Brief answers to problems and questions for review

1. NTBs apply to 10 to 12 percent of imports in Japan and the EU, respectively. There
are NTBs on over 16 percent of US imports.

2. Quotas restrict imports of a good to a certain quantitative level. An import quota

differs from an import tariff in that a quota restricts imports of a good to a certain
quantitative level and a tariff is a tax on the imported good. In the case of a tariff, the
amount of tariff revenue the government collects can be spent on the provision of
public goods. In the case of a quota, the higher price received by the foreign firms
creates additional revenue that accrues to the foreign producers and makes them more
profitable. As a result, the net welfare loss to the quota-imposing country is larger
under a quota than a tariff.

3. First, nonmembers of the WTO can still use quotas as well as new members that have
not completely phased in WTO rules. Second, some countries still employ quotas in
defiance of WTO rules or use quotas to protect agricultural products not yet fully
covered by WTO rules.

4. The sugar industry has been heavily protected by the US for a long time. The US sets
a price for sugar far higher than the world price. The government loans the producers
money and then accepts the sugar as repayment of the loan at the inflated price. The
high prices are maintained by a quota on imports of sugar.

5. A tariff equivalent to a quota has identical short-run static effects except that tariffs
tend to reward the most efficient foreign producers while quotas may be allocated
arbitrarily. However, a tariff is much less restrictive in the domestic market than a
quota when the domestic demand for the product increases. In the case of a tariff, an
increase in domestic demand would be supplied by imports at the current price. When
a quota is present, the domestic producers supply the increase in domestic demand. In
this case, the losses for consumers and society are much larger in the case of a quota
than in the case of a tariff when the demand increases.

6. Assume that this country has a comparative disadvantage in the production of steel,
and decides to open its borders to trade. In this case, the country will import steel at
price – Pw. Under conditions of free trade, the domestic price of steel would fall to Pw,
with Qs amount of steel being produced domestically and the amount Q1 to Q5 being
imported. Remember, if a tariff were imposed in this market, the domestic price
would rise, domestic production would expand, and imports would decline. Identical
effects on the domestic price, domestic production, and the amount imported could
occur if the government imposed an import quota. Let’s assume the government
imposes an import quota that restricts the supply of imported steel to Q2Q4 units.
Because the supply of imported steel is reduced, the price of steel will begin to rise
until a new equilibrium is reached. Domestic consumers are harmed as consumer
surplus declines by areas, a + b + c + d. Domestic producers benefit as producer
surplus rises by area a. As in the case of a tariff, there are efficiency losses of areas b
and d. Who receives area c is the only difference between a tariff and a quota. In the
case of a tariff, area c is the amount of tariff revenue the domestic government
collects. In the case of a quota, area c accrues to the foreign producers and makes
them more profitable. The net welfare loss to the quota-imposing country is larger

© 2015 W. Charles Sawyer and Richard L. Sprinkle

 under a quota than a tariff. With a tariff, the domestic government gains revenue, area
c, which can be spent on the provision of public goods. With a quota, area c is lost to
the foreign producers.

P S

P' Quota constrained price

a b c d
Pw World price

D
Quota
Q1 Q2 Q3 Q4 Q5 Q

7. Assume that the demand for the imported good increases after a quota has been placed
in the market. The quantity imported cannot increase when there is an increase in
demand. As a result, the price of imports rises. In the case of a tariff, the price would
remain constant and the additional demand for the good would be supplied with
additional imports. However, when a quota is present in the domestic market, the
domestic producers supply the increase in demand. The foreign producers also gain in
this case as the price they receive for their product increases. The important point is
that the losses for consumers and society are much larger in the case of a quota than in
the case of a tariff when demand increases.

8. There are two methods available for a government to capture area c under a quota.
First, the government could auction quotas to foreign producers in a free market. The
advantage to this auction quota method is that the domestic government would gain
area c which now accrues to foreigners, and the limited quota supply would go to
those importers most in need of the product who would pay the highest prices.
Another method available to a government or society to capture area ‘c’ is to convert
the quotas into an equivalent tariff. The conversion of quotas into a tariff has several
advantages. First, tariffs are legal under the WTO and quotas are not. If foreign firms
find the quota sufficiently onerous, they can perhaps get their government to complain
to the WTO for a remedy. Second, calculating a tariff equivalent for an existing quota
is easy to do. To calculate a tariff equivalent, take the difference between the good's
world market price and the good's quota-constrained domestic price and divide that
difference by the good's world market price.

9. A tariff equivalent refers to the tariff that would be necessary to afford the same level
of protection as a quota. It is the difference between the world market price and the
quota constrained price in the domestic market.

10. Although quotas reduce foreign competition in the short run, the long-run anti-
competitive effects may be greatly diminished for several reasons. First, quotas may
entice foreign firms that are exporting to the domestic market to engage in foreign
direct investment. If the domestic market in the importing country is large enough and

© 2015 W. Charles Sawyer and Richard L. Sprinkle

 the barriers to exporting are sufficiently high, foreign firms may find it profitable to
build production facilities within the importing country. This effect is analogous to
firms building plants to jump over high tariffs. Second, when an importing country
enforces a quota, the quota is stated as a specific number of units without regard to
their price. In this case, the exporters have a clear incentive to export the highest
quality and most expensive versions of the product.

11. Differences in industrial policy have created some interesting issues in international
trade. As tariffs have declined, national differences in industrial policy have a greater
chance of altering the pattern of world production and trade. This is especially true
given the increasing number of free-trade agreements between countries. Once
countries have entered into a free-trade agreement that abolishes tariffs and quotas,
then differences in business regulations among the countries become more important.
For example, as Canada and the US have abolished trade restrictions, the resulting
differences in each country's regulation of an industry can have noticeable effects on
the trade flows between the two countries. If Canada decides to heavily regulate an
industry that the US does not, then the industry will likely shrink in Canada and
expand in the US. The result is that as traditional trade barriers fall, industrial policy
takes on increasing importance.

12. One of the most obvious cases of government rules and regulations that distort trade is
in the area of government procurement. Government procurement laws are laws that
direct a government to buy domestically made products unless comparable foreign-
made products are substantially cheaper. Government purchases of goods and services
are subject to constraints and frequently governments have regulations that give
preferences to domestic firms. The rationale for these regulations is that buying
domestic is more beneficial to the country than buying an imported product. The issue
of government procurement has become important because in most countries
government purchases account for 10 to 15 percent of GDP.

13. All countries can legitimately prohibit imports that endanger the health and safety of
consumers. However, it is fairly easy in some cases to construct health and safety
regulations that would not be expensive for domestic producers to comply with but
would be expensive for foreign producers. If such a regulation can be made to look
like a form of consumer protection, then an NTB has been erected.

14. The two types of government subsidies that affect international trade are a direct
export subsidy and a domestic subsidy as part of a country's industrial policy. The
domestic subsidy is more difficult to deal with and these subsidies are being given to
the firm or industry to accomplish some domestic policy objective. Trying to
eliminate the domestic subsidy is an extremely difficult problem as it requires that a
country adjusts its industrial policy objectives.

15. Opponents of globalization argue that international competition will create an endless
“race to the bottom” as firms search for ever cheaper labor to produce products. This
argument ignores factor-price equalization. Firms do indeed search for cheaper labor.
However, they do this because globalization has made labor expensive in some
countries. The more expensive labor indicates that workers in these countries have
been made better off through international trade.

© 2015 W. Charles Sawyer and Richard L. Sprinkle

16. Corruption can potentially influence international trade through government
procurement. Firms may attempt to export products purchased by foreign
governments by bribing government officials in these countries to purchase their
products.

17. Imposing developed-country labor standards on developing countries as a condition of

trade is unlikely to improve the welfare of workers in these countries. The
comparative advantage of labor abundant countries is cheap labor. By forcing wages
up, this would reduce the number of job opportunities for workers in developing
countries. In many cases this would mean workers would remain in lower paying jobs
in the agricultural sector.

18. Pollution levels and GDP per capita tend to follow a U-shaped relationship. Pollution
tends to rise as a country moves from low- to middle-income. From a peak it tends to
decline as a country moves from middle- to high-income.

19. Economic sanctions are interferences of trade and/or financial flows designed to
accomplish foreign policy objectives. Countries tend to use them to augment other
forms of diplomacy. They are a convenient way for a government to emphasize its
goals without resorting to other forms of pressure such as the use of force.

20. With positive transportation costs, the quantity of goods traded declines as the price of
imported goods increase and the price of exported goods falls. In addition, in the
importing country, the consumption of imports declines while the domestic
production of import-competing goods increases. For the exporting country, the
consumption of the export good increases while the production of the exported good
decreases. Thus, the effect of transportation costs is to move the price of cloth and the
quantities traded partially back toward the no trade situation. As such, transportation
costs act as a barrier to trade much like tariffs and other nontariff barriers.

21. The total amount of trade between the US and any two countries becomes a function
of the product of the countries’ GDPs and the distance between the two countries. The
model makes good sense. As the GDPs increase, trade increases. The amount of trade
is positively correlated with income. As countries become richer, consumers buy both
more domestic goods and more foreign goods. The gravity model simply puts this
logic into a more formal model. The model would predict a large volume of trade
between the US and Mexico as the two countries share a common border. Brazil
would be an interesting comparison as it is further from the US but the GDP of Brazil
is substantially larger than the GDP of Mexico.

© 2015 W. Charles Sawyer and Richard L. Sprinkle