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IFT Notes for Level I CFA® Program

LM07 International Trade and Capital Flows

Part 4

6.3 Export Subsidies     

Export subsidies are payments by the government to a firm for each unit exported:

  • The objective is to stimulate exports, increase production in certain industries, and create domestic employment.
  • The exporter has an incentive to focus on the export market because the firm receives the international price plus the per-unit subsidy for each unit of the good exported.
  • The most export subsidized industry in the world is agriculture.
  • Countervailing duties are duties levied by the importing country against subsidized exports entering the country. This tariff is imposed to offset the effect of subsidy.
  • If a small country imposes export subsidies, domestic price rises.
  • If a large country imposes export subsidies, world prices decline as quantity increases.
  • For example the European Union subsidizes sugar and is the second largest exporter in the world.
  • Net welfare is down in the large and small country.

The exhibits below are reproduced from the curriculum.

Note: these are important and testable. They summarize the effects of all the alternative trade policies we have seen so far.

Effects of Alternative Trade Policies
  Tariff Import quota Export subsidy VER
Impact on Importing country Importing country Exporting country Importing country
Producer surplus Increases Increases Increases Increases
Consumer surplus Decreases Decreases Decreases Decreases
Government revenue Increases Mixed (depends on whether the quota rents are captured by the importing country through the sale of licenses or by the exporters) Falls (government spending rises) No change (rent to foreigners)
National welfare Decreases in small country (could increase in large country). Decreases in small country (could increase in large country). Decreases Decreases
Effects of alternative trade policies on price, production, consumption, and trade
Tariff Import quota Export subsidy VER
Impact on Importing country Importing country Exporting country Importing country
Price Increases Increases Increases Increases
Domestic consumption Decreases Decreases Decreases Decreases
Domestic production Increases Increases Increases Increases
Trade Imports decrease Imports decrease Exports increase Imports decrease

7. Trading Blocs, Common Markets, and Economic Unions

regional trading bloc, is an agreement between a group of countries that are geographically close to each other, to reduce and eliminate barriers to trade and movement of factors of production among the members of the bloc. They have zero or very low tariffs on imports from members.

The diagram below shows the various types of regional trading blocs in an increasing order of integration.

econ r19 3.4 1

8. Capital Restrictions

Key points related to capital restrictions are given below:

  • Some governments restrict the inward and/or outward flow of capital.
  • Restrictions on inflows might be due to strategic or defense-related reasons.
  • During an economic crisis, capital might flow out of the country.
  • Countries with scarce foreign exchange might restrict outflows and might also want to boost local investment.
  • Over the long term, capital restrictions reduce welfare.

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