0.75, Country A gets 0.75 cars for a tonne of wheat that cost it only 0.5 cars to produce, gaining 0.25 cars. Country B obtains wheat for 0.75 cars when producing it itself would have cost 1 car, gaining 0.25 cars. Both consume beyond their own production possibility curves, which is the gain from trade.

Step 5 is the part most often omitted and it is where the marks concentrate. The terms of trade must lie between the two domestic opportunity cost ratios; outside that range one country would rather produce the good itself, and no trade occurs.

Step 1. Base year. (100 / 100) x 100 = 100.

Step 2. Five years later. (110 / 125) x 100 = 88.

Step 3. Interpret. The terms of trade have fallen by 12%, a deterioration. Export prices rose, but import prices rose faster, so each unit of exports now buys 12% fewer imports than before. The country must export more to buy the same quantity of imports.

Step 1. Work out the delivered prices before joining. Domestic: $90. From W: $60 x 1.5 = $90. From M: $75 x 1.5 = $112.50. The cheapest options are domestic production and imports from W, both at $90.

Step 2. Work out the delivered prices after joining. Domestic: $90. From W: still $90, since the external tariff is unchanged. From M: $75 with no tariff. Country A now buys from M at $75.

Step 3. Identify the trade creation element. Domestic production at $90 has been replaced by imports from M at $75. M is genuinely the lower-cost producer relative to A's own industry, so inefficient domestic production has been displaced. This is trade creation and it raises welfare.

Step 4. Identify the trade diversion element. Imports previously coming from W at a resource cost of $60 now come from M at a resource cost of $75. W is the world's most efficient producer and A has switched away from it purely because of the tariff differential. This is trade diversion and it wastes $15 of real resources per unit.

Step 5. Account for the tariff revenue. On the units previously imported from W, A's government collected $30 per unit in tariff. That revenue is now gone. The consumer pays $15 less per unit while the government loses $30, so on those units the economy is $15 worse off, exactly the resource waste identified in step 4.

Step 6. Reach the judgement. Both effects are present, which is the normal case. The net welfare effect depends on how many units fall into each category: how much domestic production is displaced by genuinely cheaper member output, against how many imports are diverted from a more efficient non-member. Membership is beneficial only if the first exceeds the second.

Setting out the delivered prices in a small table before and after is the fastest route through any question of this type. The tariff revenue in step 5 is what candidates most often forget, and it is where the welfare loss actually shows up.

F, E, B, A, D, C, G

1. A tariff raises the domestic price of the imported good above the world price.
2. Domestic producers expand output, because production is now profitable at the higher price for firms that could not compete at the world price.
3. Those additional units are produced using more resources than it would have cost to import them, so resources are being used inefficiently.
4. Consumers face the higher price on every unit they buy, whether domestic or imported, so consumer surplus falls.
5. Part of that lost consumer surplus is transferred to domestic producers as higher profit and part to the government as tariff revenue, and transfers are not net losses.
6. But two portions are transferred to nobody: the extra resource cost of the inefficient domestic production, and the surplus lost by consumers priced out of the market entirely.
7. Those two triangles are the deadweight welfare loss, so national welfare falls even though a visible and vocal group of domestic producers has gained.

Step 7 explains the politics as well as the economics. The gains are concentrated on an identifiable industry that will lobby for them, while the losses are spread thinly across all consumers who mostly will not notice, which is why protection is politically durable despite the welfare arithmetic.

G, F, C, E, D, A, B

1. Before joining, a country imports a good from the cheapest world producer and applies its own tariff to it.
2. On joining, tariffs against fellow members are removed while the common external tariff continues to apply to non-members.
3. Trade creation occurs where the country now imports from a member producer that is genuinely lower cost than its own domestic producers, so inefficient domestic production is replaced by cheaper imports and welfare rises.
4. Trade diversion occurs where the country switches from the cheapest world producer to a higher-cost member producer, purely because the member's output is now tariff-free while the world producer's is not.
5. In that case the good is being bought from a less efficient supplier, so real resources are wasted even though the price the consumer pays may have fallen.
6. The country also loses the tariff revenue it previously collected on those imports, which was a transfer to its own government and now accrues to the member producer instead.
7. Whether membership raises welfare therefore depends on whether trade creation exceeds trade diversion, which is an empirical question and not settled by the fact that trade has increased.

Step 5 is the point examiners are testing. A fall in the consumer price is consistent with a welfare loss for the economy as a whole, because the tariff revenue lost exceeds the consumer gain. Rising trade volumes after joining prove nothing on their own.