Restrictions on Free Trade

Reasons for Protectionism

Governments may restrict free trade in order to protect domestic industries even though free trade can create efficiency gains.

Methods of Protectionism

Tariffs

A tariff is a tax on imports. It raises the price of imported goods, making domestic goods relatively cheaper.

Before the tariff:

• Domestic sales: Q1
• Imports: Q4 - Q1
• Consumption by domestic consumers: Q4

After the tariff:

• Domestic sales: Q2
• Imports: Q3 - Q2
• Consumption by domestic consumers: Q3

The tariff raises the price of imports from P1 to P2, which reduces imports and increases domestic production, but also raises prices for consumers.

Areas on the diagram:

• Purple Area: Tariff revenue for the government
• Green Area: Gain in domestic producer surplus
• Red Area: Net welfare loss resulting from the tariff. It is the sum of the loss of consumer surplus, less the gain in domestic producer surplus and tariff revenue.

Quotas

A quota is a physical limit on how much of a good can be imported. It restricts supply and raises the price of imports, benefiting domestic producers but harming consumers.

Subsidies to Domestic Producers

Subsidies lower production costs for domestic firms and allow them to compete more effectively with imports, benefiting domestic producers.

Non-Tariff Barriers

Non-tariff barriers include product standards, health and safety rules, and administrative procedures that make imports more difficult and costly, effectively protecting domestic industries without using tariffs or quotas.

Evaluations of Protectionist Policies

The effectiveness of protectionist policies depends on the following:

• The elasticity of demand for imports: If demand is inelastic, tariffs and quotas may not significantly reduce imports.
• The ability of domestic producers to increase production: If domestic producers cannot meet the increased demand, or the UK does not produce effective alternatives, prices may rise further.
• The potential for retaliation by trading partners: Other countries may impose their own trade restrictions in response, leading to trade wars which harm consumers and producers in both countries.
• The long-term impact on efficiency and innovation: Protectionism such as subsidies may support inefficient firms and reduce incentives for innovation and productivity growth.