Assessment Task 2
There are two main ways to protect a domestic industry: (1) Subsidise production and (2) Place a tariff on imports of similar goods. Compare and contrast the economic welfare effects of such industry assistance measures. In the light of these welfare effects, can a sound economic case be made for continuing to protect the Australian car industry?
Tutor: Augustine Conteh
Date due: Week 11 Monday 5pm
Word count: 1399
The Australian automotive industry is fundamental within the manufacturing industry. As a viable domestic producer, the automotive industry is a vital source of employment and economic research and development. However, with the accessibility and low cost of imports and the stability of the Australian dollar, the automotive industry has suffered major cutbacks that are presently being tended to through government intervention policies such as the Automotive Transformation Scheme. To maintain international and domestic competition, the Australian government delivers production subsidies and import tariffs to the automotive industry. Due to this ‘band-aid’ solution, the long-term effects are being overlooked. Subsidies and tariffs solve a short-term problem but are damaging to the long-term solution creating significant and extensive harm to consumer and producer surplus. Therefore, a sound economic case cannot be successfully made to continue to protect the Australian automotive industry.
Market equilibrium occurs when supply and demand for goods or services are in sync (Mankiw 2012). A ‘deadweight loss’ occurs when supply and demand for goods or services are not in equilibrium; there is a surplus or a shortage in supply (Frank & Bernanke 2004). A deadweight loss is considered a market failure, or inefficiency; this comes at a cost to society due to inefficient allocation of resources (Doyle 2005: 225). Mankiw and Taylor state that subsidies and tariffs will result in a deadweight loss as the cost of the protective measure exceeds the gains in consumer and producer surplus (Mankiw & Taylor 2006).
A government subsidy can be defined as an economic benefit (such as a tax allowance or duty rebate) or government provided financial aid to support desirable activities (exports), keep market price low, maintain employment levels and encourage investment (Rubini 2009). The distinguishing feature of all government subsidies is for the cost of production to exceed the market price of an item (Runge & Jones 1996). Subsidies are primarily utilised to keep prices for consumers below market equilibrium price. This would seem to increase the cost for producers however; a subsidy lowers the cost to both consumers and producers as the government expends the excess; the deadweight loss (Besanko & Braeutigam 2010) – shown in figure 1.
Figure 1: The effect of a subsidy in a perfectly competitive market (Beggs 2013) A tariff is a compulsory contribution to state revenue imposed by government that is added to the cost of a particular class of imports and exports to protect domestic suppliers (Cordes, Ebel & Gravelle 2005). Tariffs are only effective if domestic suppliers cannot produce their product costing less than world price (Mankiw 2012: 177). No tariffs would be collected if buyers preferred the domestic product rather than the import (Mankiw 2012: 177). As tariffs raise import prices and reduce the quantity sold, the market for that good or service moves closer to domestic market equilibrium without international trade (Mankiw 2012: 177). As domestic buyers spend more for a good or service, this will aid both the producers and the government; producers charge a higher price increasing their surplus and government collects revenue produced by the tariff once consumers buy imported products (Mankiw 2012: 177). The imposing of a tariff on an imported good or service can create a deadweight loss. The...