Free Trade

Free trade is where trade between two or more countries can be done without the interference of protection, which may lead to the advantage or disadvantage to one of the parties involved in the trade (Parry & Kemp 2002, p. 93). Protection refers to and action by the government which is designed to give the domestic producer and artificial advantage over a foreign producer. Types of protection can be classified in three different categories. These are:

• Those which impose quantitative restrictions on imports including quotas, import licenses and embargoes.

• Those which lead to a cost advantage to producers such as subsidies.

• Those which lead to the increase of price in foreign products such as tariffs (Parry & Kemp 2002, p. 93).

The main goal of protection is to encourage production in the domestic markets that are protected. The main beneficiaries from protection include those owners and workers in the protected industries and in some cases the government benefits from tariff revenue (Parry & Kemp 2002, p. 93).

Protection has got its downsides such as the possible costs on the economy. Industries that obtain protection will expand and use resources that other industries could have used. This will lead to a decline in production in non-protected industries and possibly higher prices for imported inputs which will lead to a reduction in competitiveness. Protection which obviously causes a decrease in imports, also leads to a decrease in exports. Consumers will be forced to pay more for both domestic and imported goods. Basically consumers pay more and get less (Parry & Kemp 2002, p. 93).

There are many different types of protection, with most having similar aims. Quotas are limits that are placed on a product that can be imported. Quotas are usually imposed by the government but nations can voluntarily restrict the amount of exports to a particular location through agreements with other governments (Sloman & Norris 2005). Embargoes are a complete ban on certain imports or exports to certain or all countries (Sloman & Norris 2005). Exchange controls are limits on the amount of foreign exchange that is available to importers and citizens that are traveling abroad. Export taxes are used to increase the price exports and this often occurs when the country has monopoly power in supply (Sloman & Norris 2005, p. 366).

Tariffs are taxes on imports and are basically an added percentage on the price of the import. The main aim of tariffs is to restrict imports, and it is most effective if demand is elastic (Sloman & Norris 2005, p. 366; Clarke & Bruce 2006). In the diagram below, the tariff is FT and the new price on domestic goods is OT. The higher price leads to benefits to the local producers because they have got an advantage over foreign producers. This tariff increases the cost of both goods imported and locally produced. Domestic production expands to Oq3, demand contracts to Oq4 and imports are reduced to q3q4. This leads to domestic producers having a bigger slice of the market. The shaded area is the benefit from taxes that the government receives (Parry & Kemp 2002, p. 95).

Subsidies are grants from the government to domestic producers. They aim to reduce the cost of production for the producer so they can be more competitive in the international market. The effect of a subsidy granted to domestic producers is showed in the following diagram. The world price is at OF. Total demand is Oq2 of which Oq1 is locally supplied and q1q2 is imported. If subsidies are put in place the supply curve would shift to the right. A subsidy has the same effect of decreasing costs. Domestic firms can supply more for the same cost, which lead to production expanding to Oq3 gaining a larger share of the market while imports are reduced to q3q2 (Parry & Kemp 2002, p. 97).

Protection leads to problems and inefficiency in the economy. It generally leads to an increased world equilibrium price, inefficient use of resources throughout the world, and disadvantages to the growth of less wealthier nations (Castro 2006). Protection, such as tariffs are used to protect the inefficient industries from foreign competitors. This type of protection is sometimes justified with the positive effect of helping prevent unemployment in the industry that is protected. While this is a positive, it can be achieved another way as the negative effects of tariffs leads to higher prices for consumers and more inefficient use of resources (Sloman & Norris 2005, p. 371)

When a team imposes protection imports will be reduced. As these imports are other countries exports it means that exports are reduced. A reduction in exports will lead to a reduction in the level