International trade, protectionism and globalisation
Key terms
Define each term.
Multiple choice
Circle the correct answer.
Which is a disadvantage to a host country of a multinational company setting up there?
A government replaces a tariff with a quota that restricts imports to the same quantity. Compared with the tariff, the quota means:
Which is the strongest economic objection to protecting a domestic industry indefinitely?
Worked problems
Show your working.
Who gains and who loses from a tariff. A country imports 50,000 tonnes of sugar a year at a world price of $400 per tonne. Domestic producers supply 20,000 tonnes. The government imposes a $100 per tonne tariff. Imports fall to 35,000 tonnes and domestic supply rises to 30,000 tonnes. Calculate the tariff revenue, the extra cost to consumers on the quantity still imported, and identify who gains and who loses.
Diagrams
Draw a domestic demand and supply diagram for a good, with a horizontal world supply line below the domestic equilibrium price. Mark domestic production, total consumption and imports. Then raise the world supply line by the amount of a tariff and mark the new domestic production, consumption and imports, shading the government's tariff revenue.
Answers
Free trade: International trade that takes place without restrictions such as tariffs, quotas or subsidies to domestic producers.
Globalisation: The process by which the economies of the world become increasingly connected through trade, investment, the movement of people and the spread of technology.
Protectionism: Government policies that restrict international trade in order to shield domestic industries from foreign competition.
C. The other three are benefits to the host country. When profits are sent abroad to the MNC's owners, the host keeps less of the income created, which is why a country's GDP can rise faster than the income its residents actually receive.
B. Both measures restrict imports to the same level and raise the domestic price similarly, so consumers and domestic producers are affected much the same way. The difference is where the money goes: a tariff collects it as government revenue, while a quota transfers it to whoever holds the right to import.
B. Protection removes the competitive pressure that forces firms to improve, so costs stay high and consumers pay for it permanently. This is why even supporters of the infant industry argument insist protection must be temporary and withdrawn on a stated timetable.
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.
Four quantities change and all four should be labelled: domestic output rises, consumption falls, imports are squeezed from both sides, and the government collects revenue on what still comes in. Candidates who mark only the price change miss most of the available marks, since the whole argument is about the quantities.