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Unlock This CourseYou have already met the methods of protection: tariffs, import quotas, subsidies and embargoes. This lesson asks a different question: why would a government use them?
Free trade gives consumers choice and lower prices, so governments need a good reason to interfere. There are eight reasons in your syllabus. Some are about protecting firms and workers. Some are about the economy as a whole. Some are about society and the planet.
Key terms:
The first three reasons are about keeping particular industries alive or helping them grow.
A new firm is small, has high costs per unit and cannot yet match big foreign rivals. Protection gives it time to grow, gain economies of scale and become competitive. Then the protection can be removed.
An old industry may be shrinking because of falling demand or cheaper imports. Protection slows the fall, so workers have time to retrain and find new jobs instead of facing sudden structural unemployment.
A country does not want to depend on other countries for things it cannot do without, such as food, energy or defence equipment. Foreign supplies could be cut off in a war or crisis, so the government protects home producers.
Orlenda has a new firm, Kavoro Buses, making electric buses. It costs Kavoro $120,000 to build one bus at present. Imported buses cost $90,000. Nobody will buy from Kavoro. The government adds a 40% tariff to imported buses.
New price of an imported bus = $90,000 × 1.40 = $126,000. Now Kavoro's $120,000 bus is cheaper. Kavoro sells more, builds more buses and its cost per bus falls through economies of scale. This is the infant industry argument: protect it while it grows.
The next two reasons are about problems in the economy as a whole.
Remember, dumping is selling goods abroad at a very low price, often below the cost of making them. Foreign firms may do this to drive home producers out of business. Once the rivals have gone, they can raise prices. A government may put a tariff or quota on dumped goods to protect home firms.
A deficit on the current account of the balance of payments means that, overall, more money is leaving the country than coming in, mainly because the country spends more on imports than it earns from exports. Restricting imports can cut spending abroad and so reduce the deficit.
The last three reasons are about what the government wants for its people.
A tariff is a tax, so every imported item brings money to the government. A government may use this money to pay for public services. It can be useful where other taxes are hard to collect.
Demerit goods, such as cigarettes, harm the people who use them. A government may ban or tax imports of these goods to reduce how much people consume.
A government may restrict imports of goods that damage the environment, such as timber from illegal logging or products made from endangered animals. This helps protect resources for future generations.
Mandovia is a small country. A new firm, Nuvo Solar, has just started making solar panels there. Large foreign firms sell panels in Mandovia at very low prices. The government is thinking of putting a quota on imported solar panels.
(a) Define an infant industry. [2 marks]
(b) Explain one reason why a government might restrict imports of a good that harms health. [3 marks]
(c) Analyse why the government of Mandovia might restrict imports of solar panels. [5 marks]
(a) An infant industry is a new industry that is just starting up in a country (1) and is still small, so it cannot yet compete with large foreign producers (1).
(b) Such a good is a demerit good, such as cigarettes (1). Consuming it harms the user, so a government may ban or tax imports (1) to reduce consumption and protect people's health (1).
(c) Nuvo Solar is a new firm, so it is an infant industry (1). Its costs per panel are high because it is small, so it cannot match the low prices of foreign firms (1). A quota limits the number of foreign panels that can be sold (1), so more customers buy from Nuvo Solar (1). It can then grow and gain economies of scale, and become able to compete without protection (1). The low foreign prices might also be dumping, which could drive Nuvo Solar out of business (1, maximum 5 marks).
For a "why might" question, name the reason from the syllabus, then link it to the clues in the question. Here the clues are "new firm" and "very low prices".