The Instruments of Trade Policy

The Instruments of Trade Policy

1. Tariffs

   • A specific tariff is levied as a fixed charge for each unit of imported goods
     • An ad valorem tariff is levied as a fraction of the value of imported goods
       • A tariff acts like a transportation cost, making sellers unwilling to ship goods unless the Home price exceeds the Foreign price by the amount of the tariff: PT – t = P*T
         • A tariff raises the price of a good in the importing country, so it hurts consumers and benefits producers there.
   • Who loses
     • Consumers who pay higher prices  The economy which remains inefficient  Employees of protected industries who don’t develop new skills
   • Who Gains
     • -Government - Domestic producers - Employees of protected industries keep their jobs

2. Export Subsidy

   • An export subsidy can also be specific or ad valorem: A specific subsidy is a payment per unit exported. An ad valorem subsidy is a payment as a proportion of the value exported.
   • An export subsidy raises the price in the exporting country, decreasing its consumer surplus (consumers worse off) and increasing its producer surplus (producers better off).
   • In contrast to a tariff, an export subsidy worsens the terms of trade by lowering the price of exports in world markets.
   • An export subsidy lowers the price paid in importing countries PS* = PS – s.

3. Import quotas

   • Restrict the quantity of some good that may be imported into a country
     • A binding import quota will push up the price of the import because the quantity demanded will exceed the quantity supplied by Home producers and from imports.
   • Tariff rate quotas - a hybrid of a quota and a tariff where a lower tariff is applied to imports within the quota than to those over the quota
   • A quota rent - the extra profit that producers make when supply is artificially limited by an import quota

4. Voluntary export restraints

   • Works like an import quota, except that the quota is imposed by the exporting country rather than the importing country.
   • These restraints are usually requested by the importing country
   • The profits or rents from this policy are earned by foreign governments or foreign producers. Foreigners sell a restricted quantity at an increased price.

5. Local content requirements

   • A local content requirement is a regulation that requires a specified fraction of a final good to be produced domestically.
     • It may be specified in value terms, by requiring that some minimum share of the value of a good represent home value added, or in physical units.
   • From the viewpoint of domestic producers of inputs, a local content requirement provides protection in the same way that an import quota would.
   • From the viewpoint of firms that must buy home inputs, however, the requirement does not place a strict limit on imports, but allows firms to import more if they also use more home parts.

6. Antidumping policies

   • Aka countervailing duties designed to punish foreign firms that engage in dumping and protect domestic producers from “unfair” foreign competition
   • Dumping - selling goods in a foreign market below their costs of production, or selling goods in a foreign market below their “fair” market value
   • May be predatory behavior - producers use profits from their home markets to subsidize prices in a foreign market to drive competitors out of that market, and later raise prices