Quick questions on Free trade, comparative advantage and protection: HSC Economics Topic 1

The classic case for trade is comparative advantage, due to David Ricardo (1817). A country has a comparative advantage in producing a good when it can produce that good at lower opportunity cost than another country.

Trade according to comparative advantage delivers:

The WTO is the multilateral body that administers world trade rules and dispute resolution. Created in 1995 as successor to the GATT. Three pillars: trade in goods, trade in services (GATS), and intellectual property (TRIPS). Decisions are by consensus among 164 member economies.

A free trade agreement (FTA) is a treaty between two or more countries that progressively eliminates tariffs and other barriers between them. Australia is party to 17 FTAs, including:

1. Tariff. A tax on imports. Raises the price of imports, reduces import volume, raises domestic price, transfers some surplus from consumers to domestic producers and the government, and creates a deadweight loss.

Draw the domestic demand and supply curves intersecting at the autarky equilibrium. Add a horizontal world price line below the autarky price. Add a tariff that lifts the price by the tariff amount.

After three decades of liberalisation, world trade has entered a more protectionist phase. The US has imposed tariffs averaging 19 percent on roughly USD 360 billion of Chinese imports since 2018. The EU's Carbon Border Adjustment Mechanism (CBAM, 2026) levies a carbon-equivalent tariff on imports of cement, iron and steel, aluminium, fertilisers, electricity and hydrogen. Industrial policy subsidies (US Inflation Reduction Act 2022; EU Green Deal Industrial Plan) have raised concerns about renewed subsidy competition.

Suppose Australia and Japan can each produce wheat or cars with one unit of labour:

A tax on imports. Raises the price of imports, reduces import volume, raises domestic price, transfers some surplus from consumers to domestic producers and the government, and creates a deadweight loss.

A government payment to domestic producers. Shifts the domestic supply curve right, reduces the import price gap, transfers from taxpayers to producers, and creates a deadweight loss similar to a tariff (but no government revenue).

A quantitative limit on imports. Raises the domestic price like a tariff but the revenue goes to the importer holding the quota licence rather than the government.

Require firms to use a specified percentage of domestic inputs. Common in defence and automotive procurement. Distort input choice and raise production cost.

Comparative advantage is about opportunity cost. Even if one country is absolutely worse at producing both goods, mutually beneficial trade is still possible.

Markers expect the two-triangle DWL on every tariff diagram.

Always raise trade diversion alongside trade creation.