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Types of protection: tariffs, the economic theory

This tutorial was written by
Ken Edge
Head Teacher Social Science
Cardiff High School

Outcomes
Overview
Content
Review exercises
More

Outcomes

HSC Topic: The Global Economy is covered in the Board of Studies NSW Stage 6 Economics Syllabus (1999) on pages 31-33. The specific outcomes for this tutorial are:

H1	demonstrates understanding of economic terms, concepts and relationships
H3	explains the role of markets within the global economy
H7	evaluates the consequences of contemporary economic problems and issues on individuals, firms and governments
H8	applies appropriate terminology, concepts and theories in contemporary and hypothetical economic contexts.

Overview

There are a number of reasons why governments may choose to protect domestic industries as discussed in the tutorial titled, Features of the Global Economy: the reasons for protection.

However the Australian government has a policy of opening markets. This means removing or lowering trade barriers that restrict other countries goods and services coming into Australia. In response to a more liberalised global trading environment other countries are also lowering their barriers for Australian exports.

Some groups oppose free trade and see an open market as having a negative impact on the workforce and trade barriers are needed to protect local industries.

Other groups view free trade as a way of increasing employment and prosperity in Australia. This tutorial examines tariffs as a method of protection used to protect domestic industry and highlights some of the impacts on the domestic and global economy.

Content

Tariffs

A tariff is simply a tax imposed by the government on imported goods. Such a tax (tariff) has the effect of raising the price of imported goods, usually resulting in domestically produced goods becoming cheaper. Consequently the demand for imported goods falls, and the demand for domestically produced goods increases.

Free trade situation

Consider the following example:

Figure 1 shows the free trade position for Great Southern Land, a domestic company that sells hockey equipment.

Figure 1 indicates the domestic market supply (S_dS_d) and demand (D_dD_d) before a tariff is imposed on imported hockey sticks.

With no international trade in the domestic market the price of hockey sticks is at the equilibrium price of 0Pe and the equilibrium quantity is 0Qe. If the world price is 0P₁ then free trade will cause domestic prices to fall to this level,

At a price of 0P₁ local producers will only supply 0Q₁, hockey sticks, however consumers demand 0Q₂. The difference Q₁Q₂ will be made up of imports.

Total expenditure by consumers is 0P₁BQ₂. Domestic producers receive 0P₁A Q₁ and foreign producers receive Q₁ABQ_2.
The effects of tariffs on the domestic and global economies.

Using figure 2 and the information provided complete the following activity.
Flash version HTML version

Review exercise

Answer the following multiple choice questions by clicking on the required response.

Another graph showing the effects of a tariff

The following questions are based on the above diagram showing the domestic supply and demand curves for a particular product. The world price is OA and the domestic price is 0B.

If the government imposes a tariff of AB total domestic production will:
1. Rise from 0E to 0F
2. Rise from 0G to 0H
3. Fall from 0F to 0E
4. Fall from 0H to 0G
The volume of imports after the imposition of the tariff is:
1. EF
2. GH
3. FG
4. 0E
The revenue effect of the tariff is given by the area:
1. JIKL
2. CJEF
3. FJLG
4. LMGH
After the tariff, the foreign exchange earnings of overseas producers is:
1. IKJL
2. GLMH
3. FJLG
4. FIKG
If Australia removed the tariff on the clothing imported from China, we would expect:
1. the price of clothing in Australia to rise
2. the price of clothing in Australia to fall
3. employment to rise in the Australian textiles industry
4. employment to fall in the Chinese textile industry
Tariffs on imported commodities effectively transfer income to:
1. overseas producers
2. domestic producers
3. overseas consumers
4. domestic consumers
Increasing tariff protection for a country’s industries will tend to:
1. reduce the price of domestic products
2. reduce competition in the domestic market
3. encourage international competition
4. increase the standard of living for consumers
What would be the immediate effect of the government placing a tariff on footwear?
1. increase in the price of domestic footwear
2. increase in the price of imported footwear
3. increase in domestic sales
4. increase in export sales
Which of the following is a benefit of free trade?
1. increased consumers choice of goods and services
2. more efficient use of domestic resources
3. increased employment opportunities
4. all of the above
A tariff is a tax on imported goods and would be considered as a:
1. progressive tax
2. regressive tax
3. proportional tax
4. sales tax

Answers

The Department of Foreign Affairs and Trade web site has a section for students to work through, with activities to help enhance the understanding of trade liberalisation.

Productivity Commission (2000) General Tariff Review, Canberra. “The Productivity Commission is the Australian Government's principal review and advisory body on microeconomic policy and regulation.

The commission conducts public inquiries and research into a broad range of economic and social issues affecting the welfare of Australians, including: competition policy, productivity the environment, economic infrastructure, labour markets, trade and assistance, structural adjustment and microeconomic reform.”

The World Trade Organisation web site provides articles that help understand the reasons for developing countries using protectionist policies.

Visit The Centre for Trade web site and read the information on the benefits of free trade. This web site also contains some very current information on global trade issues.