Question

1. Suppose that a perfectly competitive industry in a small country is to be protected by either a production subsidy or an import quota so that a particular level of domestic production above the free trade level is to be produced. That is, output is to be the same under either policy. Are these policies fully equivalent in their effects upon the domestic industry? IF so or if not, compare the deadweight losses. Why does the WTO discourage the use of each of these policies?

2. Suppose that the Fascist States and the Socialist States produce steel and textiles using capital and labor. Steel is relatively capital intensive. Each industry is perfectly competitive in both countries. Assume that the steel industry has a better technology for utilizing labor in the Socialist States than does steel in the Fascist States. All other technologies are identical. Let steel and capital cross the border costlessly. Labor and Textiles incur prohibitive crossing costs. Will all goods and factor prices equalize? Prove.

Answer 1

Yes subsidy and import quota have the same effect on domestic industry.Both increase domestic production.A subsidy is financial aid given by the government to increase domestic production . Subsidy increases the producers' price but does not effect the world price and the consumers' price. As domestic production increases imports will fall. Due to the subsidy ,producers get more per unit of output.This leads to producers surplus and increase in welfare.Import quota is government imposed trade restriction .Countries impose import quota to restrict imports and increase domestic production production

Import quota reduce import ,increase domestic price of good ,reduce the welfare of domestic consumers,increase the welfare of producers'and thus cause deadweight loss.Subsidy cause reduction of consumers surplus and reduce the welfare of consumers and thus cause dead weight loss.

According to WTO , imported and locally produced goods should be treated equally after foreign goods enter the market.Lowering trade barriers encourages trade. WTO restricts subsidies on the use of domestic over import goods because subsidies can create unfair competition..