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PART 1 : Trade Theory

1 Why do Nations Trade ? What are some of the major argument for and against a Free

Trade ? What are the (Benefits and Costs) of Free Trade (Present: at

Individual/Firms/Nation)?

 Nation Trade because:

Countries trade with each other when, on their own, they do not have the resources, or capacity to satisfy their own needs and wants By developing and exploiting their domestic scarce resources, countries can produce a surplus, and trade this for the resources they need

Goods and services are likely to be imported from abroad for several reasons Imports may be cheaper, or of better quality They may also be more easily available or simply more appealing than locally produced goods In many instances, no local alternatives exist, and importing is essential This is highlighted today in the case of Japan, which has no oil reserves of its own, yet it is the world’sfourth largest consumer of oil, and must import all it requires

The production of goods and services in countries that need to trade is based on two fundamental principles, first analysed by Adam Smith in the late 18th Century (in The Wealth of Nations, 1776), these being the division of labour and

Specialisation

+ Specialize in the manufacture and export of products can be produced most efficiently in that country : The exploitation of a country's comparative advantage, which means that trade encourages a country to specialise in producing only thosegoods and services which it can produce more effectively and efficiently, and at thelowest opportunity cost

+ When countries specialise they are likely to become more efficient over time This is partly because a country’s producers will become larger and exploit economies of scale Faced by large global markets, firms may be encouraged to adopt mass production, and apply new technology This can provide a country

with a price and non-price advantage over less specialised countries, making it increasingly competitive and improving its chances of exporting in the future

- Importing products can be produced more efficiently in other countries

- Trade is also likely to increase employment, given that employment is closely

related to production Trade means that more will be employed in the export sector and, through the multiplier process, more jobs will be created across the whole economy

 The major argument for Free Trade

- All countries can benefit if each country specializes in production those goods

it can produce best and satisfy their other wants and needs by trading for them.This will lead to an optimum and efficient utilization of resources and, hence, economy in production

- Free trade can raise aggregate economic efficiency and aggregate economic welfare

- Because of unrestricted trade, global output increases since specialization, efficiency, etc., make production large scale Free trade enables countries to obtain goods at a cheaper price This leads to a rise in the standard of living of people of the world Thus, free trade leads to higher production, higher

consumption and higher all-round international prosperity

- Free trade will benefit a country even if it is less efficient than all other

countries in every industry

- Accessibility of Domestically Produced Goods and Services: Free trade enables each country to get commodities which it cannot produce at all or can only produce inefficiently Commodities and raw materials unavailable domesticallycan be procured through free movement even at a low price

- Free trade would cause world resources to be utilized most efficiently,

maximizing world welfare

- Import products can be produced more efficiently in other countries

- Competitive Spirit: Free Trade keeps the spirit of competition of the economy

As there exists the possibility of intense foreign competition under free trade, domestic producers do not want to lose their grounds Competition enhances efficiency Moreover, it tends to prevent domestic monopolies and free the consumers from exploitation

- Greater International Cooperation: Free trade safeguards against

discrimination Under free trade, there- is no scope for cornering raw

materials or commodities by any country Free trade can thus promote

international peace and stability through economic and political cooperation

- Free from Interference: Free trade is free from bureaucratic interferences Bureaucracy and corruption are very much associated with unrestricted trade

 The major argument Against Free Trade (Protectionism):

- Governments do restrict free international trade in order to protect domestic industries from foreign competition The restriction of international trade is called protectionism

- Supporters of "protectionist" laws claim that keeping out foreign goods will+ Save jobs

+ Give ailing domestic industries a chance to recover and prosper

+ Reduce the trade deficits

+ More growth opportunities: Protectionism provides local industries with growth opportunities until they can compete against more experienced firms inthe international market

+ Lower imports: Protectionist policies help reduce import levels and allow the country to increase its trade balance

+ More jobs: Higher employment rates result when domestic firms boost their workforce

+ Higher GDP: Protectionist policies tend to boost the economy’s GDP due to a rise in domestic production

+Protectionism can also prevent dumping

+Protectionism makes domestic firms less competitive in the export market+Protectionism could improve a nations economic well-being is when a countryhas monopoly power over a goods

+Protectionism permits the new and upcoming firms to work and develop at anaceptable rate Because they will not be pressured by foreign, more

experienced firms

 Benefits of International Trade

- High prices for exports and lower prices for imports is a net gain for a

country Efficient allocation of resources is a result of such exchanges There’s

an increase in overall welfare because of the larger bundle of goods from such affiance

- Trade liberalization increases real GDP Efficient allocation of resources has a

positive influence on GDP International trade offers the exchange of ideas and technical flow of expertise

- Development of high quality and more effective institution’s policies

encourages domestic innovations Domestic productivity benefits from foreign

development and researchers

- Global competition motivates companies to become more efficient because they face an open field Multinationals also operate on a larger scale leading to

cost savings

- Consumers access a variety of goods and services at lower prices Hence,

living standards of people improve The absence of restrictions and tariffs enable production and shipment; hence, ensuring availability of goods and services

- An increase in competition leads to a fall in monopoly power Thus, the

market becomes more efficient

- Trade encourages efficiency Through specialization, countries have to

concentrate on producing more of the goods they could produce very well overgoods they cannot produce with efficiency

 Costs of International Trade

- Loss of jobs and inequality in income caused by competition As states

concentrate on free trade, the domestic industries adjust to this change As a result, they exist as the main exporters However, the same exporters face import competition

- Less efficient firms exit the market Reason being resources are re-allocated

according to whether the firm is growing or contracting As firms close, some countries can be at a loss at the expense of other countries

- An increase in imports causes domestic industries to compete with imports

Technology and capital might not be as developed in some countries As such, they cannot compete with developed countries in some industries

2 What were the Mercantilists view on Trade ? What are the new contribution of

Mercantilist’s views on Trade ? What is the weak point of Mercantilist’s ? Discuss?

 The Mercantilists view on trade:

- Mercantilism is an economic theory that advocates government regulation ofinternational trade to generate wealth and strengthen national power Merchants and the Government work together to reduce the trade deficit and create a surplus It funds corporate, military, and national growth Mercantilism is a form of economic nationalism.It advocates trade policies that protect domestic industries

- Export surpluses brought inflow of gold and silver

- Trade policy was to encourage exports and restrict imports

- One nation gained only at the expense of another

 Mercantilism suggests that it is in a country’s best interest to maintain a trade surplus – to export more than it imports To ensure that a country exported a lot and imported only a little, the Mercantilists were in favor of high tariffs Mercantilism advocates government intervention to achieve a surplus in the balance of trade

 The new contribution of Mercantilist’s views on Trade

- To recognize the importance of International Trade.

- Mercantilism suggests that countries | government should design policies that lead to an increase in their holdings of gold and silver

- This was usually done by increasing exports and limiting imports This economic

philosophy was used by Europeans from about the 1500s to the late 1700s

- To ensure that a country exported a lot and imported only a little, the mercantilistswere in favor of high tariffs Mercantilism advocates government intervention to achieve a surplus in the balance of trade

 The weak point of Mercantilist’s

- The key problem with the mercantilist view is that it views trade as a zero sum

game, where if one country benefits the other must lose As an economic

philosophy, Mercantilism is flawed Mercantilism weakens country in long run; enriches only a few

- In 1770s, Adam Smith argued that import restrictions would reduce the gains from specialization and make a nation poorer He used absolute advantage to explain the benefits of trade

- It creates high levels of resentment.

Trickle-down economics works on paper It just doesn’t work well in real life thanks

to the inherent greed that so many people have Why give others money when youcan keep it for yourself? The rich tend to get richer in a system of mercantilism andthe working class gets to be stagnant at best Eventually this creates resentment, which leads to rebellion, and ultimately it led to many colonies seeking out their own independence

- It creates a preference for the mother nation to always be first.

Many colonies are also treated as a foreign nation in a system of mercantilism Thecolonies are forced to sell their local raw materials for a bargain basement price and then be forced to purchase manufactured goods at a higher price than

necessary This creates an even wider wealth gap between the different income classes

- There is always a risk of local raw materials and resources running out.

Because mercantilism is based on the complete use of natural resources, there willalways be a day when those resources run out Natural resources are finite in nature, so even if there is an extensive reserve in place that can be accessed, that reserve will one day run out If that happens sooner rather than later, then the entire economy can collapse

- The system is ultimately quite inefficient.

Because materials and goods are shipped back and forth between colonies and their mother nation, the price of goods is inflated more than it needs to be Even with modern shipping methods, it costs less to manufacture goods locally where

raw resources are available than it does to ship those items back and forth

Because of this, it also creates vulnerabilities in both economies should those shipments be intercepted by someone else

gains from trade generated ? What policies did Adam Smith advocate in International Trade ? What did he think was the proper function of government in the economic life of the

Nation?

- "It is the maxim of every prudent master of a family, never to attempt to make at home what it will cost him more to make than to buy.” (Adam Smith)

- Specialization and trade among regions and countries are based upon the same principle as among individuals

- 1776 Adam Smith, The Wealth of Nation

+ Word’s wealth is not a fixed quantity+ International trade

 Increase the general level of productivity within a country

 Increase world output (wealth)

- Adam Smith argued that a country has an absolute advantage in the production of

a product when it is more efficient than any other country in producing it

- According to Smith, countries should specialize in the production of goods for which they have an absolute advantage and then trade these goods for the goods produced by other countries

 Gains from trade generated

- In 1770s, Adam Smith argued that import restrictions would reduce the gains fromspecialization and make a nation poorer He used absolute advantage to explain the benefits of trade Adam Smith argued that a country has an absolute

advantage in the production of a product when it is more efficient than any other country in producing it

- When one nation has absolute advantage in production of a commodity, but an absolute disadvantage with respect to the other nation in a second commodity, both nations can gain by specializing in their absolute advantage good and exchanging part of the output for the commodity of its absolute disadvantage

- According to Smith, countries should specialize in the production of goods for which they have an absolute advantage and then trade these goods for the goods produced by other countries

- Specialization and trade advantage both countries

- Adam Smith and other classical economists advocated policy of laissez-faire, or minimal government interference with economic activity

- Free trade would cause world resources to be utilized most efficiently, maximizing

world welfare

- As one might expect from Smith’s conviction that markets were extremely

efficient, he was in favor of a government that did not hamper the working of the market

- However, Smith emphasized the fact that the government should

+ Maintain law and order+ Ensure the defense of the nation from foreign enemies,+ Erect and maintain public works that private citizens would not build+ Subsidize education for those who could not afford it, and

+ Regulate international trade when free trade endangers ‘infant industries’ or compromises national security

Absolute Advantage ?( Compare the theory of Absolute Advantage and Comparative

Advantage ?) Why this theory is more relevant to the modern trade situation ? How do gains from Trade Arise with Comparative Advantage?

Ricardo’s law of Comparative Advantage superior to Smith’s Theory of absolute advantage:

 A country has an absolute advantage when it produces a large number of goods with the same resources that other country are using, on the other hand, the comparative advantage means producing better quality at cheaper price incurring lower

opportunity cost than the other country

 The Smith does not take the limitation of production factor into the account while Ricardo does According to Smith, a country would produce all the goods in which they are better performing They have low absolute cost after having an absolute advantage; spend fewer factors in making one unit of product, but it cannot be the manufacturing center of all goods and services A country cannot outperform in all types of goods and secondly, it cannot take an advantage of economies of scale which leads to inefficiency if a country tries to produce all goods and it may lead to an increase in prices

 Instead, Ricardo focused on the relative cost of production He emphasized that the country should produce those goods in which they have comparatively low

opportunity cost than the other countries A country has to decide what to produce and what to sacrifice This gives other countries an opportunity to produce goods efficiently and to take advantage of economies of scale in which a large number of goods are produced at a low cost

Compare the theory of Absolute Advantage and Comparative Advantage:

Comparative Advantage Absolute Advantage

- Even if someone is absolutely

more productive at 2 activities,

if he is comparatively more productive at 1 activity than another relative to a 2nd person, he will be better off specializing and trading than producing in isolation

The causes of economic

progress and the creation of wealth was Adam Smith’s main topic of interest

- David Ricardo, by contrast, focused on how wealth is sharedamong different groups in society

- According to Smith, the wealth

of a nation derives from the level of the technology in use

- The level of technology and its

rate of improvement depend onthe division of labor

- Ability of a country to produce more goods with same amount of resources than other country

Benefit - Trade is mutually beneficial

- Benefits both the countries

- Trade is not mutually beneficial

- Beneits the Country with absolute advantage

producing good impact the Country’s comparative advantage

- Absolute cost of producing goods impacts if the country has absolute advantage

Economic Nature - It is mutual and reciprocal - It is not mutual and

reciprocal

This theory is more relevant to the modern trade situation:

 A contemporary example: China’s comparative advantage with the United States is in the form of cheap labor Chinese workers produce simple

consumer goods at a much lower opportunity cost The United States’ comparative advantage is in specialized, capital-intensive labor American workers produce sophisticated goods or investment opportunities at lower opportunity costs Specializing and trading along these lines benefit each

 The theory of comparative advantage helps to explain why protectionism is typically unsuccessful Adherents to this analytical approach believe that countries engaged in international trade will have already worked toward finding partners with comparative advantages

 If a country removes itself from an international trade agreement, if a government imposes tariffs, and so on, it may produce a local benefit in theform of new jobs and industry However, this is not a long-term solution to

a trade problem Eventually, that country will be at a disadvantage relative

to its neighbors: countries that were already better able to produce these items at a lower opportunity cost

Gains from Trade with Comparative Advantage:

 Country should specialize in the production of those goods in which it is relatively more productive even if it has absolute advantage in all goods itproduces

 Gain from trade depends on the comparative cost conditions Comparative cost doctrine suggests that trade can provide benefit to all countries if they specialise in the production of those goods and, hence, export them in which they have comparative advantage

 The idea of gains from trade was at the core of the classical theory of international trade propounded by Adam Smith and David Ricardo

According to Smith, the gains from trade arise form the advantages of division of labour and specialisation—both at the national and internationallevel Such advantages arise, according to Smith, due to the absolute

differences in costs Ricardo goes a step further He says that trade

contributes “to increase the mass of commodities, and therefore, the sum

of enjoyments…” Ricardo adds that the gain from trade consists in the saving of cost resulting from obtaining the imported goods through trade instead of domestic production

 Ricardo’s comparative cost thesis may be applied to establish the existence

of gains from trade In other words, gain from trade depends on the

comparative cost conditions Comparative cost doctrine suggests that trade can provide benefit to all countries if they specialise in the production of

those goods and, hence, export them in which they have comparative advantage.

 A country, thus, specialises in production and export in accordance with its comparative advantage Ricardo’s trading nations acquire complete

specialisation in production As a result, global output becomes larger than under autarky Trade also enables each country to consume more than under isolation Thus, there is a production gain and a consumption gain arising out of international trade Such gains cannot be reaped in the absence of trade

disadvantage in the production of both goods

- Even if a nation has an absolute cost disadvantage in the production of both goods

+ The less efficient nation

 Specialize in and export the good in which it is relatively less inefficient

o Where its absolute disadvantage is least + The more efficient nation

 Specialize in and export the good in which it is relatively more inefficient

o Where its absolute disadvantage is greatestThere are gains from trade for both countries This is the second lesson of the

Ricardian model

Countries have comparative advantage in producing different goods and hence they can get mutual benefits from trade This is because countries differ from each other The more different they are, the larger the (potential) benefits from trade

5 What are the sources of Comparative Advantage ?

 Comparative advantage is a dynamic concept meaning that it can and does change over time For a country, the following factors are important in determining the relative unit costs of production:

 The quantity and quality of factors of production available for example some countrieshave an abundant supply of good quality farmland, oil and gas, fossil fuels Climate and geography have key roles in creating differences in comparative advantage

 Different proportions of factors of production – some countries have abundant cost labour suitable for volume production of manufacturing products

low- Increasing returns to scale and the division of labour – increasing returns occur when output grows more than proportionate to inputs Rising demand in the markets wheretrade takes place helps to encourage specialisation, higher productivity and internal

and external economies of scale These long-run scale economies give regions and countries a significant advantage.

 Investment in research & development which can drive innovation and invention

 Fluctuations in the exchange rate, which then affect the relative prices of exports and imports and cause changes in demand from domestic and overseas customers

 Import controls such as tariffs, export subsidies and quotas – these can be used to create an artificial comparative advantage for a country's domestic producers

 The non-price competitiveness of producers - covering factors such as the standard of product design and innovation, product reliability, quality of after-sales support Manycountries are now building comparative advantage in high-knowledge industries and specializing in specific knowledge sectors – an example here is the division of

knowledge in the medical industry, some countries specialize in heart surgery, others

in pharmaceuticals

 Institutions – these are important for comparative advantage and important for growth too Banking systems are needed to provide capital for investment and export credits, legal systems help to enforce contracts, political institutions and the stability

of democracy is a key factor behind decisions about where international capital flows

6 What is meant by labor-intensive commodity ? Capital-Intensive commodity? What is meant

by Capital-Abundant nation ? Suppose that there: Airplane is Capital-Intensive commodity and Rice is labor-intensive commodity, and we have 2 nations : France is rich and Capital- Abundant nation ; Somali is a labor abundant country

 Labor-intensive commodity: The demand for labor relative to capital is assumed to be

higher in shoes than in computers, LS/KS > LC/KC These two curves slope down just like regular demand curves, but in this case, they are relative demand curves for labor (i.e., demand for labor divided by demand for capital

 Capital-Intensive commodity: The term "capital intensive" refers to business

processes or industries that require large amounts of investment to produce a good orservice and thus have a high percentage of fixed assets, such as property, plant, and equipment (PP&E) Companies in capital-intensive industries are often marked by highlevels of depreciation

Capital intensive refers to the production that requires higher capital investment such

as financial resources, sophisticated machinery, more automated machines, the latest equipment, etc Capital intensive industries pose higher barriers to entry as they require more investment in equipment and machinery to produce goods and services

An industry, firm, or business is considered to be capital intensive taking into

consideration the amount of capital that is required in comparison to the amount of labor required Good examples of capital intensive industries include the oil refining

industry, telecommunications industry, airline industry, and public transport

authorities that maintain the roads, railways, trains, trams, etc

 Capital-Abundant nation: The U.S., therefore, is capital abundant and Mexico is labor

abundant Letting K measure the quantity of capital and L the quantity of labor,

(K/L)US>(K/L)MEX, or the amount of capital per laborer in the U.S exceeds that of

Mexico (Verify that it is possible for LUS to be greater than LMEX and (K/L)US>(K/L)MEX ) Now invert the ratios, which reverses the inequality, so (L/K)US<(L/K)MEX, which says that Mexico is labor abundant relative to the U.S If one country is capital rich (more capital relative to labor) then the other is labor rich (more labor relative to capital)

 France vs Somali

- A country has comparative advantage in those commodities that use its abundant factors intensively

- Factor Endowments:

+ Notation: K=capital, L=labour, r = price of capital, w = price of labour

+ Physical definition: (K/L)1 > (K/L)2  France is capitalabundant (labour-scarce), Somali is labour-abundant (capital-scarce)

+ Price definition: (r/w)1 < (r/w)2  France is capital-abundant, Somali is abundant

labour In this case, the apparent contradiction of the Heckscher-Ohlin model could be explained by factor-intensity reversal In the France , Aviation industry belongs to TOP most developed industry in France, production utilizes considerable capital and, thus, many commodities such as airplane are relatively capital-intensive In Somali , however, agricultural production uses relatively much more labor than capital and, in all likelihood, is a labor-intensive product Since there is

considerable substitutability between capital and labor in the production of, for example, rice, it would not be surprising to find that rice is a labor-intensive

product in a labor-abundant country such as Somali and capital-intensive in a capital-abundant country such as the France Consequently they both end up exporting the product because it is intensive in their respective abundant factors

What can we say from the Trade pattern between two countries ?

 Trade is the exchange of goods and services between countries Goods bought into

a country are called imports, and those sold to another country are called exports Developed countries have a greater share of global trade than developing

countries

 Trading globally gives consumers and countries the opportunity to be exposed to goods and services not available in their own countries, or which would be more expensive domestically

 The importance of international trade was recognized early on by political

economists like Adam Smith and David Ricardo

 To better understand how modern global trade has evolved, it’s important to understand how countries traded with one another historically Over time,

economists have developed theories to explain the mechanisms of global trade The main historical theories are called classical and are from the perspective of a country, or country-based By the mid-twentieth century, the theories began to shift to explain trade from a firm, rather than a country, perspective These

theories are referred to as modern and are firm-based or company-based Both of these categories, classical and modern, consist of several international theories

What does Heckscher and Ohlin theory postulate ?

 The Heckscher-Ohlin theory argues that trade occurs due to differences in labor, labor skills, physical capital, capital, or other factors of production across countries

- Countries have different relative abundance of factors of production

- Production processes use factors of production with different relative intensity

 They wanted to explain this increase in trade during the “golden age” of

international trade

- Definition: A nation will export the commodity whose production requires the intensive use of the nation’s relatively abundant and cheap factor and import the commodity whose production requires the intensive use of the nation’s relatively scare and expensive factor

- Or: the relatively labor-rich nation exports the relatively labor-intensive

commodity and imports the relatively capital -intensive commodity

 Heckscher-Ohlin theorem: An economy has a comparative advantage in producing,and thus will export, goods that are relatively intensive in using its relatively

abundant factors of production, and will import goods that are relatively intensive

in using its relatively scarce factors of production

 In summary, the capital-abundant country exports the capital-intensive

commodity, and the labor-abundant country exports the labor-intensive

commodity

PART 2 :

disadvantages of Ad valorem and Specific Tariff ?

 Tariffs have three primary functions: to serve as a source of revenue, to protect

domestic industries, and to remedy trade distortions (punitive function)

- The revenue function comes from the fact that the income from tariffs provides

governments with a source of funding In the past, the revenue function was indeed one of the major reasons for applying tariffs, but economic development and the creation of systematic domestic tax codes have reduced its importance in the developed countries For example, Japan generates about 90 billion yen in tariff revenue, but this is only 1.7 percent of total tax revenues (fiscal 1996) In some developing countries, however, revenue may still be an important tariff function

- Tariffs is also a policy tool to protect domestic industries by changing the

conditions under which goods compete in such a way that competitive imports areplaced at a disadvantage In some cases, “tariff quotas” are used to strike a

balance between market access and the protection of domestic industry Tariff quotas work by assigning low or no duties to imports up to a certain volume and then higher rates to any imports that exceed that level

- Punitive tariffs may be used to remedy trade distortions resulting from measures adopted by other countries

 The advantages and disadvantages of Ad valorem and Specific Tariff

Advantages - Automatic adjustment for

inflation Since the tax is tied to

the product price, the tax automatically adjusts with inflation

- Higher profit margin is taxed Ad

valorem tax reduces the industryprofit margin since a part of any price/profit increase goes to the government as tax revenue

- Predictable The government

revenue is therefore protected against industry price wars or price manipulations For example the government can predict tobacco taxrevenue based on tobacco demand

- Raises all product prices Since the

tax is applied to all products at the same rate, a higher tax usually results in similar prices increase across the board, regardless of product Specific taxes reduce the gap in prices between cheap and more expensive products

- Easy to determine the amount of tax.

- Easier to administer.

Disadvantages - Less predictable revenue

stream As ad valorem taxes are

based on value, it is difficult to predict tax revenue over time

- Difficult to determine the amount of tax.

- Leads to large price differences between products Ad valorem

taxation widens the gap in prices between cheap products and more expensive products

- Difficult to administer.

- Inflation erodes its value Because

the tax rate is not tied to the product price, it does not automatically adjust with inflation Instead, the government must periodically implement additional rate increases, or add into the tax law that the specific excise tax rate will automatically adjust with inflation

- Can be reduced by changing products characteristics.

What is meant by the Consumption, Production, Trade, Revenue, and Redistribution effects

of a tariff ?

 Consumption Effect: Imposition of tariff raises the price, and as a result, the demand for the commodity falls Total outlay on consumption of the commodity is larger or smaller depending upon whether demand is inelastic or elastic

 Production Effect: When a tariff or other price-increasing policy is put in place, the effect is to increase prices and limit the volume of imports

 Revenue Effect: Tariff brings revenue to the government The revenue to the

government is equal to the amount of the import duty multiplied by the quantity of imports

 Redistribution Effect refers to the transfer of real income from the consumers to the producers as a result of tariff

 Trade Effect:

- When a country imposes a tariff duty, its willingness to receive imports is reduced For a given quantity of exports, the country now demands a larger quantity of imports because a part of these imports are to be surrendered to the customs authorities in the form of tariff payment Or, putting the same thing differently, the country is now willing to offer less of exports in exchange for a given quantity of imports

- Thus, the tariff reduces the country’s offer of exports for imports This

increases the country’s terms of trade or the rate at which exports are exchanged for imports

8 What is an Import Quota ? How are they similar to and different from the effects of an equivalent Import Tariff ? How does the revenue effect of an import quota differ from that

of a tariff ?

 Meaning of Import Quotas: A limit on the quantity of imports

- Can be mandatory or voluntary, and can be legislated or negotiated with foreign governments

- Tariff Rate Quota (TRQ)—allows a certain quantity of a good into a country at low or zero tariff rate, but applies higher tariff to quantities exceeding the quota

- The import quota means physical limitation of the quantities of different products to be imported from foreign countries within a specified period of time, usually one year The import quota may be fixed either in terms of quantity or the value of the product Can be mandatory or voluntary, and can

be legislated or negotiated with foreign governments.For instance, the government may specify that 60,000 colour T.V sets may be imported from Japan Alternatively, it may specify that T.V sets of the value of Rs 50 crores can be imported from that country during a given year

- Tariff rate quotas (TRQs) allow products imported within a certain quota to enter the European Union's market at a lower tariff rate than for quantities outside the quotas They allow more variety to consumers whilst also encouraging non-EU countries to open up their markets to European goods

 They similar to and different from the effects of an equivalent import tariff:

- Secondly, a certain rate of tariff causes reduction in the quantity by a specified

extent and, therefore, it has a quota equivalent The import quota, on the other hand, while restricting the quantity, causes a rise in import price It has, therefore, an import tariff equivalent

- Thirdly, tariff and quota both have similar price, protection, consumption, redistribution, welfare, balance of payments and income effects

- The main difference is that quotas restrict quantity while tariff works through

prices Thus, quota is a quantitative limit through imports

- A tariff raises revenue for the government, whereas an import quota creates surplus for those who obtain the licenses to import.The profit for the holder of

an import licenses is the diferrent between the domestic price ( at which they sell the emported good) and the world price ( at which they buy it)

- All the benefits of quotas go to the producers and to the lucky importers who manage to get the scarce and valuable import permits In such a situation, quotas differ from tariff

- As a tax , triffs bring in revenue for the government A quota, on the otherhand, benefits the sellers because they can now sell the imported product formore money

- In assessing the costs and benefits of an import quota , it is crucial todetermine who gets the rents

When the rights to sell in the domestic market are assigned togovernments of exporting countries , the transfer of rents abroad makesthe costs of a quota substantially higher than the equivalent tariff

 How does the revenue effect of an import quota differ from that of a tariff?

- A tariff is a tax on import able whereas an import quota is a direct quantitative restriction on trade which places an absolute limit upon the volume of imports that can be imported within a fixed time span

- If government sells import licenses for full value, the revenue would equal that from an equivalent tariff and tariffs and quotas would have identical results

- Otherwise, quotas are worse than tariffs Quotas will benefit for the Quota

License holder They become temporary monopoly in importing the product It cause deadweight losses

- The Lessons for Trade Policy : Both tariffs and import Quota

o Raise domestic prices

o Reduce the welfare of domestic consumers

o Increase the welfare of domestic producers

o Cause deadweight losses

9 What is meant by dumping? What are the different types of dumping? Why is dumping undertaken? Why does dumping usually lead to trade restrictions? Analyze one case study many government have used: solar panel

 Dumping is a term used in the context of international trade It's when a country or

company exports a product at a price that is lower in the foreign importing market than the price in the exporter's domestic market Because dumping typically involves substantial export volumes of a product, it often endangers the financial viability of the product's manufacturers or producers in the importing nation

 The different types of dumping

 Sporadic dumping: Manufactures practice sporadic dumping to get rid of excess merchandise A manufacturer with unsold inventories avoids starting a price war in the home market to preserve his competitive position Excess supplies are destroyed Example, Asian farmers dumped small chickens into thesea Another method is to have the excess supply dumped in a foreign market where the product is normally not sold Thus, sporadic dumping is aimed at liquidating excess stocks that may arise occasionally

 Predatory dumping: While sporadic dumping is occasional, predatory dumping

is permanent Predatory dumping is also known as intermittent dumping It involves sale of goods in overseas markets at a price lower than the home market price This is selling at a loss to gain access to a market and eliminate competition After the competition is eliminated, the company becomes a monopolist Monopoly position is then used to increase the price Anyway, there is a disadvantage that former competitors may rejoin the market because

of high profit margins

Example

Hitachi was accused of following predatory dumping for its EPROM (electrically programmable read only memory) chips.Zenith in USA accused Japanese Television manufacturers of using predatory dumping A charge was leveled against Japanese manufacturers for false billing and secret rebates to set low predatory prices on T.V sets in U.S markets It was argued that they tried to drive U.S firms out of business in order to gain a monopoly

 Persistent dumping (Long period dumping): It involves consistent selling at lower prices in one market than in the rest of the market This practice is based

on the fact that markets vary in terms of overhead costs and demand

characteristics In persistent dumping, the firm may use marginal cost pricing abroad while using full cost pricing (covering fixed costs at home) in domestic market Japan, for example, sold consumer electronics at high prices in its own country This is because it has no foreign competition But it lowered prices in the U.S market in order to maintain market share

 Objective of Dumping