Paper 3 examination question on trade barriers (exiting syllabus)

Lesson notes

This is a continuation of the previous lesson and contains a paper three type question on the costs and benefits of being part of a trading bloc.  This exercise can be completed in 45 minutes.  While paper three type questions are only part of the higher level syllabus, I will also give paper three exercises to my standard level students to complete, as it provides good practise for all economics students. 

Paper 3 style examination question (existing syllabus)

Maximum mark for this question 25

1. The following is a middle income country which has joined a free trade association.  They produce bread domestically which they make from a combination of domestically produced and imported corn.  Prior to joining the FTA the government imposed a tariff on corn imports but after joining the organisation they were forced to remove these.  This reduced the price of corn in the country to $ 5 per Kg.

Define the following terms:

(a) i. Preferential trade area (PTA) [1 mark]

PTAs offer preferential (i.e. lower tariff barriers) between participating nations, but not free trade between members.  In some cases the PTA may only apply to a specific industry or sector.

ii. Monetary union [1 mark]

When two or more states creating a single currency area, involving a universal exchange rate and / or a single currency.

iii. Common market [1 mark]

A free trade area which also allows for a relatively free movement of capital and services.

(b) i. Calculate the total revenue spent on corn by consumers prior to joining the FTA? [2 marks]

14m Kgs x $ 7 = $ 98 m.

ii. Calculate the amount spent by consumers on corn after joining the FTA? [2 marks]

17m Kgs x $ 5 = $ 85 m.

iii. Prior to the removal of the tariff what was the level of tax revenue generated by the import tax?  [2 marks]

(14m - 8m) x $ 2 = $ 12m.

iv. Calculate the change in revenue gained by domestic producers after the removal of the tariff.  [2 marks]

(8m x $7) minus (5m x $5) = - $ 31m.

v. Calculate the change in revenue gained by imported producers after the removal of the tariff.  [2 marks]

(12m x $5) minus (6m x $7) = + $ 18m.

vi. Which area represents the gain in consumer surplus after the tariff was removed?  [2 marks]

Area d + ($2 x 14m Kgs).

vii. Which area represents the deadweight loss resulting from the imposition of the original tariff?  [2 marks]

Area a + d.

(c) Explain the impact of membership of the free trade area on the following stakeholders:  [4marks]

  • consumers
  • domestic producers
  • the government.

Two mark for each correct response, with part responses awarded one mark.

Consumers will benefit from free trade membership as they will pay lower prices for their goods and services as well as greater variety of products.  

Some domestic producers may not support the move if their own market share is threatened by cheaper goods and services from overseas.  On the other hand producers relying on imported raw materials and components will benefit from a fall in production costs.   Some domestic producers will also benefit from greater access to export markets after joining the FTA.  Overall there will be both winners and losers amongst domestic firms following the decision to join the FTA.

The government will lose a source of tax revenue. Following the abolition of tariffs on imported goods and services wwhich will leave a hole in public finances.  On the other hand they may benefit should membership of the FTA provide benefits to the economy as a whole.

(d) Explain the difference between a free trade area and a customs union.  [2 marks]

Both free trade areas and a customs union provide tariff free trade between participating members but a customs union also requires members to maintain common external barriers against nations outside of the trading bloc.

(e) Explain the difference between trade diversion and trade creation.  [4 marks]

Trade creation occurs when entry to a customs union means that the production of a good or service switches from a high cost producer to a lower cost one. 

Trade diversion occurs when the production of a good or service diverts from a low cost producer to a higher cost one. 

The paper three type questions above can be accessed as a PDF worksheet at: P3 questions

The P3 markscheme with responses is available at: Mark scheme

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