Restrictions on Free Trade (Edexcel A Level Economics A)
Revision Note
Written by: Steve Vorster
Reviewed by: Jenna Quinn
Reasons for Restrictions on Free Trade (Protectionism)
Free trade aims to maximise global output based on the principle of comparative advantage
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 limiting imports, limiting exports, boosting exports - or putting administrative barriers in place
Reasons for protectionism
Reason | Explanation |
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Infant industries |
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Sunset industries |
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Strategic industries |
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Dumping |
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Employment |
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Current Account deficit |
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Labour/environmental regulations |
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Types of Protectionism
The most commonly used forms of trade protectionism include tariffs, subsidies, quotas and administrative barriers
Tariffs
A tariff is a tax on imported goods/services (customs duty)
Domestic producers/retailers have to pay the tariff when the good/service crosses the border into the country
This raises the cost of production for domestic firms
Firms often pass on the increased costs to consumers in the form of higher prices
These higher prices allow some domestic firms to increase their output (law of supply)
More inefficient domestic firms are now producing at the expense of more efficient firms globally who reduce their output due to the tariff
With increased domestic output, employment may increase
Diagram analysis
World supply (Ws) is considered to be infinite and this supply curve is added to 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+tariffQ4
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
Quotas
A quota is a physical limit on imports e.g. in June 2022 the UK extended their quota on steel imports for a further two years in order to protect employment in the domestic steel industry
This limit is usually set below the free market level of imports
As cheaper imports are limited, a quota raises the market price
As cheaper imports are limited a quota may create shortages
Some domestic firms benefit as they are able to supply more due to the lower level of imports
This may increase the level of employment for domestic firms
Subsidies to domestic producers
A subsidy lowers the cost of production for domestic firms
They can increase output and lower prices
With lower prices their goods/services are more competitive internationally
The level of exports increases
The increased output may result in increased domestic employment
Non-tariff barriers
There are many strategies that can be used to create barriers to trade using less obvious methods than tariffs, quotas and subsidies
Health and safety regulations e.g. in 2017 the EU put a new health regulation in place regarding the permitted level of aflotoxins in nuts. Aflotoxin levels are naturally higher in southern hemisphere countries and it effectively blocked the import of southern hemisphere nuts
Product specifications e.g. Canada specified that all jam imported into Canada needed to be in a certain size of jar. Many countries do not usually manufacture jars in the required size
Environmental regulations e.g. in November 2021 new regulations were put in place in the EU and the USA to limit the amount of imports of 'dirty steel' - predominantly this is steel produced using coal fired power stations which are prevalent in China
Product labelling can be expensive for firms to apply and may limit their desire to sell into certain markets
Impacts of Protectionist Policies
Protectionist policies have a range of impacts on consumers, producers, governments, living standards, and equality
Tariffs
The best way to consider the impact of a tariff on stakeholders is to explain it using a diagram
Domestic producers
Before the tariff domestic producers produced output equal to 0Q1 and their revenue was equal to Pw X Q1
After the tariff was imposed domestic producers produced 0Q3 and their revenue was equal to Pw X Q3
Domestic producer surplus has increased by area 2
Domestic consumers
Before the tariff domestic consumers consumed Q2 products at a price of Pw
After the tariff domestic consumers consumed fewer products (Q4) at a higher price of Pw+tariff
Domestic consumer surplus has decreased by areas 1, 2, 3 and 4
Government
After the tariff is imposed the government receives tax revenue equal to ((Pw+tariff) - Pw) x (Q4-Q3) - area 3
Standards of living
The standards of living for consumers worsen as the value of their income is eroded as they are paying higher prices
Domestic firms who benefit from increased production may increase employees' wages
This would increase the standard of living for employees
Equality
Workers in industries that have been experiencing structural unemployment due to foreign competition will feel that the tariff results in them being treated more fairly
The Impact of Quotas, Subsidies and Non-tariff Barriers on Stakeholders
Stakeholder | Quota | Subsidies | Non-tariff |
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Domestic Producers |
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Foreign Producers |
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Consumers |
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Government |
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Standards of Living |
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Equality |
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