Question

Some economists have argued that, because domestic consumers gain more from free trade than domestic producers gain from (import) tariffs and quotas, consumers should buy out domestic producers and rid themselves of costly tariffs and quotas. For example, if consumers save $$\$ 400$$ million from free trade (through paying lower prices) and producers gain $$\$ 100$$ million from tariffs and quotas, consumers can pay producers something more than $$\$ 100$$ million but less than $$\$ 400$$ million and get producers to favor free trade too. Assuming that this scheme were feasible, what do you think of it?

Short answer

The proposed scheme, while theoretically benefiting both consumers and domestic producers, would likely be impractical and can lead to other complex economic challenges.

Step-by-step solution

Understand important terms

Free trade is a policy that allows traders to act and transact without interference from government. Tariffs are taxes imposed on imported goods and quotas are the limits on the amount of specific products that can be imported. Domestic producers gain from tariffs as they protect domestic markets from foreign competition.

Understand the Proposal

The proposal is suggesting that because consumers gain more from free trade, they should compensate domestic producers who would lose from lack of tariffs or quotas to get their support for free trade. In this case, consumers would still be saving, as they would only be compensating the producers part of what they gain from free trade.

Evaluate the Proposal

This may seem feasible at first, but it could have several drawbacks. For one, the execution of it may be complicated. It would be challenging to organize consumers to make such payments. Furthermore, this decision might only lead to temporary relief. Producers could still face foreign competition and this could lead to other economic problems.

Key concepts

Import Tariffs

Imagine you're at the grocery store, deciding between apples grown locally and ones imported from abroad. If the government has placed an extra charge on imported apples, that's an import tariff. The goal might be to encourage you to buy local fruit.

Import tariffs are a type of tax imposed by a country on goods brought in from other countries. This tax makes the imported goods costlier than they naturally would be, leveling the playing field for domestic businesses that might struggle to compete with cheaper or maybe more efficient international producers. Here, domestic producers gain because their products might seem more attractive price-wise to consumers.

However, this isn't the full story. Tariffs can have a range of economic effects. For example, they can lead to higher prices for consumers, retaliatory measures from other countries, and disruptions in the global supply chain. While they protect certain domestic industries, they can harm others, such as those reliant on imported materials.

Trade Quotas

Think about those apples again. What if, aside from being more expensive due to tariffs, you could only choose from a very small stack of imported apples because the store is limited in how many they can sell? That limitation is similar to a trade quota.

Trade quotas are physical limits on the quantity of a particular commodity that can be imported into a country over a set period of time. By limiting supply, quotas can raise the price of goods and protect domestic industries from foreign competition just like tariffs. But unlike tariffs, quotas don't generate revenue for the government; their main purpose is to keep a check on the quantity rather than the value of goods. Quotas can also lead to various challenges in international trade, including inefficiencies in the market and potential strain on diplomatic relations between countries.

Consumer Surplus

You're at the checkout with your apples. The price is lower than you expected, so you feel like you got a good deal - you're experiencing consumer surplus. It's the difference between what consumers are willing to pay for a good and what they actually pay.

Consumer surplus occurs when the market price is below what consumers would be willing to pay. It's a measure of the additional benefit that consumers receive because they're able to purchase a product for less than the highest price they would pay. Free trade tends to increase consumer surplus because it usually results in lower prices and more variety for consumers. This is due to the increased competition and efficiency that come with open markets. Consumer surplus is a crucial concept in understanding the benefits of free trade for the average person, especially when contrasting it against the effects of tariffs and quotas, which tend to reduce consumer surplus.

Producer Compensation

Imagine the local apple growers. The lower-cost imported apples are good for you as a consumer, but not so much for the growers. To help them out, you might pay a bit extra for their apples. This is akin to producer compensation.

Producer compensation refers to the various ways in which governments or consumers might support domestic producers who are negatively impacted by international competition. This can include direct payments, subsidies, or any financial aid that intends to offset the disadvantages faced by local businesses. The compensation can help them adapt or survive in a market that has been opened to global competitors. While the proposal from the textbook exercise suggests that consumers could pay producers to support free trade, in reality, such compensation often comes from government programs. Implementing such a private compensation scheme faces many practical hurdles, such as organizing consumers and setting fair compensation amounts.