Types of trade restrictions / methods of protection: subsidies

Specialisation & Free‑Trade

• Specialisation: a country concentrates on producing the goods and services for which it has a comparative advantage – i.e. the lowest opportunity cost.
• Comparative advantage: a country can produce a good at a lower opportunity cost than another country, even if it is less efficient in absolute terms.
• Free‑trade: removal of all barriers (tariffs, quotas, licences, subsidies, etc.) so that goods and services can move between countries without restriction.

Advantages of specialisation and free‑trade

• Higher overall output – resources are used where they are most productive.
• Consumers enjoy a larger variety of goods at lower prices.
• Countries can earn foreign exchange by exporting surplus production.
• Technology and ideas spread more quickly (knowledge spill‑overs).

Disadvantages / arguments against free‑trade

• Dependence on imports for essential goods can create vulnerability (e.g., food, energy).
• Domestic industries that are not internationally competitive may shrink, leading to job losses and regional decline.
• Developing countries may find it hard to move up the value chain if they are locked into low‑value exports.
• Environmental and labour standards can be undermined when production moves to countries with weaker regulations.

Example: Country A has a comparative advantage in coffee, Country B in electronics. By specialising, A exports coffee and imports electronics; both enjoy more coffee and cheaper phones than if they tried to produce both goods themselves.

Globalisation

Definition (syllabus wording): the increasing integration of world economies through the growth of international trade, the movement of capital and labour, and the spread of ideas and technology.

Key drivers of change

• Lower transport costs – containerisation, larger ships, cheaper air freight.
• Lower communication costs – internet, mobile phones, satellite links.
• Growth of multinational corporations (MNCs).
• Liberalisation of trade and investment policies (e.g., removal of tariffs, free‑trade agreements).
• Technological innovation – automation, digital platforms, e‑commerce.

Multinational corporations (MNCs)

• Definition: a firm that owns or controls production facilities in more than one country.
• Advantages: access to larger markets, economies of scale, spread of technology, job creation in host countries.
• Disadvantages: can dominate local markets, repatriate profits, may exert pressure on governments to lower standards.

Reasons governments impose trade restrictions

• Protect infant industries that need time to become competitive.
• Counter dumping – protect domestic producers from goods sold below cost.
• Maintain balance of payments stability.
• Safeguard national security (e.g., weapons, critical infrastructure).
• Protect the environment, health, or public morals (e.g., bans on hazardous chemicals).
• Preserve cultural heritage or domestic employment.

Evaluation of trade restrictions

Trade Restrictions – Methods of Protection

Governments may intervene in international trade for a range of policy objectives. The main protectionist tools covered by the IGCSE syllabus are:

• Tariffs (import duties)
• Quotas (quantitative limits on imports)
• Import licences (authorisations required before goods can be brought in)
• Export subsidies (payments to exporters)
• Domestic subsidies (payments to domestic producers)
• Anti‑dumping duties (tariffs imposed to counter selling below cost)

Subsidies

A subsidy is a financial contribution made by the government to a firm, industry or individual that reduces the cost of producing a good or service, or raises the price received for it. By lowering the effective marginal cost, a subsidy encourages higher output and can make domestic goods more competitive in international markets.

Types of subsidies

Economic effects of a production subsidy

In a domestic market the supply curve faced by producers shifts downwards (or to the right) by the amount of the subsidy per unit.

Welfare impacts

• Consumer surplus rises because the market price falls.
• Producer surplus rises because producers receive the market price plus the subsidy.
• Government cost = subsidy per unit (s) × quantity produced (Q′).
• Dead‑weight loss results from over‑production relative to the free‑market equilibrium.

Calculating the cost of a production subsidy

If the subsidy is s dollars per unit and the subsidised quantity produced is Q′, then

Government Expenditure = s × Q′

Example: A wheat subsidy of $ 20 per tonne raises domestic output from 1 000 tonnes to 1 300 tonnes.

Cost = 20 × 1 300 = $ 26 000

Key points for revision

1. Subsidies lower the effective cost of production, shifting the supply curve outward.
2. Both consumer and producer surplus increase, but the government bears a fiscal cost.
3. Over‑production creates a dead‑weight loss – a loss of total welfare.
4. Internationally, subsidies can breach WTO rules and provoke retaliatory measures.
5. When answering exam questions, discuss:

   • Short‑run effects on price and quantity.
   • Long‑run welfare implications (CS, PS, government cost, DWL).
   • Possible trade‑policy consequences (e.g., disputes, retaliation).

Foreign‑Exchange Rates

• Definition: the price of one currency expressed in terms of another (e.g., £1 = $1.30).
• Floating (flexible) rate: determined by supply and demand in the foreign‑exchange market; can appreciate or depreciate.
• Fixed (pegged) rate: government or central bank sets the rate and intervenes to maintain it.

Determinants of exchange rates (floating system)

• Relative inflation rates – higher inflation in a country tends to depreciate its currency.
• Interest‑rate differentials – higher interest rates attract foreign capital, causing appreciation.
• Current‑account balance – a surplus (more exports than imports) creates demand for the domestic currency, leading to appreciation.
• Speculative expectations – expectations of future movements can cause immediate shifts.

Effects of appreciation and depreciation

Simple supply‑demand diagram (description)

Horizontal axis: quantity of domestic currency; vertical axis: price in foreign currency. A rightward shift of demand (higher foreign demand) leads to appreciation; a leftward shift leads to depreciation.

Current Account of the Balance of Payments

The current account records a country’s transactions in goods, services, primary income (e.g., wages, investment income) and secondary income (e.g., remittances, aid).

Components

Calculating the current‑account balance

Current‑account balance = (Exports of goods + Exports of services + Primary income received + Secondary income received) – (Imports of goods + Imports of services + Primary income paid + Secondary income paid)

Example (all figures in $ million):

• Goods export = 150, import = 120
• Services export = 40, import = 30
• Primary income received = 20, paid = 25
• Secondary income received = 10, paid = 5

Current‑account balance = (150+40+20+10) – (120+30+25+5) = 220 – 180 = $ 40 million surplus.

Consequences of a surplus / deficit

• Surplus: net inflow of foreign currency, can lead to appreciation of the domestic currency; may indicate strong export sector.
• Deficit: net outflow of foreign currency, can cause depreciation; may need financing through capital inflows or borrowing.

Policy responses

• Exchange‑rate adjustments (devaluation to boost exports).
• Trade policies – tariffs, subsidies, or export promotion.
• Fiscal measures – reducing public spending to lower import demand.

Quick‑Reference Summary of Other IGCSE Units (1‑5)

How to use these notes for exam preparation

1. Memorise key definitions (comparative advantage, subsidy, floating rate, current‑account surplus).
2. Practice drawing and labeling the standard diagrams (PPC, supply‑demand with subsidy, foreign‑exchange market).
3. For each trade‑restriction tool, be able to state:

   • What it is and how it works.
   • One advantage and one disadvantage.
   • A real‑world example (e.g., EU sugar quota, US steel tariffs).

4. When answering essay or data‑response questions, structure answers with:

   • Definition → Mechanism → Diagram (if required) → Evaluation.

5. Link concepts across units (e.g., how a subsidy affects the current account via increased exports).