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PERFECT COMPETITION AND SHORT-RUN SUPPLY CURVE: A perfectly competitive firm's supply curve is that portion of its' marginal cost curve that lies above the minimum of the average variable cost curve. A perfectly competitive firm maximizes profit by producing the quantity of output that equates price and marginal cost. As such, the firm moves along it's marginal cost curve in response to alternative prices. Because the marginal cost curve is positively sloped due to the law of diminishing marginal returns, the firm's supply curve is also positively sloped.

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PROTECTIONISM:

The view that the domestic sector of an economy, its consumers, and its producers should be protected from imports by imposing barriers to foreign trade. This is based on the notion that imports are detrimental to the economy and to its citizens. Protectionism is intended to secure domestic jobs, increase domestic wages, promote domestic production, and create a balance of trade surplus. It usually takes the form of tariffs, import quotas, and assorted non-tariff regulatory barriers.
Protectionism is a view commonly held by many citizens and policy makers of an economy that imports for the foreign sector eliminate jobs, reduce wages, threaten national security, and create other problems. In the same way a nation should be protected from foreign military invasion, the domestic economy should be protected from the invasion of foreign imports.

The most common, and most overt, forms of protectionism are tariffs (taxes) or quotas (quantity restrictions) on imports. These trade barriers protect the domestic economy from imports due to either higher prices or limited quantities. Protectionism also takes the form of government regulations that make imports from the foreign sector more difficult.

The arguments for protectionism are usually advanced by domestic producers that face the greatest competition from imports and thus have the most to gain from trade barriers.

The Downside of Foreign Trade

The law of comparative advantage indicates that nations can benefit through international trade, trade with other nations. Benefits arise when nations produce, then trade, goods that incur relatively lower opportunity costs. Such trading is beneficial for both sides of the exchange, the exporters and the importers.

There are, however, problems that arise from international trade. While nations, in the aggregate, benefit from trade, all parties do not benefit equally. And some parties are actually harmed.

  • Domestic consumers might be better off with imports as they pay lower prices and have access to more goods, but, domestic producers, especially those competing with imports, are usually worse off. They receive lower prices and sell less output.

  • The harm to domestic producers extends to the owners of the resources -- labor, capital, land, and entrepreneurship -- used in production. With less output produced, fewer resources are needed. With lower prices received, payments to the resources are also less. Workers face unemployment and lower wages. Entrepreneurship and stockholders receive less profit.

  • The harm also extends to others not directly engaged in production. Firms, and their resources, that supply intermediate inputs to the primary producers also suffer with fewer sales, lower prices, and less revenue. And in the communities where the producers are located, various supportive activities (retail stores, newspapers, movie theaters) have a drop in productive activity and local governments receive less tax revenue.
While the benefits accruing to domestic consumers from foreign imports, in aggregate, are substantial, they are broadly dispersed and the average benefit per person is relatively small. Moreover, even though the harm to domestic producers and their resources is usually less, it tends to be more concentrated and affects fewer people, meaning the average per person is greater.

The Upside of Protectionism

The goal of protectionism, as the term implies, is to protect the domestic economy from foreign imports. The benefits of protectionism, as such, serve to prevent problems of foreign trade. The specific arguments used to justify protectionism include...
  • Domestic Employment: One of the most common protectionism arguments is to protect domestic employment. Foreign imports provide competition with domestic production. To the extent that domestic consumers purchase imports rather than domestic production, domestic production declines and so too does domestic employment. It follows then that restrictions on imports prevent the reduction of domestic production and domestic employment. Key to this justification is that production is provided by citizens of the domestic economy, who pay taxes and vote, rather than foreign workers.

  • Low Foreign Wages: Those who argue for protectionism often contend that other countries in the foreign sector gain a comparative advantage due to low wages paid to their workers. These low wages then prevent domestic producers and their workers from competing on a "level playing field." These low foreign wages might be the result of a "natural" comparative advantage based on the economic structure of a foreign country or caused by "artificial" subsidies or other policies undertaken by foreign governments. As such, domestic workers need to be protected from restrict low wage (read this as "cheap") imports.

  • Infant Industry: Another protectionism argument is to protect relatively young domestic industries that are not mature enough nor large enough to compete with larger, more mature foreign producers. These "fledgling" industries have not been around long enough to create brand name recognition, benefit from economies of scale, and develop stable input supplies. Trade barriers then protect infant industries from foreign competition while they mature and develop.

  • Unfair Trade: Protectionism proponents also contend that foreign firms often engage in unfair trade practices that "unlevel" the competitive playing field. A common contention is that foreign imports are sold in the domestic economy at prices below actual production cost. This practice of "dumping" might be undertaken to drive domestic producers out of business, lessen competition, and increase the market share of the foreign producers. In addition, foreign imports might be sold at unfairly low prices because foreign governments subsidize their producers. Trade barriers prevent foreign producers from unfairly gaining a competitive advantage in the domestic economy and help to level the playing field.

  • National Security: A last noted argument for protectionism is that domestic firms and industries produce output vital to the security and defense of the nation. Should the nation import a significant amount of goods used for national defense and should the foreign producing nations decide to restrict imports, then the nation would be vulnerable. The nation needs to be protected from security problems caused by depending on these imports.
Each of these arguments provides logical, reasonable, and necessary justification for the imposition of trade barriers. However, each is also commonly misused especially by politically powerful domestic producers that seek little more than to limit foreign competition, charge higher prices, gain greater market share, and increase profits.

For example, the infant industry argument is frequently used to justify the protection of large, dominant, and MATURE domestic firms. The national security argument is also occasionally used to protect industries that have almost nothing to do with the security of the nation.

In fact, the domestic employment and low foreign wages arguments are really a recognition that foreign producers have a comparative advantage, an advantage which the domestic economy can benefit from when engaging in foreign trade. Moreover, the charge of unfair trade practices directed at foreign producers might be little more than lower production costs enabled by comparative advantage.

Policies of Protection

The inclination to protect a domestic economy from foreign imports has existed as long as nations have engaged in trade. The result is a number of different trade protection policies or trade barriers. Consider three of the more noted policies.

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