Chapter 2 - Free Trade and Protection

Question 1

Closed Market meaning

Answer 1

In a closed market, the country does not trade with the outside world.

All demand for a good is domestically demanded.

Question 2

Why do nations trade?

Answer 2

Nations trade because it benefits them. Trade enables countries to specialise in tasks they are best suited for. For specialisation to be effective, surplus production must be exchanged with other countries for goods and services they don’t specialise in.

Question 3

When does a country is said to have absolute advantage?

Answer 3

production of a good or service over another country if it can produce that good or service in a greater quantity of output with the same quantity of input.

Question 4

Comparative Advantage Def

Answer 4

country is said to have a comparative advantage in producing a good or service if it can produce that good or service at a lower opportunity cost than another country

Question 5

Oppurtunity cost formula

Answer 5

what is given up /what is gained

Question 6

Can a country have comparative advantage in both goods?

Answer 6

NO

Question 7

Where is consumer surplus and producer surplus on D/S

Answer 7

c top p bottom

Question 8

When will a country export?

Answer 8

If a country is an effective and efficient producer of a good they will be encouraged to export it.

We say that country has a comparative advantage because it can produce that good or service at a lower opportunity cost than another country.

Question 9

If country exports what is higher domestic price or world price

Answer 9

World price higher than domestic price

Question 10

When will a country not have comparative advantage

Answer 10

If a country does not have a comparative advantage in producing a good, then the domestic price will exceed the world price.

This is because Australian producers are not as efficient in producing that good or service.

Question 10

If country imports what is higher domestic price or world price

Answer 10

Domestic price higher than world price

Question 11

Define trade liberlisation

Answer 11

removal or reduction of the barriers of trade (tariffs/subsidies)

Question 12

Benefits of trade liberilsation

Answer 12

Increase real income and living standard
increase efficiency through greater competition
Economic growth
consumer gain through lower prices
exporters gain throguh higher prices

Question 13

3 type of protection

Answer 13

Tarriff, subsidy, qouta

Question 14

Tariff defintion

Answer 14

– A tariff is a tax on imported goods. It is designed to increase the price of imports to allow domestic producers to compete with imports.

Question 15

Subsidy Def

Answer 15

A subsidy is a payment to domestic producers who compete against imports. Instead of making imports more expensive (tariff), they aid the domestic producer and lowers their cost allowing them to compete.

Question 16

Quota Defintion

Answer 16

– A quota is a set restriction on the amount of imports for a particular good that can enter a country. A quota can be a set number, or even zero. For example a country can set a quota of zero for dairy imports into the country

Question 17

Tarriffs effects on trade

Answer 17

Increased cost for importers and consumers
Reduced quantity demanded
Can lead to retaliation from other countries
Reduces overall trade

Question 17

What are the effects of tarriffs

Answer 17

It increases the price of foreign goods or services. This allows less efficient domestic producers to compete on price.

As it is a tax, it is a source of revenue for the government which can be used for other means (eg healthcare, education, transportation etc).

Question 18

Tariff effect on market efficeny

Answer 18

Inefficient resource allocation occurs as domestic producers are incentivised to be less efficient. This creates deadweight loss (DWL), with consumers paying higher prices. Although producers benefit, the consumer loss is greater. It also discourages comparative advantage.

Question 19

Tarriff effect on macroeconomy

Answer 19

Impact of Higher Prices
● Higher prices lead to higher inflation.
● Inflation slows economic growth.
● Jobs, consumption, and production across industries decrease.

Question 20

What are subsidies

Answer 20

Subsidies are grants or payments made to domestic producers.

Subsidies, funded by government tax revenue, lower domestic producers’ costs. This encourages production by helping them compete with cheaper imports.

Question 21

Subsidy effect on trade

Answer 21

Increases domestic competitiveness and output
Reduces trade (imports), as consumers switch to domestic goods.
Can lead to retaliation from other countries if seen as unfair

Question 22

Subsidy effect on market efficiency

Answer 22

Subsidies discourage competition based on comparative advantage and promote inefficiency, especially with long-term support. They create dependency and reduce innovation. Producer surplus (PS) rises, consumer surplus (CS) remains unchanged, but total surplus (TS) falls as subsidy costs exceed PS gains.

Question 23

Trade liberlisation def

Answer 23

Trade Liberalisation refers to the removal or reduction of the barriers of trade.Barriers of trade can include tariffs, subsidies or quotas.

Question 23

Subsidy effect on macroeconomy

Answer 23

Effect on gov budget. Funds for a subsidy cannot be used for other sectors of the economy (health, education etc) Opportunity cost of subsidy for other purposes Can lead to an increase in jobs in the subsidised industry or sector

Question 24

Benefits of trade liberlisation

Answer 24

liberalisation improves consumption, economic growth (real GDP), investment, real wages/income, living standards and reduces prices.

Question 25

Benefits of trade liberlisation acroncym

Answer 25

CIVIC J

Question 26

CIVIC J STANDS FOR

Answer 26

C – Consumption I – Investment V – Variety of Goods I – Income C – Competition J – Jobs

Question 27

Consumption Argument Pro

Answer 27

Trade allows countries to consume more by specialising in what they do best, expanding their consumption possibilities. This can raise living standards, improve economic welfare, and boost consumer satisfaction.

Question 28

Inflation Argument

Answer 28

Countries import when world prices are lower than domestic prices. Imports provide access to cheaper goods, helping keep prices low and slow inflation. Trade liberalisation has reduced real prices in sectors like clothing, footwear, vehicles, and electronics over the past 30 years.

Question 29

Variety of Goods Argument

Answer 29

There are limitations to the types of goods that a country can produce. A lack of natural resources or capital, or skills can prevent countries from producing some goods. Trading allows countries to access goods that they may not be able to be produced in Australia, or may be too expensive to produce.

Question 30

Income Arugment

Answer 30

Trade brings more job opportunities and therefore an increase in real incomes, purchasing power and living standards. Remember that there is a large portion of Australian’s who work in a trade related industry. Examples could be jobs in mining, shipping/transportation, legal or customs.

Question 31

Competion Argument

Answer 31

Trade pressures domestic producers to improve efficiency and compete on cost. Inefficient firms may fail, causing short-term unemployment and structural change. However, long-term benefits include higher output, better quality goods and services, increased employment, and greater innovation.

Question 32

Jobs Arguments

Answer 32

Creates new, higher-paying jobs. ● Shift from manufacturing to resources and services. ● New industries offer higher wages, require specialised skills, and benefit from global demand

Question 32

Arguments for Trade protection acronym

Answer 32

BADFINE

Question 33

What to include when arguing for trade protection

Answer 33

When discussing the arguments of trade protection it is also important to understand that there are “counter arguments” to these arguments. Ensuring that you present these will strengthen your response when asked for the arguments for trade protection

Question 34

BADFINE STANDS FOR

Answer 34

B – Balance of Trade argument A – Anti Dumping Argument D – Diversification Argument F – Foreign Labour Argument I – Infant Industry Argument N – National Security Argument E – Employment Argument

Question 35

Balance of Trade Argument

Answer 35

argued that a trade deficit can be eliminated or reduced by restricting imports through protection measures. This argument assumes that a trade deficit is “wrong” and that imports are “bad, and exports are “good”. Protection raises the costs of other domestic industries which reduces their competitiveness and therefore their exports. Other countries may also retaliate and impose restrictions on their imports. Both exports and imports bring gains to a country. Over time, a country should focus on increasing both exports and imports.

Question 36

Anti dumping arugment

Answer 36

The WTO says that dumping is “the practice whereby a company exports a product at a price lower than the price it normally charges in its own home market” The aim of dumping is to drive domestic producers out of business. Over time these overseas firms can sustain the losses. In the long run as domestic producers leave the market, they will increase prices. This arguments says that protecting industries is necessary to protect from very cheap dumped goods. One difficulty of this argument is proving whether dumping is actually taking place. Foreign goods may be cheaper because of more efficient processes.

Question 37

Diversification argument

Answer 37

This arguments says that the principle of comparative advantage may mean that a country has to specialise in a narrow range of products. (ie only iron ore) Diversifying industries may benefit a country instead of “placing all their eggs in one basket”. Protection will assist countries in diversifying industries and assist them in becoming efficient or competitive. In reality no country has a comparative advantage in only one or two industries. How do we also predict which industries to protect and diversify into?

Question 38

Cheap) Foreign Labour argument

Answer 38

It is often claimed that Australian industries need to be protected from countries where wages are much lower. We cannot compete on wages. Wages is a function of productivity. Wages are higher in Australia because our productivity is higher due to our superior capital and technology. Countries that have an abundance of labour have a comparative advantage in labour intensive goods. Countries like Australia should benefit by importing goods from these countries which it is relatively more efficient.

Question 39

Infant Industry argument

Answer 39

It is argued that infant or newly established industries need protection in their early years until they mature and take advantage of economies of scale. Economies of scale occur when increasing production lowers the cost per unit due to efficiencies in operations, bulk purchasing, or specialisation. The issue is that protection tends to be long term and not short term. Long term protection means that the infant industries become accustomed to operating with little competition. The incentive to innovate and become efficient and be able to compete without protection is removed. Protection can be justified in the short term, but must be regularly reviewed to ensure it is progressively removed.

Question 40

National Securit Argument

Answer 40

argued import protection is necessary to protect industries that are vital to the economy in case of wartime or conflict. Examples of industries that have been argued are defence, energy or medical supplies. However which industries are vital to the economy? May industries could present a case for this. This argument becomes popular during times of global conflict. However, trade and especially free trade, fosters international cooperation and harmony whilst protectionist policies reduce it.

Question 41

Employment Argument

Answer 41

This argument says that protection will shift consumer spending from foreign goods to domestic goods. This will then increase domestic employment in the protected industries. Employment in the protected industries may rise, but employment in all other industries will suffer. All other industries will be faced with higher input costs (due to increased prices in the protected industry). Consumers will also have less to spend on the output of the other non protected industries. A gain in employment in the protected industries will be countered by a loss in employment in the other industries