Types of Trade Protection

IB Economics · Unit 4 The Global Economy · syllabus 4.2

The instruments governments use to restrict trade, and how to analyse each on a diagram. The tariff diagram is the one that appears most often and carries the most marks.

Key definitions

Types of trade protection

Tariff versus quota is a standard comparison. Both raise the domestic price and cut imports. The difference is where the money goes: a tariff transfers it to the government as revenue, while a quota hands it to whoever holds the import licence as extra profit, often foreign exporters. That makes a quota worse for the importing country at the same level of protection, unless the licences are auctioned.

Analysing a tariff

The tariff diagram is the technical core of this topic. Build it in order:

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1. Draw domestic demand (D) and domestic supply (S).
2. Add the world price as a horizontal line below domestic equilibrium, the country is a price taker at this price.
3. At the world price, domestic supply is small and domestic demand is large; the gap is imports.
4. Impose the tariff: the horizontal line shifts up by the tariff amount.

Reading off the consequences at the higher price:

• Domestic production rises (movement along S), protected firms produce more.
• Domestic consumption falls (movement along D).
• Imports fall by both amounts combined.
• Government revenue = tariff × the new quantity of imports (a rectangle).
• Consumer surplus falls; producer surplus rises.
• Two welfare loss triangles remain: a production inefficiency (domestic firms producing at higher cost than foreign firms) and a consumption inefficiency (consumers priced out of purchases worth more to them than the world price).

The net effect on society is negative: consumers lose more than producers and government together gain.

Working the areas

The world price of steel is \$200 a tonne. A \$50 tariff raises it to \$250. Domestic supply rises from 100 to 200 tonnes; domestic demand falls from 500 to 400.

Imports fall from 500 − 100 = 400 to 400 − 200 = 200 tonnes.
Government revenue = \$50 × 200 = \$10,000
Producer surplus gain = ½ × (100 + 200) × \$50 = \$7,500
Production welfare loss = ½ × \$50 × (200 − 100) = \$2,500
Consumption welfare loss = ½ × \$50 × (500 − 400) = \$2,500
Consumer surplus loss = \$50 × ½ × (500 + 400) = \$22,500

Check the areas balance, which is what proves the diagram was read correctly:

Consumer loss \$22,500 = producer gain \$7,500 + government revenue \$10,000 + welfare loss \$5,000 ✓

Consumers lose \$22,500; only \$17,500 of that reappears anywhere. \$5,000 is simply destroyed, the two triangles, and that is the net cost of the tariff to the country imposing it.

Why the world supply curve is horizontal

This assumption is drawn without comment in most answers and is worth one sentence of justification, because it is what makes the diagram work.

A single small country is one buyer among many on the world market, so its own demand does not move the world price. It can therefore buy as much as it wants at that price, which is a perfectly elastic supply from the rest of the world, drawn as a horizontal line. If the country were large enough for its purchases to move the world price, the line would slope and a tariff would push some of the burden onto foreign exporters. That is the assumption behind the optimal tariff argument, and noting it is a genuine evaluative point.

Comparing the three main instruments

At the same level of protection, tariffs, quotas and subsidies produce the same domestic price rise for producers but distribute the cost very differently, which is the comparison examiners want.

The subsidy is the instrument that protects producers without raising the consumer price, which is why it is the standard alternative to offer when evaluating a tariff. Its cost is borne by taxpayers rather than by consumers of that good, which changes who loses rather than removing the loss.

Real-world examples

• The European Union's tariff-rate quotas on agricultural imports allow a set quantity in at a low tariff and apply a much higher rate above it, which is a hybrid of the two instruments and a useful example of why the categories blur in practice.
• Japan's rice market was long protected by quota and remains protected by very high tariffs, and the usual figure quoted is a domestic price several times the world price, which makes the consumer cost of protection concrete.
• Administrative barriers are the hardest to challenge precisely because they can be justified on other grounds. Differing safety, labelling and inspection requirements raise the cost of exporting without ever being called protection.

Exam technique

• Draw the world price line first, then the tariff line above it. Building the diagram in that order stops the common error of shifting the domestic supply curve.
• Label the four consequences separately: the fall in imports, the rise in domestic production, the fall in consumption, and the government revenue rectangle.
• When comparing a tariff with a quota, lead with where the money goes. That is the distinction, not the size of the price rise.
• If the question mentions a large economy, say that the horizontal world supply assumption no longer holds and that some of the tariff burden falls abroad.

Common exam mistakes

• Confusing a quota (a quantity limit) with a tariff (a tax), and so mislabelling who receives the revenue. A tariff raises government revenue; a quota transfers that area to whoever holds the import licence.
• Omitting the two welfare-loss triangles when analysing a tariff, which is where the efficiency argument lives.
• Treating a subsidy to domestic producers as a tariff. It lowers domestic cost rather than raising import price, so the domestic price is unchanged and consumers are not directly harmed.
• Forgetting administrative barriers and voluntary export restraints, which are on the syllabus and are the forms most used in practice.

Quick revision

• Tariff: a tax on imports. Domestic price rises, domestic output rises, imports fall, government gains revenue, two deadweight triangles appear.
• Quota: a quantity limit. Similar price effect, but the revenue area accrues to licence holders rather than the government.
• Subsidy to domestic producers: shifts domestic supply right, no rise in domestic price, cost borne by the taxpayer.
• Administrative barriers and standards restrict trade without any visible tax.

Check you have it

Cross-board concept practice · originally a CIE 9708 question, used here because the concept is the same. It is not IB Economics past-paper material.

Question 1

The following are four conditions sometimes attached to IMF loans to developing countries. Which condition would conflict with the ‘infant industry’ argument?

Athe need to allow free tradeBthe need to control inflationCthe need to have a contractionary fiscal policyDthe need to privatise government enterprises

Cross-board concept practice · originally a CIE 9708 question, used here because the concept is the same. It is not IB Economics past-paper material.

Question 2

The following are four conditions sometimes attached to IMF loans to low-income countries.
Which condition would conflict with the ‘infant industry’ argument?

Athe need to allow free tradeBthe need to control inflationCthe need to have a contractionary fiscal policyDthe need to privatise government enterprises

Cross-board concept practice · originally a CIE 9708 question, used here because the concept is the same. It is not IB Economics past-paper material.

Question 3

The diagram shows the change in the supply curve of imports, S–S1 to curve S–S2, after the introduction by the government of a trade protection measure. price of imports O quantity of imports S S1 S2 What is the form of protection?

Aan ad valorem tariffBan embargoCa quotaDa specific tariff

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