Lecture 7
TRADE POLICY II

1. Instruments of trade policy

• Tariffs
• Quotas
• Export subsidies
• VERs
• Local Content Requirements
• Export credit subsidies (EXIM Bank)
• National procurement
• Standards: Health, environmental, labor

2. Effective Rate of Protection (ERP)

1. Value added per unit of output
   
   • Definition:
     V = Price of good - Cost of intermediate inputs (raw materials)
   • Value added at world prices:
     V₀ = P₀ - C_R

   • Value added with ad-valorem tariff:
     V₁ = (1+t)P₀ - C_R

2. Effective Rate of Protection
   • ERP = (V₁ - V₀)/V₀

3. Question
   • Show that ERP is greater than t.

3. Pros and Cons of Trade Policy

1. National welfare arguments
   • Optimum tariff

   • Large country

   • Small country: Optimum tariff = 0 (why?)

2. Domestic market failure
   • Technological spillovers among industries

   • Externalities

   • Labor market does not clear

   • Capital market does not allocate credit efficiently

3. Income distribution
   
   
   • Social welfare

   • Different weights for different groups

   • Collective action (Olson's analysis):
     Dispersed costs; concentrated benefits of tariffs