Chapter 21: Problem 14

Assume a perfectly competitive market and the exporting country is small. Using a demand and supply diagram, show the impact of increasing standards on a low-income exporter of toys. Show the tariff's impact. Is the effect on toy prices the same or different? Why is a standards policy preferred to tariffs?

Short Answer

Expert verified

In a perfectly competitive market, increasing standards on a low-income exporter of toys leads to higher production costs and a leftward shift in the supply curve, resulting in a higher equilibrium price (P2) and lower equilibrium quantity (Q2). Imposing a tariff raises the prices of imported toys further to a new price level (PT). Although both measures increase toy prices, their magnitude may differ. A standards policy is preferred over tariffs because it promotes better quality products, ensures fair competition, and reduces the risk of trade wars.

Step by step solution

Draw the initial demand and supply diagram

Start by drawing a standard demand and supply diagram with the horizontal axis representing the quantity of toys (Q) and the vertical axis representing the price of toys (P). Label the initial equilibrium price and quantity as P1 and Q1, respectively. Step 2:

Increase standards

In the context of this exercise, increasing standards means imposing stricter regulations and requirements for toy production. This would lead to higher production costs for the low-income exporter. Represent this on the diagram by shifting the supply curve to the left (to a new position named S'). This will result in a new equilibrium point, with a higher price (P2) and a lower quantity (Q2). Step 3:

Show the tariff's impact

Now let's analyze the impact of a tariff. A tariff is a tax imposed on imported goods, which raises their price. Therefore, introduce a tariff on imported toys by increasing the price from P2 to PT (P2 + Tariff) and show the new price level on the diagram. Due to the higher price, the quantity demanded will decrease, moving to a new point QT on the demand curve. Step 4:

Compare the effect on toy prices

Compare the impact of increasing standards to the tariff's impact on toy prices. Both measures result in higher prices for consumers: P2 in the case of increasing standards, and PT in the case of the tariff. However, the magnitude of these price changes might be different, given that the tariff directly affects the price of imported toys, while increasing standards has an indirect effect through higher production costs. Step 5:

Explain the preference for a standards policy over tariffs

A standards policy is preferred to tariffs for several reasons. Firstly, increasing standards can lead to better quality and safer products, which can benefit both consumers and producers in the long run. Secondly, standards policies are generally viewed as less distortionary compared to tariffs, as they apply uniformly to all producers (domestic and foreign), promoting fair competition. Lastly, tariffs can lead to trade wars and retaliation from other countries, harming global trade and causing negative externalities for all parties involved. In conclusion, increasing standards and imposing tariffs both result in higher prices for imported toys, although their effects might be different in terms of magnitude. A standards policy is preferred over tariffs because it promotes better quality products, encourages fair competition, and reduces the risk of trade wars.

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Key Concepts

These are the key concepts you need to understand to accurately answer the question.

Demand and Supply Diagram

Understanding the demand and supply diagram is fundamental to analyzing market scenarios. In a perfectly competitive market, the demand curve slopes downwards, indicating that as the price decreases, consumers are willing to purchase more. Conversely, the supply curve slopes upwards, which suggests producers are willing to supply more as the price increases.

When standards on an exported commodity like toys increase, representing stricter safety measures or improved quality, production costs escalate for exporters. On a demand and supply diagram, this is depicted as a leftward shift of the supply curve. As the supply decreases due to higher costs, the new equilibrium shows an escalated price and reduced quantity, directly impacting market dynamics.

The simple yet effective graphical representation of these changes allows students to visualize market adjustments. It also offers insight into the immediate economic consequences of policy changes, such as increased production standards or imposed tariffs, on both price and quantity of goods.

Effects of Tariffs

Tariffs have a direct impact on international trade by adding extra costs to imported goods, thus affecting the price and demand for these products. When a tariff is applied to imported toys, the immediate result is an increase in the consumer price of those toys. The demand and supply diagram can be adapted to illustrate this by showing the supply curve shifting upwards, reflecting the increased costs due to tariffs.

Consumers, facing higher prices, reduce their demand, which can lead to a decline in the quantity of imports, challenging the exporting country's revenue from that market.

Understanding Tariff-induced Price Changes

Analyses typically highlight the protective nature of tariffs for domestic industries but also the downside of consumers paying higher prices and the possible sparking of trade disputes. This complex landscape is important for students to understand as they navigate the global trade environment affected by such policy decisions.

International Trade Standards

International trade standards encompass a wide range of policies and regulations designed to ensure safety, quality, and fairness in the trade of goods and services across borders. These standards may cover product specifications, labor conditions, and environmental protections, among other factors.

In the context of toy exports, adherence to stringent international standards can raise production costs for manufacturers, reflected in the leftward shift of the supply curve on a demand and supply diagram. Nevertheless, higher standards can lead to increased consumer confidence and potentially expand market access long term, which are critical considerations in competitive market analysis.

Benefits Beyond Price Implication

While standards can initially lead to higher prices and decreased demand, they often promote improved quality and safety, paving the way for sustainable growth and reduced trade conflicts. They are preferred over tariffs because they aim to provide benefits that extend beyond immediate market price effects, fostering innovation and better practices across industries.

Competitive Market Analysis

Competitive market analysis involves assessing the dynamic interplay between producers and consumers under the influence of various market forces and policy decisions. By scrutinizing the roles of supply, demand, and price adjustments, analytical tools such as demand and supply diagrams provide critical insights.

A comprehensive market analysis considers the effects of trade policies like tariffs and standards, assessing their impact on market equilibrium and overall economic welfare.

Impact on Market Efficiency

Tariffs may protect certain industries but can also lead to inefficiencies and market distortions. In comparison, uniform standards promote a level playing field and can enhance market efficiency. By understanding these effects, students can appreciate the delicate balance policymakers must achieve to foster a thriving, competitive marketplace while considering the long-term implications for all stakeholders.