Tariffs & Export Subsidies (Cambridge International A-Level Economics)

Why engage in protectionism?

• Protectionism refers to government policies that restrict international trade in order to protect domestic industries from foreign competition

• Typical protectionist methods include:

  • tariffs
  • import quotas
  • export subsidies
  • embargoes
  • excessive administrative burdens (‘red tape’)

Arguments for and against protectionism

Tariffs

• A tariff is a tax imposed on imported goods, raising their price in the domestic market

A tariff results in fewer imports

Diagram analysis

• Without a tariff, the world supply curve (Sw) is perfectly elastic at world price Pw

• At Pw, domestic producers supply Q₁ and domestic consumers demand Q₂ - imports = Q₁ to Q₂

• The tariff raises the price from Pw to Pw + tariff, shifting world supply up to Sw + tariff

  • At the higher price, domestic producers expand output from Q₁ to Q₃
  • Domestic consumers reduce demand from Q₂ to Q₄

• Imports fall from (Q₁ to Q₂₎ to (Q₃ to Q₄) - shown by the "imported" bracket

  • Area 1 = consumer surplus transferred to domestic producers
  • Area 2 + 4 = deadweight welfare loss - inefficiency created by the tariff
  • Area 3 = government tax revenue from the tariff

• Employment in domestic industries rises as output expands from Q₁ to Q₃

Impact of a tariff

Worked Example Which type of import control allows a country to develop a potential comparative advantage in a particular good?

A. a quota that protects jobs in a depressed region

B. a short-term tariff that protects an infant industry

C. a tariff that improves an industry's terms of trade

D. an embargo on goods with negative externalities

Final answer: Answer: B

The key phrase is "develop a potential comparative advantage" - this means the country does not yet have comparative advantage but could develop it over time with protection

This is the infant industry argument - a new domestic industry needs temporary protection from established foreign competitors until it achieves economies of scale and becomes internationally competitive

A short-term tariff provides this protection temporarily while the industry matures - the word "short-term" is critical, as it implies the tariff is removed once competitiveness is achieved

Worked solution

• Option A is incorrect - protecting jobs in a depressed region does not develop comparative advantage; it preserves an existing industry rather than building a new one
• Option C is incorrect - a terms of trade tariff benefits a large country by reducing world import prices; it does not develop comparative advantage
• Option D is incorrect - an embargo on goods with negative externalities is a welfare argument, not a comparative advantage argument

Export subsidies

• An export subsidy is a government payment to domestic producers to lower the price at which they can sell goods abroad, making exports more competitive in world markets

The impact of an export subsidy

Diagram analysis

• Without a subsidy, the domestic equilibrium is below P_w - the country already exports at world price (supply exceeds demand at P_w)

  • Original exports = Q1 to Q2 at world price P_w

• The subsidy raises the price domestic producers receive from P_w to P_w+S

  • At P_w+S, domestic production rises from Q2 to Q4 - production rises
  • At P_w+S, domestic consumption falls from Q1 to Q3 - consumption falls
  • New exports = Q3 to Q4 - a much larger bracket than original exports

• Producer gain (coral) = producers receive higher price on all output

• Consumer loss (teal) = domestic consumers pay higher prices and consume less

• Government subsidy cost = (P_w+S - P_w) × Q4

• Employment in the export sector rises as domestic production expands

Impact of an export subsidy

Worked Example A country subsidises domestic production of manufactured goods. What is the most likely outcome?

A. a rise in economic growth

B. a rise in imports of manufactured goods

C. a rise in the rate of inflation

D. a rise in unemployment

Final answer: Answer: C

A domestic production subsidy raises the price domestic producers receive, increasing domestic output of manufactured goods

Higher domestic output increases demand for factors of production - wages and input costs are bid up across the economy

This feeds through into higher prices across the economy - cost-push inflation rises

Worked solution

• Option A is incorrect - a subsidy may boost output temporarily but creates inefficiency and misallocates resources; sustained economic growth requires productivity improvements, not subsidies
• Option B is incorrect - a production subsidy makes domestic goods cheaper to produce, so domestic goods substitute for imports; imports fall, not rise
• Option D is incorrect - subsidising domestic production incentivises firms to expand output and hire more workers; employment rises, not falls

Exam Hint A common error is to show an export subsidy as a rightward shift of the supply curve - this is correct for a domestic production subsidy (which lowers costs and increases supply at every price) but not for an export subsidy

An export subsidy works differently - the government pays producers a fixed amount per unit exported, so producers will only sell domestically if they receive the same price as abroad (P_w + subsidy)

The correct diagram therefore shows the domestic price rising to P_w+S as a new horizontal price line - the supply curve itself does not shift

Always check which type of subsidy the question refers to before drawing your diagram