An Introduction to Protectionism
- Free trade aims to maximise global output through national specialisation
- However, there are numerous reasons why countries would seek to limit free trade in order to protect themselves from certain outcomes
- This is called protectionism and may take the form of import tariffs, export subsidies, the use of quotas or embargoes
An Explanation of Tariffs
- The most commonly used forms of trade protectionism include tariffs, subsidies, quotas and administrative barriers
- A tariff is a tax on imported goods/services (customs duty)
- The tax raises the selling price of the good/service within the country
- The tax raises the selling price of the good/service within the country
- The higher price allows more inefficient domestic firms to increase their production and market share
- More efficient global competitors reduce their output due to the tariff
- With increased domestic output, employment may increase
A tariff raises the price of the world supply from PW to PW + Tariff. This reduces the quantity of imports from Q1Q2 to Q3Q4
Diagram Analysis
- World supply (SW) is considered to be infinite and this supply curve is included with the domestic demand (DD) and supply (SD) curves
- The pre-tariff market equilibrium is seen at PwQ2
- Domestic firms supply up to Q1 at a price of Pw
- Foreign firms supply the difference equal to Q1Q2 at a price of Pw (imports)
- After the tariff is imposed, the world price increases from Pw to Pw+ tariff
- The new market equilibrium is seen at Pw+tariff and Q4
- Following the law of demand, the quantity demanded contracts from Q2 to Q4
- Following the law of supply, the quantity supplied by domestic firms extends from Q1 to Q3
- The level of imports is reduced from Q1Q2 to Q3Q4
An Evaluation of Tariffs
- The best way to consider the impact of a tariff on stakeholders is to explain it using a diagram
A tariff impacts domestic producers, consumers, foreign producers and the government
The Impact of Quotas on Stakeholders
Stakeholder |
Explanation of Impact |
Domestic Producers |
|
Foreign Producers |
|
Domestic Consumers |
|
The Government |
|
Downstream Producers |
|
Society (welfare loss) |
|
Exam Tip
Tariffs are one of the most frequently examined sub-topics in Paper 2. When evaluating their use, consider how many jobs are protected (or created) in the industry that is targeted by the tariff as opposed to jobs which may be lost in multiple downstream industries due to higher prices.
For example, a tariff on solar panel imports protects a few firms who manufacture solar panels. However, the higher prices can cause a significant fall in the quantity demanded leading to the possible loss of thousands of jobs for installation experts.