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Trade Barriers Review for AP Economics

By — McGraw-Hill Professional
Updated on Mar 2, 2011

Review questions for this study guide can be found at:

International Trade Review Questions for AP Economics

Main Topics: Tariffs, Quotas

The issue of free trade is hotly politicized. Proponents usually argue that free trade raises the standard of living in both nations, and most economists agree. Detractors argue that free trade, especially with nations that pay lower wages than those paid to domestic workers, costs domestic jobs in higher-wage nations. The evidence shows that in some industries, job losses have certainly occurred as free trade has become more prevalent. To protect domestic jobs, nations can impose trade barriers. Tariffs and quotas are among the most common of barriers.

Tariffs

In general, there are two types of tariffs. A revenue tariff is an excise tax levied on goods that are not produced in the domestic market. For example, the United States does not produce bananas. If a revenue tariff were levied on bananas, it would not be a serious impediment to trade, and it would raise a little revenue for the government. A protective tariff is an excise tax levied on a good that is produced in the domestic market. Though this tariff also raises revenue, the purpose of this tariff, as the name suggests, is to protect the domestic industry from global competition by increasing the price of foreign products.

Example:

The domestic supply and demand for steel is pictured in Figure 17.9. The domestic price is $100 per ton and the equilibrium quantity of domestic steel is 10 million tons. Maybe other nations can produce steel at lower cost. As a result, in the competitive world market, the price is $80 per ton. At that price, the United States would demand 12 million tons, but only produce eight million tons and so four million tons are imported. It is important to see that in the competitive (free-trade) world market, consumer surplus is maximized and no dead weight loss exists. You can see the consumer surplus as the triangle below the demand curve and above the $80 world price.

If the steel industry is successful in getting a protective tariff passed through Congress, the world price rises by $10, increasing the quantity of domestic steel supplied, reducing the amount of steel imported from four million to two million tons. A higher price and lower consumption reduces the area of consumer surplus and creates dead weight loss.

Economic Effects of the Tariff

  • Consumers pay higher prices and consume less steel. If you are building airplanes or door hinges, you have seen an increase in your costs.
  • Consumer surplus has been lost.
  • Domestic producers increase output. Domestic steel firms are not subject to the tariff, so they can sell more steel at the price of $90 than they could at $80.
  • Declining imports. Fewer tons of imported steel arrive in the United States.
  • Tariff revenue. The government collects $10*2 million = $20 million in tariff revenue as seen in the shaded box in Figure 17.10 This is a transfer from consumers of steel to the government, not an increase in the total well being of the nation.
  • Inefficiency. There was a reason the world price was lower than the domestic price. It was more efficient to produce steel abroad and export it to the United States. By taxing this efficiency, the United States promotes the inefficient domestic industry and stunts the efficient foreign sector. As a result, resources are diverted from the efficient to the inefficient sector.
  • Dead weight loss now exists.

Trade Barriers

Trade Barriers

Quotas

Quotas work in much the same way as a tariff. An import quota is a maximum amount of a good that can be imported into the domestic market. With a quota, the government only allows two million tons to be imported. Figure 17.11 looks much like Figure 17.10, only without revenue collected by government. So the impact of the quota, with the exception of the revenue, is the same: higher consumer price and inefficient resource allocation.

Trade Barriers

"It is important to know the differences between tariffs and quotas"

    —Lucas, AP Student

Tariffs and quotas share many of the same economic effects.

Review questions for this study guide can be found at:

International Trade Review Questions for AP Economics

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