Free trade and protection

PPF

• illustrates consumer preferences

Absolute advantage

• has an absolute advantage if it can produce that good more efficiently

• more efficiently- using less resources to produce a given quantity/ using given resources to produce greater quantity

Assumptions of the absolute advantage model

• world consists of two countries

• each country produces and consumes two goods

• resources are perfectly mobile (can be shifted between industries with no displacement cost)

• no transport costs when trading

terms of trade

• rate that different commodities exchange for each other between countries

• lies between opportunity cost ratios

• after specialisation and trading, both countries can enjoy a higher standard of living and consume outside PPF

Comparative advantage

• lower opportunity cost (relative price)= compartive advantage

• domestic price is lower than world price= country is efficient and will benefit from exporting

• lies where absolute advantage is greatest when country has absolute advantage of both goods

Sources of comparative advantage

• quality and quantity of natural resources

• demographics

• rates of capital investment

• economies of scale

• investment research and development

• strong financial institutions

• non- price competitiveness of producers

• import controls (tariffs, export subsidies, quotas make an artificial comparative advantage)

Alternative of specialisation

self sufficiency

• each country produces everything itself

• inefficient

draw and explain graph showing gains of exports

• net increase in total welfare

gains from imports

• if world price is lower than domestic price

• net increase in economic welfare and total surplus

trade liberalisation

• achieved by removing or reducing restrictions which limit trade in goods and services

• level of protection on Australian industry has significantly reduced- average tariff protection across all manufacturing industries is below 5%

Arguments for free trade

• increases real incomes and living standards- cheaper world price, greater access to a variety of products

• increases efficiency through greater competition (only the most efficient domestic producers are able to operate)

• promotes economic growth through trade and investment (exports contribute to GDP)

• benefits domestic producers through lower input prices, greater volume of sales greater market access

Protectionism

• achieved by introducing restrictions which limit trade in goods and services

• level of protection on Australian industry has significantly reduced- average tariff protection across all manufacturing industries is below 5%

Tariffs

• tax imposed that increases domestic price of imports/ exports

• artificially higher prices for consumers causes decreased domestic consumption

• designed as a price benefit to domestic goods

• most widely used, efficiently produces government revenue

• commonly imposed on motor vehicles, clothes and footwear

Subsidies

• grants or payments to domestic producers to lower production costs

• opportunity cost exists

• used in motor industry

quotas

• government imposed trade restriction that limits number/ monetary value of goods that a country can import/ export during a particular period

• restricts foreign competition

• more effective in restricting trade than tariffs, especially if demand is inelastic

• can be used as a coercive economic weapon, making it more disruptive to international trade

Arguements for protectionism

• infant industry argument

• national security argument

• diversification argument

• anti-dumping argument

• increased employment argument

• cheap foreign labor argument

infant industry argument

• require government support to accumulate economies of scale and compete globally

• - hard to judge how long support is required, and if the industry can compete independently. causes market inefficency that outweighs benefit to soceity in short term

diversification argument

• variety of different production and export industries

• enables diverse skill set in workforce

• involves supporting inefficient industries and teaching workers skills that may become redundant

anti- dumping argument

• impose duties on foreign products below market price that undercut local businesses to gain market share

• protect domestic producers by keeping their prices competitive

• difficult to determine if they’re dumping or just more efficient + higher consumer prices (reduced international competitivenss, domestic producers can raise prices to duty level)

national security argument

• protect essential industries in case of war or pandemic

• subjectively “essential”, may support inefficient industries that we’ll never need

increased employment argument

• sustaining industries= more domestic jobs

• prevents structural unemployment, which would’ve been good since it forces labor force away from inefficient industries to industries with a comparative advantage or a need for more workers

• results in workers whose skills are suited to inefficient industries

cheap foreign labor argument

• discourage benefiting from exploitation

• can create poverty in areas where it didn’t exist before

favorable balance of trade

• negative trade balance can shrink economy

• isnt necessarily bad- can result from various economic factors and can indicate high living standards and disposable income where consumers can afford a variety of imported products

general arguments against protectionism

• allows inefficient industries to benefit at the expense of efficient industries- inefficient resource allocation and disincentives inefficient industries from increasing efficiency to compete