Which of the following best describes the basis of the diversification-for-stability argument for trade protection in the context of public solutions to externalities?

• A. Trade protection helps countries diversify their economies, reducing dependence on a narrow range of exports and increasing economic stability.
• B. Trade protection encourages specialization in the most efficient industries, leading to greater economic growth.
• C. Trade protection eliminates all negative externalities by restricting imports.
• D. Trade protection ensures that domestic consumers have access to the lowest possible prices for goods.

Answer: (A)

Verified step by step guidance

1. Step 1: Understand the concept of externalities and why they might require public solutions. Externalities occur when a market activity affects third parties not directly involved in the transaction, leading to market failure.
2. Step 2: Recognize that trade protection policies, such as tariffs or quotas, can be used as public solutions to address certain externalities by influencing the structure of the economy.
3. Step 3: Analyze the diversification-for-stability argument, which suggests that by protecting certain industries, a country can reduce its economic dependence on a narrow range of exports. This reduces vulnerability to external shocks affecting those exports.
4. Step 4: Contrast this with other arguments for trade protection, such as encouraging specialization or eliminating negative externalities, and understand why diversification focuses on economic stability rather than efficiency or price effects.
5. Step 5: Conclude that the diversification-for-stability argument supports trade protection as a means to create a more resilient economy by broadening the industrial base, thereby reducing risks associated with external economic fluctuations.