Question

An export subsidy has the opposite effect on terms of trade to the effect of an import tariff. Domestically a tariff will raise the price of the import good, deteriorating the domestic terms of trade. A production subsidy for the export product will lower the local price of the export good, lowering the domestic terms of trade for the country. Hence the export subsidy and the import tariff have the same effect. This analysis seems to contradict the first sentence in this paragraph. Discuss this paradox.

Answer 1

Answer: An export subsidy achieves cheaper goods in foreign markets while an import tariff makes imported goods more expensive.

Explanation: An export subsidy and an import tariff have different goals. For the domestic market, subsidies reduce the price of domestic goods and tariffs increase the price of foreign goods, making domestic goods more competitive, more desirable and fueling the domestic market.

When an imported good has enjoyed a substantial production subsidy, the price will be so low that tariffs will not prevent it from being sufficiently competitive in the foreign market against their domestic goods. In this case it achieves the same goal as a production subsidy.

Both ideas seem contradictory at first, but are both true.