International Business Chapter 15 Krugman Journal Economic Perspectives Article Excellent Outside Reading Accompany The Material This

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CHAPTER 15

ARGUMENTS FOR INTERVENTIONIST TRADE POLICIES

Learning Objectives:

■ Explain how trade policy instruments are often part of broader social policy and why

other policy instruments might be less costly.

■ Evaluate the effectiveness of trade policy in the presence of market imperfections.

I. Outline

Introduction

– Calls for Protection

Trade Policy as a Part of Broader Social Policy Objectives for a Nation

– Trade Taxes as a Source of Government Revenue

– National Defense Argument for a Tariff

– Tariff to Improve the Balance of Trade

Protection to Offset Market Imperfections

– The Presence of Externalities as an Argument for Protection

Protection as a Response to International Policy Distortions

– Tariff to Offset Foreign Dumping

– Tariff to Offset a Foreign Subsidy

Miscellaneous, Invalid Arguments

Strategic Trade Policy: Fostering Comparative Advantage

– The Infant Industry Argument for Protection

– Concluding Observations on Strategic Trade Policy

Summary

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II. Special Chapter Features

In the Real World: The Relative Importance of Trade Taxes as a Source of Government

Revenue

In the Real World: Industry Employment Effects of Trade Liberalization

III. Purpose of Chapter

The purpose of this chapter is to present and assess various arguments for protection. It

is particularly hoped that students will learn to think in terms of benefits and costs and in terms

IV. Teaching Tips

A. The chapter begins with a number of statements in support of protection. Evaluating the

merit of the arguments is a nice place to begin the discussion in this chapter.

B. The macroeconomic interpretation of a trade deficit interests students. It is sometimes

helpful also to make the point in terms of S + (T – G) – I = (X – M), in order to focus directly on

C. It is useful to stress that the optimum tariff rate can only occur in the elastic range of the

foreign offer curve. Only in that range will the imposition of a higher tariff have its positive

D. In presenting the argument for a “tariff to increase employment in a particular industry,”

it is useful to repeat the partial equilibrium graph from Chapter 14 (Figure 4) showing that the

home country welfare loss is less with a production subsidy than with a tariff. Students seem to

have difficulty accepting that conclusion.

E. Because antidumping claims are filed regularly in the United States and are reported in

the press, you should have no trouble in providing more current examples than are provided in

the “In the Real World” box on page 337. Students seem to like these specific examples.

F. In fairness to the authors of the various “strategic trade policy” approaches, it should be

pointed out to the students that the authors of the theories do not necessarily advocate protection.

G. An exercise of interest to the students is to work through a situation like Figure 8 (or

Figure 11), but where the home firm’s reaction function is “flatter” than the foreign firm’s

H. In covering the material related to Figures 12 and 13, it is useful to stress that the profit of

the home firm being greater than the size of the subsidy can mean that home country welfare

increases because of the subsidy. This possibility is more certain with the standard assumption

I. We have found the Krugman 1987 Journal of Economic Perspectives article to be an

excellent outside reading to accompany the material of this chapter.

V. Answers to End-of Chapter Questions and Problems

1. Consider Figure 2 in the text. For a given tariff t and a given starting point, the transfer

2. No, Krugman’s results would not follow. Turn to Figure 9 in the text. In Figure 9(a), the

MM curve would slope upward. Protection would cause QQ to shift to the right and would lead

3. No. The reduced costs per unit and ultimately lower consumer prices can then potentially

be realized (if they have not already been realized) by the foreign producer as that producer sells

4. The negative effects on domestic employment caused by foreign retaliation, reduced

5. The use of a tariff will raise the price of imports of the good, and the price of the

domestically-produced good will also rise as home demand switches toward it. Thus consumers

will have their well-being reduced because they will be paying more for each unit of the good

6. No. The dumping can simply reflect price discrimination by the foreign producer,

whereby a lower price is being charged in the importing (home) country than in the foreign

7. This statement can be evaluated in the framework of the discussion at the end of the

8. Consider Figure 8 in the text and suppose that the H and F labels are switched. If point C

is the starting point, the foreign firm is satisfied but the home firm is not since, with 0X2* of

9. Yes, the foreign firm will always produce because it makes a profit by doing so, no

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10. Yes, the production pattern will change. The home firm will now receive $20 million

profit if it produces at the same time that the foreign firm produces, and $150 million profit if it

11. (a) $19.

(b) $21.

12. In Figure 14, the reaction curves for each country show the various tariff rates that

maximize that country’s welfare, given different tariff rates for the other country. If the

countries find themselves at point F, only country II is on the reaction curve that maximizes its

welfare. As country I attempts to maximize its welfare, given that country II has a tariff rate of

t*2, it will need to raise its tariff to place itself on the TI tariff reaction function. This movement

VI. Sample Exam Questions

1. Illustrate and explain how a country could attain its optimum tariff position (optimum

terms of trade) on the foreign offer curve by using an import quota rather than a tariff. Could

this position also be attained by negotiation of a “voluntary” export restraint (VER) with the

foreign country rather than by the use of a tariff? Why or why not?

2. Remembering micro theory, why can it be assumed that home demand for the product of

a foreign monopoly supplier (at the initial as well as the post-tariff point) is elastic? Even if the

3. How would you respond to an argument to impose a tariff on imports arriving from a

particular country in order to improve the balance of trade with that particular country? Do the

criticisms of the tariff to improve the overall trade balance with all partners apply in this bilateral

context? Why or why not? Are there additional considerations to be taken into account?

4. In the situation of the “tariff to extract foreign monopoly profit,” do you think that the

existence of a home producer of the good would strengthen or weaken the case for protection

from the standpoint of the impact on home country welfare? Explain.

5. Why might a foreign export subsidy decrease welfare in the foreign country? Why might

the foreign country provide such a subsidy despite the adverse welfare effect?

6. Would it be possible for the infant industry argument to be applicable to a perfectly-

competitive industry? Why or why not?

7. It is noted in the text that the infant industry argument is more frequently used in

developing countries than in developed countries. Why might this be the case? Does this

necessarily have to be the case?

8. Suppose that a relatively capital-abundant country is exporting the capital-intensive good

9. In the model relating R&D spending to output and output to R&D spending, suppose that,

for whatever autonomous reason, the home firm desires to spend more on R&D at each level of

output. In this model, what does this greater R&D spending by the home firm do to R&D

spending by the foreign firm? Why? Does this result conform to your expectation of foreign

firms’ reactions in practice to increased R&D spending by home firms? Explain.

10. Why do you suppose that “reaction functions” are not used in analyzing the market

structure of perfect competition (or even monopolistic competition)? If you were to draw

reaction functions for any home firm and any foreign firm engaged in perfect competition, what

would the functions look like?

11. (a) Assume that there are only two firms in an industry – a home firm and a foreign

firm – and that the firms are competing in third-country markets. (You can have them

competing in each other’s domestic markets if you wish.) Explain a “reaction function

diagram” for the two firms, including the definition of a “reaction function” in this