Managerial Economics: Basics of the Government's Role in International Trade

Managerial economics calls for a solid understanding of the government's role in international trade. Importing similar goods is a major source of competition for domestic businesses. Governments can influence this trade through tariffs and quotas, managing the levels of importation and their ability to compete with domestic companies.

Tariffs

A tariff is a tax charged on imports. Government uses tariffs to protect domestic industries from foreign competition. As a result of a tariff, domestic firms typically are able to charge a higher price while also producing more output. it's not uncommon for tariffs to lead to higher employment in protected industries as compared to the employment level that would exist if the industry were unprotected.

The illustration shows a protective tariff's impact as compared to free trade. The underlying assumption is that the United States government is imposing a tariff on imports in order to protect U.S. firms.

The market illustrated is the market for the good in the United States. Thus, the demand curve labeled DUS is the good's demand from customers in the United States. The supply curve SUS is the U.S. supply curve and illustrates the quantity of the good U.S. firms are willing to produce and sell at various possible prices.

The supply curve SFT is the world supply of the good to the U.S. market assuming free trade — no tariffs. The world's supply includes the quantity U.S. firms are willing to produce plus the quantity foreign firms are willing to produce to sell in the U.S. market.

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If free trade exists and the market is in equilibrium, the good's equilibrium price is PFT, which corresponds to the intersection of DUS and SFT. The quantity of the good U.S. consumers purchase is QFT. The quantity of the good U.S. firms produce equals QUSFT.

Given the good's free-trade price PFT, this is the quantity U.S. firms are willing to provide based upon the U.S. supply curve SUS. The difference between the quantity purchased by U.S. consumers, QFT, and the quantity produced by U.S. firms, QUSFT, is made up with imports.

If U.S. firms are successful in lobbying the federal government for tariff protection, the world's supply of the good to the U.S. market shifts to STariff.

As illustrated, the vertical difference between the world supply curve with no tariffs, SFT, and the world supply curve with tariffs, STariff, represents the amount of the tariff as labeled. If the tariff is the same for each unit of the good imported, the vertical difference doesn't change.

With a tariff in place, the market adjusts to a new equilibrium. The good's equilibrium price increases to PT, which corresponds to the intersection of DUS and STariff. The quantity of the good U.S. consumers purchase is QT. The quantity of the good U.S. firms produce equals QUST.

Given the good's price with the tariff, PT, this is the quantity U.S. firms are willing to provide given the U.S. supply curve SUS. The difference between the quantity purchased by U.S. consumers, QT, and the quantity produced by U.S. firms, QUST, is made up with imports as labeled.

The tariff has the desired effect. It increases the price U.S. firms receive and, as a result, the firms increase their production from QUSFT to QUST. Not surprisingly, imports also shrink because the foreign firms have to subtract the tariff from the price they receive.

Tariffs help protect domestic industries, but often at the expense of consumers. Tariff protection means that consumers of the good pay higher prices.

Quotas

Quotas restrict the quantity of imports from other countries. Quotas are another method government uses to protect domestic industries from foreign competition. Like a tariff, quotas lead to higher prices for domestic firms, which provides incentive to produce more output. Thus, quotas also lead to higher employment if an industry is protected for foreign competition.

The illustration shows an import quota's impact as compared to free trade. The United States government is imposing an import quota to protect U.S. firms. The illustration shows the good's U.S. market. The demand curve labeled DUS is U.S. consumer demand for the good.

The supply curve, SUS, is the U.S. supply curve and illustrates the quantity of the good U.S. firms are willing to produce and sell at various possible prices. The supply curve SFT is the world supply of the good to the U.S. market assuming free trade — no quotas or tariffs.

The world supply includes both the quantity U.S. firms are willing to produce and the quantity foreign firms are willing to produce to sell in the U.S. market at various possible prices.

If free trade exists and the market is in equilibrium, the good's equilibrium price and quantity are PFT and QFT as determined by the intersection of DUS and SFT. U.S. consumers purchase the quantity QFT. Given free trade, U.S. firms produce QUSFT — this is the quantity U.S. firms are willing to provide given where the good's free trade price PFT hits the U.S. supply curve SUS.

The difference between the quantity purchased by U.S. consumers, QFT, and the quantity produced by U.S. firms, QUSFT, is made up with imports as labeled.

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U.S. firms successfully lobby the federal government for an import quota. As a result, the world's supply of the good to the U.S. market shifts to SQuota. As illustrated, the horizontal difference between the U.S. supply curve, SUS, and the world supply with the quota, SQuota, equals the quota. This is the maximum permitted quantity of imports. The quota's impact on supply is illustrated.

A quota leads to a new market equilibrium. The good's equilibrium price increases to PQ, which corresponds to the intersection of DUS and SQuota. U.S. consumers purchase QQ of the good. U.S. firms produce QUSQ — this is the quantity U.S. firms are willing to provide given the market price PQ and the U.S. supply curve SUS.

The difference between the quantity purchased by U.S. consumers, QQ, and the quantity produced by U.S. firms, QUSQ, is made up with imports as labeled. Thus, imports equal the amount of the quota.

The quota accomplishes its intended goal by increasing the price U.S. firms receive. As a result, U.S. firms produce more — moving to QUSQ from QUSFT. This production increase may lead to higher employment in the protected industry. At the same time, imports decrease to the amount of the quota.

Quotas, like tariffs, protect domestic industries. But that protection comes at a price; more specifically, it comes at a higher price for consumers. In a real sense, consumers are footing the bill for the domestic industry's protection.

Other types of trade restrictions include embargos that prevent trade with another country and negative lists that exclude items from free trade agreements.

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