Cars

Cars

Question 1

i. The tariff on cars imported into Australia has decreased in 2005. Apply economic theory to analyze the impact of this policy on:

a. New buyers of cars

A tariff is a tax imposed on imports, the purpose of a tariff is to restrict the quantity being imported, raise government revenue and also protect infant industries in a country. A decrease in the tariffs on imports in Australia will result into a decline in the price of new cars, this decline will reduce the tax burden of new car buyers, more people will afford new cars and therefore more quantity will be demanded, these can be diagrammatically analyzed as follows:

From the above diagram the price of new cars will decline as shown by the arrow, the quantity demanded will rise as shown by the x axis arrow, therefore the effort of a decline in tariffs will lead to a decline in the price level and at the same time an increase in the quantity demanded, the new cars buyers will experience a decline in the tax burden for imported new cars.

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b. Sellers of cars

Sellers of cars will experience a decline in the cost of the new cars imported, this decline which has caused an increase in the demand for cars will also result into an increase in sales level, and an increase in sales level will result into an increase in the profit levels of the car sellers.

c. Domestic manufacturers of cars

When a decline in the tax level is imposed then the price of imported cars goes down, this put competition of these domestic firms and this will result into a decline in the demand for domestically manufactured cars. This is because the tariff is a way in which the government will protect local industries and at the same time prevent unhealthy external competition, therefore when a tariff declines more substitute goods enter the economy, when this happens the demand for locally manufactured goods goes down due to increased supply of cars and increased competition.

d. Current owners of cars (those who bought their cars prior to 2005)

the car owners who had acquired cars before the decline in tariffs of imports will experience a decline in their wealth, assuming that they had bought the cars at a much higher price than the current price, the price of cars will go down and therefore the value of their cars will drastically decline to a much low level resulting to a loss of wealth to car owners due to the decline in the

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price of cars.

ii. What are the arguments for imposing tariff on cars?

Tariffs are imposed in order to decrease the level of quantity imported, protect infant industries and government revenue.

Reducing quantity:

A reduction in the quantity imported will result into improved balance of trade, these will as a result of a decline in the difference between imports and exports that result into balance of trade, when tariffs are imposed less will demanded and therefore there will be an improvement in the balance of trade. Therefore the tariff will help reduce balance of trade and therefore improve balance of trade.

Protection of infant industries:

The increased or imposition of tariffs will aid in protecting infant industries, when firms in a country are not internationally competitive in terms of quantity and price of their goods, where imports are cheaper than domestically produced goods, the government will impose a tariff on

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imports of these goods so that the consumption of locally produced goods increase, though this the government will be protecting infant industries through tariffs.

Government revenue:

Tariffs are in form of taxes and they are a source of government revenue, therefore when tariffs are imposed on goods then the government will earn revenue as a result, the revenue earned will be equal to the price increase times the quantity demanded, the diagram below shows the level of government revenue to be earned:

When the tariff increases the price of a product then this will result to government revenue whose value is equal to the value of the shaded area above.

Question 2

One of the most powerful legislation ever enacted in Australia is the trade Practices Act. Australian Competition and Consumer Commission (ACCC) are responsible for administering this act. One of the provisions of this act is anti-competitive behavior.

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a. Why is competition so important to the economy?

When there exist competition then the economy produces at the most efficient and effective mode of production, competition will result into a decline in the consumer prices as firm under price each other to increase sales, the firms in the economy will also strive to produce at the most effective way in order to reduce the cost of production so that they will under price their competitors, therefore competition is very important in an economy because this results into effectiveness and efficiency in the economy in the allocation of resource and pricing mechanism of demand and supply.

b. Is competition always beneficial? Under what circumstances can competition be harmful?

Competition is beneficial in that it ensures low consumer prices and effective resource allocation where firms will try to reduce their cost of production and offer their goods at low prices, in a monopoly industry where there exist no competition then the prices are determined by the firm, the firm in a monopoly industry is a price maker while the firm in a competitive market the firm will be a price taker where prices will be determined by the demand and supply of the products in the market.

Competition can be harmful in some situations; the government will always try to reduce unhealthy competition in the economy, especially in chemical industries whereby stiff competition may lead to some firm manufacturing generic products in order to lower the production costs, this will be harmful competition in that products in the market will be substandard and therefore the government will only allow only a few firms to operate in the industry so as to maintain the standard of goods produced.

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c. Is it necessary to have a large number of producers or sellers to result in healthy competition? Explain giving examples.

No, there is no need to have a large number of firms and consumers in order to have healthy competition, the number of firms in an industry is determined by the market size and the capacity of firms in the industry, when the market size is large and the capacity of each firm is low then there will be the existence of more and more firms.

The demand of products will determine the number of firms in an industry, the higher the demand the more the firms there will exist, the demand of products on the hand will be determined by the price, taste and preferences, therefore it does not necessarily mean that for there to be competition there must be a large number of consumers and producers.

A competitive market is characterized by free entry and exit by firms into the industry, proper information on products by consumers and the price is determined by the demand and supply where firms are price takers and not price makers.

d. Is the size of a firm related to the degree of market power enjoyed by firms? Do large firms necessarily have more market power than smaller ones? Explain giving examples.

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Market power refers to the ability of a firm to alter its prices of its goods or products without losing the demand for its products to its competitors, firms with market power can be a monopoly firm and oligopoly, a monopoly is that which there exist only one firm and the firm has the entire market power to dominate the market, an oligopoly exists where there are two firms in the industry and firms will first have to determine the outcome of a price change and the actions of the second firm.

The size of a firm is determined by the degree of market power the firm enjoys, a monopoly power holding firm can be termed as a large firm because it is a price maker and it dominates a market where it is the only firm that is in the industry and there are barriers for entry into the industry, therefore it does not necessarily mean that a large firm has more market power than a small firm, a firm can be a monopoly but the product it deals with makes it a small firm, it can be an oligopoly and the market power is shared between the two firms that dominate the market.

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References:

Australia Department of Trade affairs (2007) history of Australia trade, retrieved on 25th August, available at

www.dfat.gov.au/dept/history.html

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Brian Snow (1997) Macroeconomics: Introduction to Macroeconomics, Rout ledge publishers, UK

Philip Hardwick (2004) Introduction to Modern Economics, Pearson Press, New  York

Stratton (1999) Economics: A New Introduction, McGraw Hill Publishers, UK

Codington A. (2003) Keynesian Economics: The First Principles, Rout ledge publishers, US

Wikipedia the free encyclopedia (2007) international trade, retrieved on 25th August, available at

www.en.wikipedia.

org/wiki/International_trade