Introduction

This report is the solution to discussion questions from Tutorial 1. This report will discuss to four questions regarding with free trade, regulations, forms of interference, and gainers and losers due to trade regulation.

Free Trade and Comparative Advantage

In this section, we will discuss the reason why most economists are in favor of free trade in terms of comparative advantage theory.

First of all, most people want the gains from trade, which will benefit them through profit creation. The same principle also applies to every countries that does trade. They make an effort to maximize economic gains from trading.

Gain improvement can be effectively achieved through specialisation in a particular or a few areas. Specialisation is inevitable because of different quality of possessed resources and different people ability to produce particular goods and services. This potential certainly will result in a different opportunity cost in producing goods and services.

A country has a comparative advantage in producing particular goods or services if it can produce them at a lower opportunity cost than other countries do. Different possession of resources and different skills acquired by the people in a country result in different opportunity costs in producing various goods and services. The lower the opportunity cost, the greater the comparative the country has.

To improve comparative advantage, specialisation is the key. Therefore, to acquire economic gain, there is a strong relationship between comparative advantage and free trade --because no country excels in every area.

For example, some countries may richer in land and natural resources but have few peoples; other countries have more labors, capitals, and technology intensive production systems, but lacks of natural resources, and fertile areas.

To illustrate this, Australia and Japan are good examples. Australia has very large areas of land, natural resources, and minerals. Australia’s population density is about two people per square kilometres, while in Japan there are over 300 per square kilometres, in Korea over 400, and in Taiwan around 550 (McTaggart, Findlay, Parkin, 1999).

This potential provides Australia with a lower opportunity cost in producing agricultural and mineral products than Japan, South Korea, or Taiwan do for the same products.

Japan, South Korea, or Taiwan devotes their labor to the high technology manufacturing area. They have no such large areas for farming like Australia does. Thus, their specialisation provides them with a lower opportunity cost in producing manufactured goods such as cars, computers, electronic goods than Australia does.

Now, to gain economic welfare, countries must trade with each other to obtain goods or services more cheaply than trying to produce all goods and services by themselves. Australia sells its agricultural goods to Japan, while Japan sells manufactured goods to Australia. Australia gets imported manufactured goods more cheaply than if Australia itself produces all of them. Similarly, Japan gets imported agricultural goods more cheaply than if Japan tries to produce all agricultural products. In conclusion, a freer trade will result in lower costs in obtaining goods and also services.

In fact, a lower cost in obtaining goods or services gives more people the ability to afford more products. People can buy more while producers are encouraged to produce more too. In addition, this will gain producer earnings, and eventually, due to more affordable products and services, this will improve people’s standard of living. This means benefit for the whole economy for all.

Economic Justification to Regulate Trade

Many people in the government argue that trade must be regulated for several reasons. The major goals to restrict the trade include raising revenue, protecting the growth of new (infant) industries, and encouraging competition and restraining monopoly. The other popular minor goals are job saving, and competition with cheap labor.

Raising revenue is a common judgment to achieve government revenue target. However, doing so only results in deadweight costs, the costs lost for nothing.

The reason for protecting infant industries and encouraging competition is also popular. The government uses this reason to provide new industries with a softer environment in which encourage such industries into industrial maturity and international competitiveness. However, this argument is valid only if the benefits accrue not only to the owners and the workers of infant industries, but also spill over to other industries and other parts of the economy. In fact, to guarantee such spill over, it is more efficient to do so by granting a subsidy to the firms in the infant industry. For instance, it is better that the government grants a tax exemption instead of taxing imported products.

Restraining monopoly is based on prejudice that there is a dumping strategy from foreign companies to kick out local industries. However this bias is difficult to prove and dumping itself is hard to detect. Furthermore, there are virtually no goods, which are natural global monopolies – other sources of supply are available. Even if there is a dumping strategy, the best response would be the application of competition policy, involving international cooperation.

Job saving and competition with cheap labor are two minor arguments to restrict trade. Yet, protection does not save jobs. It merely changes their mix, and it does so at the cost of deadweight loss. Also competition with cheap labor does not mean that high wage labor cannot compete with cheaper ones. In fact, higher wage labors –in many developed countries—have better productivity due to better knowledge and skills. This potential provides different comparative advantage compared to less skilled labor in many developing countries. So, by freer trade with other countries, which have different comparative advantages areas, we can make ourselves and trading partners better off.

Forms of Trade Protection

There are two common methods of protection that are employed by governments. The first is tariff barrier, and the last is non-tariff barrier.

Tariff barrier is simply a tax for imported goods to raise the selling price of particular goods and services. By taxing imported products, their prices become higher. This will lead local producers to increase their product price too to make more so-called gains; but at a deadweight loss suffered by the whole economy.

A non-tariff barrier is also simply a direct restriction to imported product volume through a certain quota. A regulated amount of imported product is intended to reduce significant effect in supply-demand curve. Thus, this provides local industries with a favorable environment to compete with imported products and to raise revenue.

The Gainers and Losers from Trade Restriction

There are gainers and losers according to trade restriction through tariff and non-tariff barriers. For tariff employment, the gainers will be local producers who enjoy a comfortably competitive business environment due to high price of imported products, and the government also captures more tax revenues. The losers, of course, are the whole economy: the country and the consumers. The country loss is both a deadweight loss and consumer loss; while the consumer loss is a degradation of consumer surplus.

For import quota employment, the gainers will only be importers and local producers who take advantages from no significant competitors. The losers would be the people who lose consumer surplus due to higher market prices.

Conclusion

It is obvious that comparative advantage means lesser opportunity cost to produce goods and services. By specializing in particular areas, a country is able to strengthen its comparative advantages. When each country trades each other with lower costs of goods and services freely, people in each country can afford more goods and services. This, in turn, will gain the economic situation within a country; therefore increases standards of living widely.

Any judgment can be made to restrict trade between countries. However, in the long run, such trade regulation will only create prolonging deadweight loss and will sacrifice the whole economy of every country. Therefore, most economists do not favor in such trade regulations.