Oct 17 2007

IB – Graphing and understanding the economic impacts of protectionism

Here’s an online special for my IB students. We’ve recently started our unit on International economics, and one of the first topics is free trade, protectionism, barriers to trade, and the arguments in support of and against such protection. Below are the graphs we discussed in our Smartboard lesson during today’s class.

If you click on each image it will take you to a full size version.

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What to notice about the impact of a tariff: Domestic producers benefit at the expense of domestic consumers and foreign producers. The green triangles represent efficiency or welfare loss because that is consumer surplus that is forgone after the tariff. The yellow rectangle is not DWL because it is tariff revenue for the government.

Be sure to understand the indirect effects of such policies also. For example, any of the three forms of protection shown here will lead to a decrease in net exports for America’s trading partners, which means a decrease in Aggregate Demand and the possibility of higher unemployment, recession, lower income, thus less demand for American products abroad. So, not only does the tariff hurt American consumers through higher prices and lower quantity, but it could harm other American businesses whose products are no longer in demand from foreigners whose incomes have declined thanks to the American tariffs.

Note also the regressive nature of tariffs. Much like a VAT or an excise tax, tariffs place a greater burden on low income earners than high income earners, as a particular tax on imports represents a larger percentage of a poor person’s income.

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Subsidies appear to result in less of a welfare loss to society than tariffs, but this is unclear since the size of the subsidy is unknown. Obviously, larger subsidies create a greater welfare loss, because they result in more scarce resources being allocated towards the production of a product which the US lacks a comparative advantage. The size of the green triangle in the graph above represents the size of the welfare loss… or the degree to which resources are being over-allocated towards this product.

The Quota scenario is the most complicated to understand graphically. Here’s how to interpret the graph above. The government says that foreigners can only import Q1Q2 units, which means at Pw, where American firms are only producing 0Q1 units, there is a severe shortage of automobiles. The price rises in response to the excess demand, which attracts more firms into the automobile market (or existing firms open new plants) shifting domestic Supply out.

unit-4-international-economics_12.png

The price will settle where the new domestic Supply curve intersects demand, but the number of cars produced by American firms will equal 0Q4 minus Q1Q2. In other words, since foreigners were happy to import Q1Q3 even at the lower Pw before the quota, they will continue to import as much as they are allowed (equal to the government’s quota of Q1Q2 at the new higher price. But since consumers demand Q4 at the new higher price, new domestic producers will step in and satisfy the demand beyond what foreign firms can meet with their restricted imports. So the domestic output is represented by two segments, 0Q1 and Q2Q4. Imports are represented by Q1Q2 (restricted by the government’s quota). Confusing, but once you study it for a while it makes sense.

IB students should be able to illustrate, explain and evaluate the effects of and the arguments for and against the various types of government protection as shown above.


About the author:  Jason Welker teaches International Baccalaureate and Advanced Placement Economics at Zurich International School in Switzerland. In addition to publishing various online resources for economics students and teachers, Jason developed the online version of the Economics course for the IB and is has authored two Economics textbooks: Pearson Baccalaureate’s Economics for the IB Diploma and REA’s AP Macroeconomics Crash Course. Jason is a native of the Pacific Northwest of the United States, and is a passionate adventurer, who considers himself a skier / mountain biker who teaches Economics in his free time. He and his wife keep a ski chalet in the mountains of Northern Idaho, which now that they live in the Swiss Alps gets far too little use. Read more posts by this author

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