chapte5 - Chapter 5 I. Free Trade vs. Actual Trade Policies...

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Chapter 5 I. Free Trade vs. Actual Trade Policies A. “Protectionism”: efforts by governments to protect industries from competing imports. Some methods are: 1. Tarriffs: a tax (or “levy”) on imported goods of a specified type or national origin. Domestic producers benefit. Domestic consumers of the good lose out, as they have to pay higher prices, and foreign producers lose sales. a. How “Elasticity” affects the burden of the tariff. Elasticity is the change in Quantity that results from a Change in Price. A steep demand curve is called inelastic. In this diagram, the higher price after the tariff is largely absorbed by the consumers, and quantity does not fall much. This is characteristic of goods which are viewed as necessities or have few substitutes. b. On the other hand, with an “elastic” Demand curve, which is flatter, has a significant decline in quantity demanded for just a small increase in price. These sorts of goods are viewed by consumers as strictly optional purchases, and have many available substitutes. In this case, the burden of the tariff is mostly on the foreign producer, while in the inelastic case, most of the burden is on the domestic consumers. c. Another party that may lose out is other domestic businesses in related industries. For example, the steel tariffs imposed in the last few year saved jobs in the U.S. steel industry but cost more jobs in industries that were relying on (now higher- priced) steel. d. Another party that benefits is the government, which collects more tax revenue in the form of the tariff, and even more revenue correlating with the improved fortunes of the domestic producers in the protected industry. 2. Quotas A maximum quantity of imports allowable for a certain good. This has the same effects as a tariff, and is equally dependent on demand elasticity to determine where the burden predominantly falls, but a big difference is the lack of tax revenue relative to a tariff. 3. Embargoes A prohibition against importation of a country’s goods. While other protectionist measures are usually responses to economic conditions (like a flood of inexpensive imports of a certain type) the embargo is usually a response to a political situation. It is a condemnation that sends a message to a foreign government, and may be accompanied by restrictions on the types of goods that will be legal for export to that country. 4. “Rational Ignorance” The question is raised, why would domestic consumers accept quotas and other government-maintained distortions in goods prices (like agricultural subsidies) when they result in higher market prices, to the benefit of some producers. “Rational Ignorance” argues that when benefits are concentrated (in this case, in the profits of producers) and losses are spread thin across the population, it is not seen as worth people’s time to resist the protectionist measures. The same principle is at work when the losses are concentrated in certain
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This note was uploaded on 08/04/2008 for the course ECON 1A taught by Professor Patyk during the Spring '08 term at Foothill College.

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chapte5 - Chapter 5 I. Free Trade vs. Actual Trade Policies...

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