Free Trade, Protectionism, Tariff Good or Bad? PDF

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Free Trade, Protectionism, Tariff Good or Bad?...

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FREE TRADE GOOD

BAD

Comparative advantage ● where a country should specialize in a good that they are best at and has lower production costs to increase total world output

There are flaws in the theory ● due to diminishing returns and diseconomies of scale acting as limitation of the theory ○ ex. US FOPs may not be transferable (diminishing returns graph) ● over specialization ○ rely on just one primary source ● unstable economic activities ○ ex. Malawi tobacco production → 53% of their GDP

Consumer surplus increases, producer surplus decreases ● overall gain in terms of welfare ● countries have a variety of goods to choose from

Dumping: allows producers to sell products at a lower cost than that of production ● if this continues, firms that are not dumping will experience fall in revenue ○ causing them to reduce variable costs: wages ○ laying off workers causing structural unemployment ● LD shifting in

Increases competition ● and helps firms become more dynamically efficient through research and development

Firms from LEDCs cannot compete with MEDCs + infant industries ● more competition can lead to an increase in poverty in LEDCs

 Argument #1 Free trade  is beneficial  as it  allows firms to enjoy  comparative  advantage,  where in countries should produce goodsthat they  are bestat whichhasthelowestopportunitycostandresultsinalarger total  world output. This causes firms to be more productively and allocatively efficient. HOWEVER this can be dangerous as  it  can  foster  overspecialization on a certain good or service,  which causes economic uncertainty as a country may rely on just  one primary source. This isseen in Malawi where  53% of  their Real GDP is reliant  on  their tobacco  industry.  Additionally,  there are  limitations to the  theory as it does not take into consideration diminishing returns and diseconomies of scale.  This is depicted on  the  graph  above  where an increase in a factor of production may lead to an  increase in  long run average costs, therefore being one of the flaws in the theory.   

Argument #2 In addition, an advantage of free trade is that it benefits consumers because as a result, consumer surplus increases while producer surplus decreases. Therefore, this suggests that  there is an overall welfare gain as consumers have a larger variety to choose from. HOWEVER free trade may foster acts such as dumping, which allows producers to sell products at  a  lower cost than that of production. If firms continue this practice, it may cause structural  unemployment.  If  dumping occurs, firms that are not dumping will experience a fall in revenue, whichwillcause firmsto  reduce their variable costs, in the form of wages for their employees thusresulting to firms laying off  workers. A decrease in employment may cause structural unemployment topersistwhereLD shiftsin  to LD1.   Argument #3 Free trade also fosters more  competition  as  firms  have an incentive to become more dynamically  efficient through research and development of their products. ALTHOUGH this can be bad as heavy competition may not allow firms in LEDCs to compete against firms in  MEDCs. More competition can lead to anincrease inpovertyforLEDCs. Infant industries would notbe  able to develop as well.   

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TRADE PROTECTIONISM GOOD

BAD

Comparative advantage ● lead to an increase in total world output and increase in allocative and productive efficiency

Does not take into account diminishing returns and diseconomies of scale ● goods that are specialized destroys cultural protection and food security because there is free trade

Dumping: price of a country’s exports is below the true costs of production ● allows countries to take action against dumped products: beneficial to local producers less foreign competition

Limits exchange of new ideas and technology ● dynamically inefficient, not allowing for research and development to occur ○ lacking competition within the industry, no incentive to innovate

Infant industry ● protecting newly established industries from foreign competition ○ infant industries cannot compete with foreign competition ○ governments can impose a tariff or subsidy or quota to adjust infant industries thus theoretically create less competition as well as decreased costs

Subsidies are inefficient ● large opportunity cost ○ government is not good at picking winners ● tariffs mean that there’s less consumer choice as there is less competition also potentially productively inefficient

 1. COMPARATIVE ADVANTAGE a. lead to an increase in total world output and increase in allocative and productive efficiency b. HOWEVER more often than not i. goods that are specialized destroys cultural protection and food security because there is free trade ii. does not take to account diminishing returns and diseconomies of scale 2. DUMPING a. allows countries to take action against dumped products: beneficial to local producers less foreign competition b. HOWEVER protectionism may limit the exchange of new ideas and technology thus being dynamically inefficient, not allowing for research and development to occur i. lacking competition within the industry, no incentive to innovate 3. INFANT INDUSTRY a. protecting newly established industries from foreign competition

i.

infant industries cannot compete with foreign competition, helps them grow domestically and internationally ii. governments can impose a tariff or subsidy or quota to adjust infant industries thus theoretically create less competition as well as decreased costs iii. subsidy/tariff/quota graph b. HOWEVER subsidies are a large opportunity cost and can be inefficient as the government is not good at picking winners i. tariffs mean that there’s less consumer choice as there is less competition also potentially productively inefficient   

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TARIFF Comparative advantage ● comparative advantage to domestic producers ○ increase in market share which foreign producers experience decrease in market share

Higher prices, lower quantity ● more domestic consumers lose out because they have to pay higher prices of less varied goods ● domestic producer surplus increases while domestic consumer surplus decreases ● overall welfare loss

Tariff revenue increases government May anger foreign producers ● causes them to retaliate and engage in expenditure ● taxes from tariff goes to gov expenditure tariff war ● gov expenditure is determinant of AD ● ideally increase in revenue in Vietnam ○ helps countries close should go to the distribution of merit deflationary gaps and public goods; however theory may ○ ex. gov revenue of vietnam 40% not hold due to corruption from tariff Infant industry faced with heavy competition Less choices ● tariff will help them compete and grow ● tariffs mean that there’s less consumer until they are able to achieve economies choice as there is less competition also of scale and when they can become potentially productively inefficient competitive on their own ● helps them grow domestically and internationally  1. DOMESTIC VS. FOREIGN PRODUCERS a. tariff gives artificial COMPARATIVE ADVANTAGE to domestic producers i. experience increase in market share while foreign producers experience decrease in market share b. HOWEVER i. higher prices and lower quantity → more domestic consumers lose out because they have to pay higher prices for less varied goods ii. domestic producer surplus increases while the domestic consumer surplus decreases iii. overall welfare loss resulting from the tariff 2. TARIFF REVENUE VS. TRADE WAR a. tariff revenues increase government expenditure i. government expenditure is a determinant of aggregate demand, AD → AD 1 ii. aid LEDCs close to deflationary gaps iii. example: 40% government revenue of Vietnam from tariff iv. AD shifts out to YF graph b. HOWEVER imposition of tariff may anger foreign exporters

i. ii.

causes them to retaliate and engage in tariff war ideally increase in revenue in Vietnam should go to the distribution of merit and public goods; however theory may not hold due to corruption 3. INFANT INDUSTRY a. infant industries would be faced with very heavy competition i. tariff will help them compete and grow until they are able to achieve economies of scale and when they can become competitive on their own    

 WHY DOES IT MAKE SENSE FOR COUNTRIES TO FOLLOW COMPARATIVE & ABSOLUTE ADVANTAGE SPECIALIZATION GOOD OR BAD  1. TOTAL WORLD OUTPUT INCREASES a. if they follow and specialize, the total world output should increase therefore being productively and allocatively efficient b. creative destruction from structural unemployment c. HOWEVER theory assumes that countries are at free trade, which is highly unlikely i. does not take into account diseconomies of scale and diminishing returns therefore graph line would not be straight ii. FOPs would not always transfer smoothly 2. ALLOWS EXCHANGE OF NEW TECHNOLOGY AND IDEAS a. structural unemployment → government can still achieve full employment therefore not completely detriment the economy (side issue) 3. OTHER NEGATIVE EFFECTS a. government may give subsidy to good from service A therefore unfair comparative advantage b. country A may dump their goods to country B i. there must be a level playing field c. can engage in retaliation and cause a trade war 

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FREE TRADE NOTES 1. COMPARATIVE ADVANTAGE a. where a country should specialize in a good that they are best at and has lower production costs to increase total world output b. HOWEVER → theory may not hold true due to diminishing returns and diseconomies of scale acting as limitation of the theory i. example: US FOPs may not be transferrable (diminishing returns graph) ii. over specialization → fall in total output as they may rely on just one primary resource iii. unstable economic activities  iv. example: Malawi tobacco production → 53% of their GDP 2. INCREASES COMPETITION: benign a. allows firms to enter the market which helps lower domestic monopoly power i. increase consumers ii. example: World Bank and International Monetary Fund has trade condition that if firms were to borrow money from them they need to open firms in poorer countries in order to achieve efficiency, lighter growth, and lower poverty b. HOWEVER → may not be the case i. a decrease in price can be potentially deflationary → loss of price stability one of the macroeconomic objectives and decrease in total revenue 3. FREE EXCHANGE FOREIGN RESOURCES: benign  a. allows for free exchange of resources b. HOWEVER → trade is malignant i. it could lead to the loss of cultural diversity ii. free exchange of goods could lead to producers selling demerit goods at cheaper prices iii. could lead to political conflicts 1. example: China and Philippines refuse to trade bananas due to spratly islands conflict ...