4.1.6 Restrictions on Free Trade
Edexcel A-Level Economics (9EC0) | Theme 4.1.6
Reasons for Protectionism
Governments may restrict free trade in order to protect domestic industries even though free trade can create efficiency gains.
| Reason | Explanation |
|---|---|
| Protect infant industries | New industries may need temporary protection until they become established and competitive. |
| Prevent dumping | Governments may act against foreign firms selling below cost in order to drive domestic competitors out of the market. |
| Correct a current account deficit | Reducing imports can help improve the trade balance. |
| Protect employment | Protection may be used to save jobs in sunset or strategically important industries. |
| Strategic and security reasons | Countries may want self-sufficiency in key areas such as food, energy, or defence. |
| Environmental or labour standards | Imports may be restricted to put pressure on countries with lower standards. |
Methods of Protectionism
Tariffs
A tariff is a tax on imports. It raises the price of imported goods, making domestic goods relatively cheaper.
The tariff raises the price of imports from P1 to P2, reducing imports from (Q4-Q1) to (Q3-Q2). Domestic producers increase output from Q1 to Q2 resulting in a rise in producer surplus (green area), and the government gains tariff revenue (the purple shaded area). However, consumer surplus falls (green + red + purple areas), and there is a deadweight loss due to reduced consumption and inefficient domestic production (the red shaded area).
Quotas
A quota is a physical limit on how much of a good can be imported.
Subsidies to Domestic Producers
Subsidies lower production costs for domestic firms and allow them to compete more effectively with imports.
Non-Tariff Barriers
Non-tariff barriers include product standards, health and safety rules, and administrative procedures that make imports more difficult.
Impacts of Protectionist Policies
| Stakeholder | Impact of a Tariff or Quota | Impact of a Subsidy |
|---|---|---|
| Domestic producers | Higher prices, higher revenue, increased output, and protected jobs. | Lower costs, greater output, and improved competitiveness. |
| Domestic consumers | Higher prices, less choice, and lower consumer surplus. | Prices may be lower, but the cost of the subsidy is borne by taxpayers. |
| Government | Receives tariff revenue in the case of tariffs. | Pays the subsidy, so there is an opportunity cost. |
| Foreign producers | Lose access to the market and face lower sales. | Face stronger competition from subsidised domestic firms. |
| Efficiency | Efficiency falls because production shifts toward less efficient domestic producers. | The market may be distorted and inefficient firms may survive artificially. |
Evaluation of Protectionism
Protectionism may be justified for infant industries, for national security, or to prevent unfair practices such as dumping.
However, it can also create higher prices for consumers, reduce economic efficiency, encourage retaliation and trade wars, and weaken innovation by reducing competition.
In many cases, protectionism ends up supporting inefficient firms.
Exam Preparation
- Explain the economic and political reasons for protectionism.
- Draw, label, and analyse the tariff diagram, including price, domestic output, imports, and stakeholder welfare.
- Compare the effects of tariffs, quotas, and subsidies on different stakeholders.
- Evaluate protectionist policies in context, rather than assuming they are always good or bad.