Chapter 21: Problem 4

Explain how trade barriers raise wages in protected industries by reducing average wages economy-wide.

Short Answer

Expert verified

Trade barriers, such as tariffs and import quotas, protect domestic industries from foreign competition, raising the demand for domestically produced goods and leading to a higher demand for labor in the protected industry. This increased labor demand can result in higher wages for that protected industry. However, trade barriers may negatively impact wages in other sectors by increasing their input costs, reducing labor demand, and affecting overall growth. If the wage increase in the protected sector is offset by wage decreases in other sectors, overall average wages could be reduced economy-wide. The final outcome depends on several factors, such as the extent of wage changes across industries and each industry's share of employment.

Step by step solution

1. Understand Trade Barriers

Trade barriers are government policies, regulations, or restrictions that limit the flow of goods and services across international borders. Examples of trade barriers include tariffs, import quotas, and non-tariff measures such as licensing and technical standards. The main aim of trade barriers is to protect domestic industries from foreign competition and promote self-reliance.

2. Analyzing the Effects of Trade Barriers on an Industry

When a government implements a trade barrier, this has several effects on the protected industry. First, it limits the number of imported goods, which reduces competition and raises the demand for domestically produced goods. Consequently, firms in the protected industry may experience increased profits, greater investment, and a higher demand for labor. This increase in demand for labor can potentially lead to higher wages in the protected industry.

3. How Trade Barriers May Reduce Average Wages Economy-Wide

Reducing imports through trade barriers may negatively impact other sectors of an economy. For instance, when the government implements tariffs on imported goods, importers must pay higher taxes, which can result in an increase in the price of imported goods. The increase in prices for these goods may, in turn, lead to a decrease in demand for them, and consequently, a reduction in labor demand in the importing sector. Moreover, firms using imported goods as inputs in their production process may also experience higher input costs, affecting their ability to employ labor at the same wage rate as before. As a result, wages in these negatively impacted sectors may be forced to decrease.

4. The Impact on Overall Average Wages

As wages increase in the protected industry due to trade barriers, wages may decrease in other sectors that are negatively affected by these policies. The net impact on overall average wages depends on several factors, including the share of employment in the protected industry compared to other sectors and the extent of wage changes in different industries. If the wage increase in the protected industry is overshadowed by wage decreases in other sectors, it might lead to a decrease in average wages economy-wide.

5. Recap and Conclusion

In summary, trade barriers have the potential to raise wages in protected industries by limiting imports and increasing demand for domestic production. However, these effects may be offset by the negative impact that such policies can have on the wages in other sectors. The overall outcome for average wages depends on various factors such as the extent of the wage change in each industry and the share of employment in each sector. As a result, while trade barriers may raise wages in specific protected industries, they could potentially reduce the average wages across the entire economy.