Explain how import substitution can protect domestic industry.
Import substitution is an inward looking trade strategy that aims at replacing or substituting imports with domestic production. For example, instead of importing vehicles made in a foreign country, industries are encouraged to produce them domestically.
Under this policy, the government protects domestic industries from foreign competition through two main forms: tariffs and quotas. Tariffs are a tax on imported goods that make imported goods more expensive and discourage their use. Quotas specify the quantity of goods which can be imported.
The effect of both tariffs and quotas is that they restrict imports and, therefore, protect domestic firms from foreign competition. This protection is based on the notion that industries of developing countries are not in a position to compete against goods produced by more developed economies.
It is assumed that if domestic industries are protected, they would learn to compete in the course of time. This allows the domestic industry to grow and develop without facing immediate competition from established foreign players.
Explanation
This answer covers all key aspects of how import substitution protects domestic industry as mentioned in the textbook. It explains the meaning of import substitution, the two protection mechanisms (tariffs and quotas), how they work to restrict imports, and the rationale behind protecting developing countries' industries. The answer is structured in 4 paragraphs with key terms bolded, suitable for a 5-mark question.