International Trade

Quotas

Free Trade

Suppose we have an economy with domestic supply SS [1] and domestic demand DD. [2]

Under free trade, with a world price of PW: [3]
  • Domestic producers produce M1, [4]
  • domestic consumers consume M2, [5]
  • and the economy imports (M2 - M1). [6]


    • The consumer surplus is APWC [7] and the producer surplus is HPWB. [8]

    Quota

    If a quota is imposed on the imports of M - say, as much as Q - the total supply SS' will be the domestic supply plus the amount Q imported by quota - in other words, SS' = SS + Q. [1] Then:
  • The economy consumes at E, [2]
  • domestic production is M3, [3]
  • domestic demand is M4, [4]
  • the amount Q imported is (M4 - M3), [5]
  • and the domestic price increases to Pd. [6]


    • The consumer surplus, APdE, [7] has decreased, and the producer surplus, HPdD, [8] has increased.

    The surplus reduced with the quota imposed is the area DBCE. [9] As in the tariff case, DBF and EGC [10] represent "efficiency loss". But now DFGE, [11] which was previously government tariff revenue, is now the quota rent belonging to import license holders.

    Offer Curve Approach

    We can analyse the effect of quotas using an offer curve approach, in a similar way to tariffs.

    Consider two countries with offer curves OH and OF. The home country imports M1 and exports X1. [1] If it imposes a quota, say M', [2] it restricts its imports, so that its new offer curve is OE'M'. [3]

    Its offer curve intersects the foreign country's offer curve at E", [4] which means that it will now export X3 and import M'. [5]

    However, when importing M', the home country is willing to pay X2. The difference (X2 - X3) is the quota license holder's revenue. [7]

    You can compare this with imposing a tariff.

    Tariffs vs Quotas

    What are the differences between tariffs and quotas?
  • The area DFGE represents different things.
  • If price elasticity of demand for M is very low, the tariff will not be very effective.
  • If the aim is to reduce imports to a specific amount, the quota is more direct and accurate.

    • Question: If business people try to get the license to import M, how much are they willing to pay for the lobbying cost?



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    [Topic] Trade Policies


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    [mtcha@ecel.uwa.edu.au]
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