Protectionism - Tariffs and Subsides and Quotas et al.

Protectionism, whose antonym is free trade, occurs when countries use techniques (formal or informal) to prevent or to make difficult imports coming into their border for sale.  There are several forms of protectionism.  A tariff is a tax on imports and is probably the best-known way countries use to stop free trade.  In fact, the other types of trade barriers are often referred to as non-tariffs barriers (NTBs)!  These include subsidies (assistance to domestic firms by the government to cheapen production), quotas (a numerical limit of the amount of imports that can enter), and government policies such as health and environmental standards which work to keep foreign g/s out. 

There are several reasons for protectionism (can be evaluative when pros and cons are discussed):
- assist domestic producers (and thus "save" jobs and ensure votes?)
- protect an infant industry
- combat dumping and low cost labor from abroad
- make money for the government
- avoid over reliance on too few industries
- have important products in case of emergency
- fix balance of payments deficit
- protect domestic consumers against dangerous imports

Tariff:

Graph Analysis:
If this country (Domestic) were closed to trade, equilibrium would occur at a price of Pe and a quantity of Qe for corn.  However, when the country opens itself to uninhibited free trade, the country benefits from a global supply of corn, much of which is produced at a lower cost (and thus a lower price) from foreign producers.  In this situation, the domestic producers produce 0Q1 corn and foreign produces make the rest, Q1Q2.  Both groups of producers accept a price of Pworld, and by multiplying price by quantity, we see domestic producers earn box a and foreign producers earn b, c, d and e.

Let's now assume the domestic government imposes a tariff on foreign corn to protect its own producers.  The supply curve Sworld shifts up the value of the tariff to Sworld+Tariff and the new price is Pworld+Tariff.  When this occurs, moving up along the domestic supply curve, we observe domestic producers produce 0Q3.  Because these firms are more inefficient than the foreign producers who can produce more cheaply, we identify box h as a loss in world efficiency.  Moreover, we also have to move backwads up along the demand curve because the price has changed, showing us that foreign producers produce Q3Q4 since Q4Q2 is now lost.  This represents a loss of consumer surplus (see relevant post) and is labeled k.  As for earnings, the domestic producers now make a, b, f, g, h and foreign producers make c, d.  The domestic government receives i, j as tariff (tax) revenue from the foreign producers.  The combination of losses in world efficiency and consumer surplus together are called a deadweight loss of welfare because they make some people worse off.

Subsidy:

Graph Analysis:
If this country (Domestic) were closed to trade, equilibrium would occur at a price of Pe and a quantity of Qe for barley.  However, when the country opens itself to uninhibited free trade, the country benefits from a global supply of barley, much of which is produced at a lower cost (and thus a lower price) from foreign producers.  In this situation, the domestic producers produce 0Q1 barley and foreign produces make the rest, Q1Q2.  Both groups of producers accept a price of Pworld, and by multiplying price by quantity, we see domestic producers earn box a and foreign producers earn b, c, d.

Let's then assume the domestic government assists its producers by given them a subsidy (financial aid to domestic producers of g/s making production cheaper).  The supply curve Sdomestic shifts out the value of the subsidy to Sdomestic+Subsidy.  Domestic firms receive the new price Pworld+Subsidy.  When this occurs, moving up along the domestic supply curve, we observe domestic producers produce 0Q3.  The foreign producers supply the rest, Q3Q2 and earn c, d.  Because the domestic firms are more inefficient than the foreign producers since they require a higher price to produce Q1Q3, we identify box g as a loss in world efficiency (and thus deadweight loss in welfare).  The domestic producers now make a, b, e, f, g and foreign producers make c, d. 

Quota:

Graph Analysis:
If this country (Domestic) were closed to trade, equilibrium would occur at a price of Pe and a quantity of Qe for sorghum.  However, when the country opens itself to uninhibited free trade, the country benefits from a global supply of sorghum, much of which is produced at a lower cost (and thus a lower price) from foreign producers.  In this situation, the domestic producers produce 0Q1 of sorghum and foreign produces make the rest, Q1Q2.  Both groups of producers accept a price of Pworld, and by multiplying price by quantity, we see domestic producers earn box a and foreign producers earn b, c, d and e.

Let's then assume the domestic government imposes a quota (a limit on foreign g/s) on foreign sorghum to benefit its own producers.  The supply curve Sdomestic shifts out to assume production after the quota is reached to Sdomestic+Quota.  When this occurs, moving up along the domestic supply curve, we observe domestic producers produce 0Q1, foreign producers produce Q1Q3 (the value of the quota) and domestic producers pick up the rest, Q3Q4.  Because these firms are more inefficient than the foreign producers who can produce more cheaply, we identify box j as a loss in world efficiency.  We move up backwards along the demand curve because the price has changed to Pw+Quota, showing us that domestic producers stop at Q4 since Q4Q2 is now lost.  This represents a loss of consumer surplus and is labeled k.  As for earnings, the domestic producers now make a, f, c, i j and foreign producers make b, g, h.   Like a tariff, the combination of losses in world efficiency and consumer surplus together are called a deadweight loss of welfare because they make some people worse off.

Consumer and Producer Surplus = Community Surplus

In this graph, we can see the equilibrium price of the good is $5.00 and the quantity demanded / supplied is 10 million. The blue triangle above the price line and below the demand curve represents consumer surplus. Consumer surplus is the benefit consumers get from being able to purchase a good or service at a price lower than what they were expecting to pay. In this example, we can see that at a price of $8.50, two million units of the good would be demanded. However, those consumers only have to pay $5.00, and thus they get a benefit from paying less than that which they were prepared. The same is true for the six million units demanded at a price of $6.50. Therefore, the entire blue triangle represents the total consumer surplus for this particular good.

The red triangle below the price line and above the supply curve represents producer surplus. Producer surplus is the benefit producers get from being able to receive a price for a good or service higher than what they were expecting. In this example, we can see that at a price of $1.50, two million units of the good would be supplied. However, those producers get to receive $5.00, and thus they get a benefit from receiving more than that which they were expecting. The same is true for the six million units supplied at a price of $3.50. Therefore, the entire red triangle represents the total producer surplus for this particular good.

Together with consumer surplus, we have the total economic benefit of the transaction, or community surplus (red plus blue triangles). With equilibrium quantity Q* and price P* determined by the forces of supply and demand, there is no way to make one person better off by making someone else worse off. This is called Pareto optimality and means that resources have been allocated efficiently.

This analysis allows us to see supply and demand in a different way. If we consider the supply curve to be the sum of the firms' costs of production for a good or service, we can consider how these costs apply to the community at large and call this the marginal social cost (MSC) curve. If we consider the demand curve to be the sum of consumers' utility in consuming a good or service, we can consider how these benefits apply to the community at large and call this the marginal social benefit (MSB) curve. These terms replace standard supply (S) and demand (D) in market failure analysis.