Textbook Notes (369,198)
Canada (162,457)
Economics (479)
ECO102H1 (54)
Chapter 34

ECO100Y1 Chapter 34 Notes

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Robert Gazzale

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ECO100Y1 Textbook Notes Chapter 34  Trade policy: a government’s policy involving restrictions placed on international trade.  Protectionism: any government policy that interferes with free trade in order to protect domestic firms and workers from foreign competition. 34.1 Free Trade or Protection  Tariff: a tax applied on imports of goods or services (purposely designed to raise the price of imported goods.  Non-tariff barriers (NTBs): restrictions other than tariffs designed to reduce imports. o I.e. import quotas and customs procedures that are deliberately more cumbersome than necessary.  Free trade encourages all countries to specialize in producing products in which they have a comparative advantage. o This specialization maximizes world production and hence maximizes average world living standards (measured by the world’s per capita GDP).  Free trade makes the country as a whole better off, even though it may not make every individual in the country better off.  Firms that do no continuously innovate will fall behind foreign competitors and will succumb to the foreign competition sooner or later.  If one country protects its domestic firms by imposing a tariff, those firms are likely to become complacent about the need to adopt new technologies, and over time they will become less competitive in international markets.  Arguments against free trade (other than maximizing national income): o Advantages of diversification  Countries whose economies are based on the production of only a few goods face risks such as:  Technological advances that may render their basic product obsolete.  Fluctuations in world prices, which will lead to large swings in national income.  Pro-tariff argument is that the government can encourage a more diversified economy by protecting domestic industries that otherwise could not compete with their foreign rivals. o Protection of specific groups  Trade restrictions can improve the earnings of one group whenever the restrictions increase the demand for that group’s services.  W/o trade restrictions, demand for labour of skilled workers will increase when the country exports a lot of product made by the skilled workforce and their wages will increase (unskilled workers wages will fall).  The trade restrictions will, however, cause a reduction in the overall national income and the country’s average living standards.  Social and distributional concerns may lead to the rational adoption of protectionist policies. But the cost of such protection is a reduction in the country’s average living standards.  Economists can do three things when presented with arguments for adopting protectionist measures regarding social and distributional concerns: o They can ask if the proposed measures really do achieve the ends suggested. o They can calculate the cost of the measures in terms of lowered average living standards. o They can see if there are alternative means of achieving the stated goals at lower cost in terms of lost national income.  Pro-tariffs (maximizing national income): o Improving the terms of trade  If an importing country has market power (represents a large portion of demand for a specific product), the imposition of a tariff can lead to an improvement in the terms of trade (if the tariff is greater than the caused increase in price to domestic consumers). o Protect infant industries  Infant industry argument: the argument that new domestic industries with potential for economies of scale or learning by doing need to be protected from competition from established, low-cost foreign producers so that they can grow large enough to achieve costs as low as those of foreign producers.  Once the end result is reached, the protection is then removed.  Successful cases: o Electronics in Taiwan o Automobiles in Japan o Commercial aircraft in Europe o Shipbuilding in South Korea o Earn economic profits in foreign markets  Strategic trade policy: a policy implemented in an attempt to help certain firms create an advantage in producing or marketing some product that is expected to generate economic profits through its sales to foreign consumers.  I.e. subsidies given to Bombardier.  Opposition to strategic trade policy argue that:  Once all countries implement similar policies, all will waste vast sums of money trying to break into industries, which there is no room for most of them. o If one government does not engage in this game, their citizens will benefit from the importing of subsidized goods and exporting of their own non-subsidized goods.  Democratic governments that enter the game of picking and backing winners are likely to make more bad choices than good ones.  Fallacious arguments for protection: o Keep the money at home  By purchasing imports, the Canadian money is sold to someone for the foreign currency who wants to spend the money in Canada.  The foreigners are not keeping our money.  It is only because Canadian money can buy Canadian products and Canadian assets that others want it. o Protect against low-wage foreign labour  If foreign workers earn low wages and the goods they produce are sold at low prices, Canadians will gain by obtaining imports at a low cost in terms of the goods that must be exported in return. o Exports are good; imports are bad  The standard of living in a country depends on the level of consumption, not on the level of income.  Income is not of much use except that it provides the means for consumption. o Create domestic jobs  The imposition of tariffs or import quotas in an attempt to create more employment in Canadian industries producing similar products as the ones hit with tariffs will reduce employment in other industries.  Employment will simply be redistributed among industries and, in the process, living standards will be reduced because employment expands in inefficient import-competing industries and contracts in efficient exporting industries. 34.2 Methods of Protection  Tariff (import duty): a tax on imported goods.  The effect of the tariff: o The domestic price of the imported product is raised by the amount of the tariff above its world price. o Imports fall. o Price rises. o Domestic producers produce more and sell at the higher price.  Both are beneficial to the producer. o Consumers are affected in two ways:  They consume less of the product.  They pay more for what they do consume. o The extra amount paid on the remaining imports goes to the government as tariff revenue.  A tariff imposes costs on domestic consumers, generate benefits for domestic producers, and generate revenue for the government. But the overall net effect is negative; a tariff generates a deadweight loss for the economy.  Import quota: a limit set on the quantity of a foreign commodity that may be imported in a given time period.  Voluntary export restriction (VER): an agreement by an exporting country to limit the amount of a good exported to another country.  Import quotas and VERs impose larger deadweight losses on the importing country than do tariffs that lead to the same level of imports. o Tariffs generate revenue for the government through the higher prices whereas import quotas simply just have higher prices.  Major difference (refers to the red area above): o The tariff permits some surplus to be captured by the importing country. o The quota allows some surplus to be captured by the exporting country.  Trade-remedy laws: non-tariff barriers that were meant to remedy certain legitimate problems that arise in international trade. o They were all too often misused and over time became a potent means of simple protection.  Dumping: the practice of selling a commodity at a lower price in the export market than in the domestic market for reasons unrelated to differences in costs of servicing the two markets. o If it lasts indefinitely, it can be a gift to the receiving country. Its consumers get goods from abroad at lower prices than they otherwise would. o Used:  To get rid of unwanted surpluses.  As a predatory attempt to drive competitors out of business.  Most governments have antidumping duties designed to protect their own industries against what is viewed as unfair foreign pricing practices.  Features that make the antidumping system highly protectionist: o Any price discrimination between national markets is classified as dumping and is subject to penalties.  Prices in the producer’s domestic market become minimum prices below which no sales can be made in foreign markets (regardless of demand in either market). o Many countries’ laws calculate the “margin of dumping” as the difference between the price that is charged in that country’s market and the foreign producer’s AC.  Foreign producers can be convicted of dumping when the profit-maximizing price for all producers is below AC during a slump in the industry.  Domestic producers are given enormous protection. o Law in the US (not in all other countries) places the onus of proof on the accused (the accused must prove the cla
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