National Welfare Arguments Against Free Trade The Terms of Trade argument for a tariff For a large country(that is, a country that can affect the world price through trading), a tariff lowers the price of imports and generates a terms of trade benefit This benefit must be compared to the costs of the tariff (production and consumption distortions It is possible that the terms of trade benefits of a tariff outweigh its costs Therefore, free trade might not be the best policy for a large countr y Copyright C 2003 Pearson Education, Inc Slide 9-11
Copyright © 2003 Pearson Education, Inc. Slide 9-11 ▪ The Terms of Trade Argument for a Tariff • For a large country (that is, a country that can affect the world price through trading), a tariff lowers the price of imports and generates a terms of trade benefit. – This benefit must be compared to the costs of the tariff (production and consumption distortions). • It is possible that the terms of trade benefits of a tariff outweigh its costs. – Therefore, free trade might not be the best policy for a large country. National Welfare Arguments Against Free Trade
National Welfare Arguments Against Free Trade Figure 9-2: The Optimum Tariff National welfare Optimum Prohibitive Tariff rate tariff to tariff rate t Copyright C 2003 Pearson Education, Inc Slide 9-12
Copyright © 2003 Pearson Education, Inc. Slide 9-12 1 National welfare Optimum Tariff rate tariff, to Prohibitive tariff rate, tp Figure 9-2: The Optimum Tariff National Welfare Arguments Against Free Trade
National Welfare Arguments Against Free Trade ° Optimum tariff The tariff rate that maximizes national welfare It is al ways positive but less than the prohibitive rate that would eliminate all imports It is zero for a small country because it cannot affect its terms of trade Copyright C 2003 Pearson Education, Inc Slide 9-13
Copyright © 2003 Pearson Education, Inc. Slide 9-13 • Optimum tariff – The tariff rate that maximizes national welfare – It is always positive but less than the prohibitive rate that would eliminate all imports. – It is zero for a small country because it cannot affect its terms of trade. National Welfare Arguments Against Free Trade
National Welfare Arguments Against Free Trade What policy would the terms of trade argument dictate for export sectors? An export subsidy worsens the terms of trade, and therefore unambiguously reduces national welfare Therefore, the optimal policy in export sectors must be a negative subsidy, that is, a tax on exports Like the optimum tariff, the optimum export tax is al ways positive but less than the prohibitive tax that would eliminate exports completely Copyright C 2003 Pearson Education, Inc Slide 9-14
Copyright © 2003 Pearson Education, Inc. Slide 9-14 • What policy would the terms of trade argument dictate for export sectors? – An export subsidy worsens the terms of trade, and therefore unambiguously reduces national welfare. – Therefore, the optimal policy in export sectors must be a negative subsidy, that is, a tax on exports. – Like the optimum tariff, the optimum export tax is always positive but less than the prohibitive tax that would eliminate exports completely. National Welfare Arguments Against Free Trade
National Welfare Arguments Against Free Trade The domestic Market Failure Argument Against Free ade Producer and consumer surplus do not properly measure social costs and benefits Consumer and producer surplus ignore domestic market failures such as Unemployment or underemployment oflabor Technological spillovers from industries that are new or particularly innovative Environmental externalities a tariff may raise welfare if there is a marginal social benefit to production of a good that is not captured by producer surplus measures Copyright C 2003 Pearson Education, Inc Slide 9-15
Copyright © 2003 Pearson Education, Inc. Slide 9-15 ▪ The Domestic Market Failure Argument Against Free Trade • Producer and consumer surplus do not properly measure social costs and benefits. – Consumer and producer surplus ignore domestic market failures such as: – Unemployment or underemployment of labor – Technological spillovers from industries that are new or particularly innovative – Environmental externalities • A tariff may raise welfare if there is a marginal social benefit to production of a good that is not captured by producer surplus measures. National Welfare Arguments Against Free Trade