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Assessment 3

Unit 4 - Economics

a) Quotas are a physical limit on the amount of imports permitted to enter a country. A benefit of putting a quota on imports is that it will lead to a fall in imports. This will mean that there will be an improvement on the current account as the quota will prevent a surge of imports. If there was no quota then countries like Bangladesh and China would be able to freely export into our countries at low prices which may not be possible for domestic firms to operate at. As the quota is introduced it limits the imports and so we will import less. This will mean that there will be a smaller deficit or a larger surplus on the balance of payments which will mean an improvement in the current account. A second benefit of putting a quota on imports is that it would lead to an increase in domestic production, making textile industries in developed countries more able to compete with Chinas cheaper produce. This could lead to an increase in employment which could then lead to an increase in consumption and AD which is further increased by the positive multiplier effect. America doesnt have any protection from Chinas textile industry and as a result have lost 350,000 jobs between 2001 and 2004. If the quota was in place then it would mean that there would be more demand for domestic products, as there would be less choice from the restricted amount of imported textiles and so the firms would have more revenue and therefore be able to pay their staff and keep them at the business.

b) The first reason which suggests that protectionism against China may be a good idea is that people are arguing that China is keeping its currency at an artificially low level and giving state subsidies. This means that Chinas exports will look more appealing to foreign importers than that of any Western exporters because it is cheaper. This is proving to be a big problem for America as they believe that if protectionism isnt introduced that China will destroy the American textile industry as China have an unfair competitive advantage. So the introduction of quotas would limit the amount of Chinese textiles allowed into the country so consumers would resort domestic produce, allowing American firms to increase their output due to the less competition. However, the danger of protecting the American textiles industry is that in the long run these firms will have no incentive to continue innovation or lower prices due to the restricted competition. Therefore, once the quota is lifted American firms wont be able to survive against the more efficient Chines firms as they offer better consumer welfare with lower prices and better quality.

Assessment 3

Unit 4 - Economics

Secondly, many jobs are being lost because firms cant compete with Chinas extremely low prices. The demand for domestically produced goods is falling because consumers want to pay a lower price and so domestic firms are taking less revenue and cant afford to employ their staff. It is estimated that 350,000 jobs have been lost in Americas textile industry between 2001 and 2004. They also believe that the remaining 695,000 jobs will be lost if the quotas are abolished. Europe employs 2.7million people in its textiles industries. This number is likely to fall as Europes imports of Chinese textiles and clothing has almost doubled between 2001 and 2003. This could lead to a negative multiplier effect causing surrounding businesses to cut back worsening the current account as consumers will buy cheaper imports due to less purchasing power. However, jobs are being created in China due to their vertically integrated supply chain and demand from the USA. This will cause a positive multiplier in China enabling the country to become more prosperous and therefore in the long run demand more Western products from the USA increasing USAs exports and stimulating job demand in America improving the current account.

c) One impact of a tariff is that there will be a reduction in imports and there will be more demand for domestically produced goods. This will mean that there is an increase in producer surplus leading to an increase in profits. These profits could be invested into lowering costs in the long run. This could lead to economies of scale which would mean lower prices and an increase in export trade. However, there may not actually be a reduction in imports. If the demand for the good is inelastic then an increase in price will cause demand to fall by a lesser percentage change, this due to the domestic firm supplying poor substitutes which results in consumers buying foreign textiles. The EU has a high marginal propensity to import therefore; it is unlikely for the tariff to have any real significant impact. Another impact is a significant gain in tax revenue as many imports will still be demanded by consumers due their brand loyalty. This then enables the government to further subsidise other industries that are struggling against foreign competition in a more subtle way so they are less likely to be investigated by the WTO. Overall this will improve the current account as firms become more competitive to be able to export at lower prices and achieve greater output. However, the use of tariffs on foreign imports is an overt measure of protectionism. This is likely to cause retaliation prompting the foreign country to impose tariffs of their own on EU exports, increasing the cost to EU exporters which may have to be passed onto the consumer resulting higher prices and

Assessment 3

Unit 4 - Economics

less demand. Therefore, the current account worsens for both countries as their exports may significantly decrease.