Types of trade restrictions / methods of protection: tariffs

International Trade and Globalisation

6.1 Specialisation by Country and Free Trade

Specialisation by Country

Specialisation occurs when a country concentrates its resources on producing the goods and services for which it has the lowest opportunity cost. By doing so it can produce more of that good than if it tried to produce everything itself.

Comparative Advantage

• Even if one country is more efficient in producing all goods, both countries can gain from trade if each specialises where its relative (opportunity‑cost) advantage lies.
• When countries specialise and trade, the world production‑possibility curve (PPC) expands outward, indicating a higher total output of goods and services.

Free Trade – Advantages and Disadvantages

Advantages	Disadvantages
Consumers gain access to a larger variety of goods at lower prices. Resources are allocated to their most efficient uses (higher total output). Domestic firms are forced to become more productive and innovative. Overall real incomes and standards of living tend to rise.	Domestic industries that are not competitive may shrink or disappear. Job losses can occur in sectors exposed to import competition. Short‑run adjustment costs (re‑training, relocation) can be significant. Dependence on foreign suppliers may create vulnerability to external shocks.

6.2 Globalisation, Trade Restrictions and Market Failure

Why Globalisation Occurs

• Lower transport and communication costs (container shipping, internet).
• Technological advances that reduce transaction costs.
• Trade‑liberalisation agreements (WTO, free‑trade areas, customs unions).
• Growth of multinational corporations (MNCs) seeking new markets and cheaper inputs.

Consequences of Globalisation

• Greater variety of goods and services for consumers.
• Potential rise in real incomes and standards of living.
• Intensified competition – some domestic firms expand, others contract.
• Increased movement of capital and labour across borders.
• Environmental pressures (carbon emissions, resource depletion).

Role of Multinational Corporations (MNCs)

• Transfer technology, managerial expertise and capital to host economies.
• Can shift profits to low‑tax jurisdictions – a fiscal concern for governments.
• Often lobby for lower trade barriers to protect global supply chains.

Why Governments Impose Trade Restrictions

• Economic reasons – protect infant industries, preserve jobs, raise fiscal revenue, improve the balance of payments.
• Political / strategic reasons – safeguard sectors deemed vital for national security, respond to diplomatic disputes.
• Social, health and environmental reasons – limit imports that threaten public health, safety or the environment (e.g., carbon‑intensive products, hazardous chemicals).

Market Failure – Monopoly

In a monopoly a single firm is the sole supplier of a good or service. Because the firm can set price above marginal cost, the market produces less than the efficient quantity, creating a dead‑weight loss. Monopoly is therefore listed in the syllabus as a type of market failure that can justify government intervention.

Types of Trade Restrictions (Methods of Protection)

• Tariffs – taxes on imported goods.
• Quotas – quantitative limits on the amount that can be imported.
• Import licences – permission required before a good may be imported.
• Subsidies – financial assistance that lowers domestic production costs.
• Voluntary Export Restraints (VERs) – exporting country voluntarily limits shipments.
• Non‑tariff barriers (NTBs) – standards, regulations or administrative procedures that restrict imports (e.g., safety standards, “green” labels).

Economic Effects of Each Measure (brief)

Restriction	Intended Effect	Typical Economic Consequences
Tariff	Raise import price → protect domestic producers.	Higher consumer prices, domestic producer gain, government revenue, dead‑weight loss.
Quota	Limit quantity imported.	Same price effect as a tariff; creates “quota rents” that may accrue to foreign exporters or domestic licence‑holders.
Import licence	Control volume through administrative approval.	Delays, higher transaction costs, possible corruption.
Subsidy	Lower domestic production costs.	Domestic output rises, world price may fall, can provoke WTO disputes.
VER	Exporting country voluntarily limits shipments.	Reduces import quantity; foreign exporters often receive higher prices (rent goes to them).
NTB	Restrict imports without using a tax.	May protect health or environment but can be disguised protectionism; harder to quantify.

Elasticity Reminder (relevant for tariff analysis)

• Perfectly elastic demand – PED → ∞; a tiny price rise eliminates quantity demanded.
• Unitary elastic demand – PED = 1; total revenue is unchanged by a price change.
• Perfectly inelastic demand – PED = 0; quantity demanded does not change with price.

6.3 Tariffs – The Most Common Trade Restriction

Definition

A tariff is a tax levied by a government on goods as they cross the border. It raises the domestic price of the imported product, giving an advantage to locally produced substitutes.

Why Governments Use Tariffs

• Protect infant industries.
• Protect jobs.
• Raise fiscal revenue (especially for developing economies).
• Retaliate against foreign trade barriers.
• Safeguard strategic or security‑sensitive sectors.
• Address environmental objectives (e.g., carbon tariffs on high‑emission imports).

Types of Tariffs

Tariff Type	Definition	How It Is Calculated	Typical Use
Specific (Fixed) Tariff	A fixed amount of money charged per unit of the imported good.	Tariff = $a per unit (e.g., $2 per kg)	Useful when the quantity is easy to measure and the good’s price is relatively stable.
Ad valorem Tariff	A percentage of the customs value of the imported good.	Tariff = b % × value (e.g., 10 % of the declared price)	Common for high‑value or price‑fluctuating items.
Compound Tariff	Combination of a specific tariff plus an ad valorem tariff.	Tariff = $c per unit + d % × value	Provides protection based on both volume and value.

Economic Effects of a Tariff (Small Open Economy)

1. Consumer surplus (CS) falls – higher price and lower quantity purchased.
2. Producer surplus (PS) rises – domestic firms sell more at a higher price.
3. Government revenue (GR) increases – tariff collected on each imported unit.
4. Dead‑weight loss (DWL) – loss of total welfare not offset by gains elsewhere.

Simple Tariff Calculation Example

World price of a widget = $20.
Ad valorem tariff = 25 %.

Domestic price after tariff: $20 + 0.25 × $20 = $25.

If imports fall from 1,000 to 600 units, government revenue is:

$$\text{GR}= (0.25 \times 20) \times 600 = 5 \times 600 = \$3{,}000$$

Advantages and Disadvantages of Tariffs

• Advantages
  • Protects domestic jobs and emerging industries.
  • Generates fiscal revenue.
  • Can be adjusted quickly in response to trade disputes.
• Disadvantages
  • Raises prices for consumers, reducing real income.
  • May provoke retaliation from trading partners.
  • Creates inefficiency – resources may be diverted to less‑competitive sectors.
  • Dead‑weight loss reduces overall economic welfare.

6.4 Foreign‑Exchange Rates

Definition

The foreign‑exchange (FX) rate is the price of one currency expressed in terms of another (e.g., £1 = $1.30).

Exchange‑Rate Regimes

Regime	Definition	Advantages	Disadvantages
Floating (flexible)	Rate is determined by market forces of supply and demand.	Adjusts automatically to shocks; can help correct current‑account imbalances.	Can be volatile; may create uncertainty for traders and investors.
Fixed (pegged)	Government or central bank sets the rate and intervenes to maintain it.	Provides stability for trade and investment; reduces exchange‑rate risk.	Requires large foreign‑exchange reserves; may become unsustainable if fundamentals diverge.

Determinants of a Floating Exchange Rate

• Relative inflation rates – higher inflation erodes a currency’s purchasing power.
• Interest‑rate differentials – higher rates attract foreign capital, increasing demand for the currency.
• Speculation – expectations of future movements can cause short‑term swings.
• Trade flows – a surplus raises demand for the domestic currency; a deficit does the opposite.

6.5 Balance of Payments – Current Account

Components of the Current Account (as named in the syllabus)

Component	What It Records
Goods (merchandise)	Exports and imports of tangible products.
Services	Exports and imports of intangible services (tourism, banking, transport, etc.).
Primary income	Earned from abroad (wages, dividends, interest) and paid to foreign investors.
Secondary income (transfers)	One‑way transfers such as remittances, foreign aid, gifts.

Example Calculation

Suppose a country records the following in a year:

• Exports of goods: $150 bn
• Imports of goods: $180 bn
• Exports of services: $40 bn
• Imports of services: $30 bn
• Primary income received: $10 bn
• Primary income paid: $12 bn
• Net secondary income received: $5 bn

Current‑account balance = (Exports – Imports) of goods + (Exports – Imports) of services + Net primary income + Net secondary income.

$$\begin{aligned} \text{CA} &= (150-180) + (40-30) + (10-12) + 5\\ &= -30 + 10 -2 + 5\\ &= -\$17\text{ bn} \end{aligned}$$

The economy has a current‑account deficit of $17 bn, meaning it is a net borrower from the rest of the world.

Policies to Achieve Balance‑of‑Payments (BoP) Stability

• Exchange‑rate policy – devaluation of a fixed rate or allowing a floating rate to depreciate can make exports cheaper and imports more expensive.
• Import controls – tariffs, quotas or licensing to reduce import volume.
• Export promotion – subsidies, tax incentives or marketing assistance for domestic exporters.
• Capital‑flow measures – controls on short‑term foreign investment or reserve requirements.
• Fiscal and monetary adjustments – reducing government deficits or tightening monetary policy to lower domestic demand for imports.

6.6 Environmental and Sustainability Dimensions of Trade Restrictions

• Carbon tariffs – taxes on imports from countries with weaker climate policies, leveling the playing field for domestic low‑carbon producers.
• Protection of biodiversity – bans or high tariffs on products linked to illegal logging, over‑fishing or wildlife trade.
• Arguments for – internalise environmental externalities, encourage greener production, support sustainable development goals.
• Arguments against – may be used as disguised protectionism, raise consumer prices, and trigger WTO disputes.

Summary

Globalisation offers greater variety, lower prices and higher real incomes, but it also creates adjustment challenges, environmental pressures and the risk of market failures such as monopoly. Governments respond with a range of trade‑restriction tools—most commonly tariffs—each with distinct economic effects. Understanding the underlying concepts (comparative advantage, elasticity, exchange‑rate regimes, current‑account components) and the broader policy context (balance‑of‑payments stability, environmental sustainability) equips students to analyse protectionist measures and to answer Cambridge IGCSE 0455 examination questions confidently.