Reasons for trade restrictions: raise tax revenue

IGCSE Economics – Complete Syllabus Overview (Cambridge 0455)

1. The Basic Economic Problem

• Scarcity: Limited resources vs. unlimited human wants.
• Factors of Production:

  • Land (natural resources)
  • Labour (human effort)
  • Capital (machinery, buildings, tools)
  • Enterprise (organisation, risk‑taking)

• Choice: What to produce, how to produce, for whom?
• Opportunity Cost: Value of the next best alternative fore‑gone.
• Economic Goods vs. Free Goods:

  • Economic goods – scarce, require a price.
  • Free goods – abundant, price = 0 (e.g., air).

Key diagram – Production Possibility Curve (PPC)

• Shows maximum output combinations of two goods.
• Points on the curve = efficient use of resources.
• Points inside = under‑utilisation; points outside = unattainable with current resources.
• Movement along the curve illustrates opportunity cost.
• Shifts:

  • Outward shift – increase in resources, better technology or higher productivity.
  • Inward shift – loss of resources, natural disaster, war.

2. Allocation of Resources

2.1 Market Demand and Supply

• Demand: Quantity consumers are willing & able to buy at each price (downward‑sloping).
• Supply: Quantity producers are willing & able to sell at each price (upward‑sloping).
• Market equilibrium: Where Q_D = Q_S; determines price and quantity.
• Market economic systems:

  • Market (capitalist) economy – decisions made by households & firms.
  • Command (planned) economy – decisions made by government.
  • Mixed economy – combination of market forces and government intervention.

2.2 Elasticities

Determinants of PED

• Availability of close substitutes.
• Proportion of income spent on the good.
• Definition of the market (narrow vs. broad).
• Time‑period (long‑run > short‑run).

Classifications of Elasticities

• Perfectly elastic demand: PED = ∞ (horizontal demand curve).
• Perfectly inelastic demand: PED = 0 (vertical demand curve).
• Unit‑elastic demand: PED = 1.
• Similarly for supply (perfectly elastic, perfectly inelastic, unit‑elastic).

2.3 Market Failure

• Public goods: Non‑rival & non‑excludable (e.g., street lighting).
• Merit goods: Under‑consumed if left to market (e.g., education, vaccinations).
• Demerit goods: Over‑consumed if left to market (e.g., cigarettes, alcohol).
• Externalities:

  • Negative – pollution, noise.
  • Positive – beekeeper’s pollination.

• Monopoly: Single seller, price‑setter, creates dead‑weight loss.
• Mixed‑economy arguments: Need for both market efficiency and government intervention to correct failures.

2.4 Government Intervention

• Taxes – reduce consumption/production of demerit goods, raise revenue.
• Subsidies – encourage consumption/production of merit goods.
• Price controls:

  • Price ceiling – protects consumers (e.g., rent control).
  • Price floor – protects producers (e.g., minimum wage).

• Regulation – standards for safety, health, environment.
• Tax classifications:

  • Direct tax – levied on income or profit (e.g., income tax).
  • Indirect tax – levied on consumption (e.g., VAT, import duties).
  • Progressive tax – higher rate on higher incomes.
  • Regressive tax – higher burden on low‑income earners (e.g., flat‑rate sales tax).

3. Micro‑economic Decision‑makers

3.1 Households

• Decide how much to spend, save or borrow based on income, interest rates and expectations.
• Consumption decisions illustrated by the budget constraint diagram.
• Utility maximisation – highest satisfaction for given income.

3.2 Firms

• Types of firms:

  • Private‑sector (profit‑maximising).
  • Public‑sector (government‑owned).
  • Co‑operatives.

• Objectives: Profit maximisation, market share, growth, social goals.
• Production decisions driven by costs (fixed vs. variable) and revenue.
• Profit maximisation condition: Marginal cost = marginal revenue.
• Cost curves – short‑run (SAC, SMC) and long‑run (LAC) – illustrate economies and diseconomies of scale.
• Economies of scale: Lower average cost as output rises (e.g., bulk buying, specialised labour).
• Diseconomies of scale: Higher average cost at very large output (e.g., management problems).
• Market structures:

  • Perfect competition – many sellers, price‑taker.
  • Monopoly – single seller, price‑setter.
  • Monopolistic competition – many sellers, product differentiation.
  • Oligopoly – few large sellers, strategic interaction.

• Mergers & acquisitions – can create larger firms, affect competition.

3.3 Money & Banking

• Functions of money: Medium of exchange, unit of account, store of value.
• Banking system creates money through fractional reserve banking.
• Central bank (e.g., Bank of England) controls money supply via:

  • Open‑market operations.
  • Reserve requirements.
  • Policy interest rate.

3.4 Labour Market

• Wage determination through interaction of labour demand (derived from marginal product of labour) and labour supply.
• Factors influencing wages: skills, education, union power, minimum wage legislation, discrimination.
• Unemployment types:

  • Frictional – short‑term transition between jobs.
  • Structural – mismatch of skills/locations.
  • Seasonal – due to seasonal demand (e.g., tourism).
  • Cyclical – caused by downturns in the business cycle.

4. Government & the Macro‑economy

4.1 Government Aims

• Economic growth (increase in real GDP).
• Low and stable inflation.
• Full employment (low unemployment).
• Equitable distribution of income.
• Balance of payments equilibrium.

4.2 Fiscal Policy

• Components: Government spending (G) and taxation (T).
• Aggregate demand: AD = C + I + G + (X‑M).
• Expansionary fiscal policy – increase G or cut T → boost AD, raise output & employment, risk inflation.
• Contractionary fiscal policy – decrease G or raise T → curb AD, lower inflation, risk higher unemployment.
• Budget deficit: T < G; Deficit = G – T.
• Budget surplus: T > G; Surplus = T – G.
• Evaluation criteria:

  • Effectiveness – size of impact on AD.
  • Efficiency – administrative cost, speed of implementation.
  • Equity – who bears the burden.
  • Side‑effects – e.g., crowding‑out of private investment.

4.3 Monetary Policy

• Managed by the central bank to influence interest rates and the money supply.
• Expansionary: Lower policy rate, buy government securities → stimulate investment & consumption.
• Contractionary: Raise policy rate, sell securities → dampen inflation.
• Policy tools:

  • Open‑market operations.
  • Reserve requirements.
  • Discount (policy) rate.

• Evaluation criteria similar to fiscal policy (effectiveness, efficiency, equity, side‑effects).

4.4 Supply‑side Policies

• Aim to increase long‑run productive capacity (LRAS).
• Key measures:

  • Improving education & training.
  • Investing in infrastructure (roads, ports, ICT).
  • Deregulation – removing unnecessary licences.
  • Tax incentives – lower corporate tax, investment allowances.
  • Promoting research & development.

• Potential side‑effects: increased inequality, environmental damage.

4.5 Inflation

• Demand‑pull inflation: AD rises faster than LRAS (e.g., booming economy).
• Cost‑push inflation: Rising production costs (wages, oil) shift SRAS left.
• Measurement – Consumer Price Index (CPI) or Retail Price Index (RPI).

4.6 Measuring Economic Performance

5. Economic Development

• Living‑standard indicators:

  • GDP per capita.
  • HDI (life expectancy, education, income).
  • Access to clean water, electricity.

• Poverty:

  • Absolute poverty – living below a set income line (e.g., $1.90 a day).
  • Relative poverty – significantly below average national income.

• Population dynamics:

  • Components of population growth: birth rate, death rate, immigration, emigration.
  • Age structure (young, working‑age, elderly) influences labour supply and demand for services.

• Causes of under‑development:

  • Low investment & savings.
  • Poor education & health.
  • Political instability & corruption.
  • Disease burden.
  • Inadequate infrastructure.

• Development policies:

  • Foreign aid – grants, loans, technical assistance.
  • Debt relief programmes.
  • Trade‑related assistance (e.g., preferential market access).
  • Micro‑finance & entrepreneurship support.

6. International Trade & Globalisation

6.1 Specialisation & Comparative Advantage

• Absolute advantage: Producing more of a good with the same resources.
• Comparative advantage: Lower opportunity cost; basis for mutually beneficial trade.
• Specialisation leads to higher global output – illustrated by a two‑country PPC.

6.2 Benefits & Costs of Free Trade

• Benefits:

  • Greater variety of goods.
  • Lower prices for consumers.
  • Economies of scale for producers.
  • Technology transfer and innovation.

• Costs:

  • Domestic industries may contract.
  • Job losses in protected sectors.
  • Dependence on external markets.
  • Potential widening of income inequality.

6.3 Globalisation – Causes

• Advances in transport and communication technology.
• Liberalisation of trade policies (e.g., WTO agreements).
• Growth of multinational companies (MNCs) and foreign direct investment (FDI).
• Rise of global supply chains.

6.4 Multinational Companies (MNCs)

• Operate in more than one country; bring capital, technology, management expertise.
• Advantages: Job creation, skill development, foreign exchange earnings.
• Criticisms: Profit repatriation, crowding‑out of local firms, labour exploitation, environmental concerns.

6.5 Reasons for Trade Restrictions

1. Protect domestic producers – infant‑industry argument, safeguard strategic sectors.
2. Protect consumers – health, safety, environmental standards (e.g., bans on hazardous chemicals).
3. Raise government revenue – especially where the domestic tax base is narrow.
4. Retaliation / political motives – respond to perceived unfair trade practices.
5. Balance of payments concerns – limit imports to improve the current account.

6.6 Types of Trade Restrictions

6.7 Calculating Revenue from Trade Taxes

Specific tariff – if the tariff is \$t\$ per unit and \$Q\$ units are imported:

\$\$

R = t \times Q

\$\$

Ad‑valorem tariff – if the rate is \$r\$ (decimal) and the total customs value is \$V\$:

\$\$

R = r \times V

\$\$

Illustrative example

1. Country Y imposes a 12 % ad‑valorem tariff on imported cars.
2. Customs value of cars imported in the year = US$150 million.
3. Revenue = \$0.12 \times 150{,}000{,}000 = US\$18 million.
4. The government may allocate this to road‑safety programmes.

6.8 Advantages & Disadvantages of Raising Revenue through Trade Taxes

• Advantages

  • Broad tax base – captures revenue from all importers and exporters.
  • Easy collection at borders; low administrative cost.
  • Can be adjusted quickly to meet fiscal targets.
  • Provides a stable source of income for countries with weak domestic tax systems.

• Disadvantages

  • Raises the price of imported goods → reduces consumer welfare, especially for low‑income households.
  • May provoke retaliation, leading to trade wars and reduced export earnings.
  • Encourages smuggling, under‑declaration and corruption at customs.
  • Distorts market signals, potentially leading to inefficiency and dead‑weight loss.

6.9 Foreign‑Exchange (FX) Markets & Balance of Payments

• Exchange‑rate regimes

  • Floating – market determines the rate.
  • Fixed (or pegged) – government/central bank maintains a set rate.
  • Managed float – occasional intervention to smooth volatility.

• Balance of Payments (BoP) – record of all economic transactions with the rest of the world.

  • Current account: Trade in goods & services, primary income (interest, dividends), secondary income (remittances, gifts).
  • Capital account: Capital transfers, acquisition/disposal of non‑produced, non‑financial assets.
  • Financial account: Foreign direct investment, portfolio investment, other investment (loans, currency).

• Persistent current‑account deficits may lead to depreciation of the domestic currency, affecting import prices and export competitiveness.
• Policy tools to correct BoP imbalances: exchange‑rate adjustments, import restrictions, export promotion, capital controls.