Basic Analysis of a Quota

A quota (or quantitative restriction) is a limit on the quantity of a good that is allowed to enter a country.

Look first at the coffee example that we used to illustrate the large-country tariff.

Suppose that instead of assessing a tariff, the U.S. government allowed only 150 million pounds of coffee to be imported each year.  What would happen?  The supply curve tells us that the foreign suppliers would be able to supply this much coffee at a price of $3 a pound, but why should they charge such a low price?  A glance at the demand curve tells them that they can get rid of 150 million pounds at a price of $5 a pound.  In other words at $5 a pound they can sell all the coffee they are allowed to export to us, so thatís the price they will charge.  Bottom line: we end up with the same loss of consumersí surplus as in the tariff above ó $175 million.  The net effect on foreign suppliers is the combination of the loss of the same light blue-shaded region that we saw in this diagram in the tariff analysis


(-$175 million), plus the gain of $300 million in extra profits from being able to charge a higher price ó the same area as the one the government got in tariffs in the previous example.

So with the simple quota consumers lose, government gets nothing, and foreign producers may actually gain.  (Whether foreign producers make a net gain as compared to free trade depends on the size of the quota and the slopes of the curves ó you can see for example that if the quota were a lot smaller, say only 5 million pounds, then foreign producers would make a net loss.)  The government could make back some or even all of this by selling import licenses, but we wonít worry much about that.  Now letís go back to our Monaco tuba market example.  Suppose that instead of imposing a tariff on imported tubas of $50, the government imposed a quota: No more than 225 tubas could be imported each year.  Again, remember that the foreign tuba makers arenít stupid, and will charge whatever price they can get.  The result again looks strangely familiar.

We will end up with the same change in domestic price and in total quantity sold domestically.  Here, since we have domestic producers, the results for them will be exactly the same as in the tariff example discussed earlier.  So the fall in consumer surplus, and the gain in producersí surplus for domestic producers, are identical with the tariff analysis developed above.  The difference is that the tariff revenue that was gained by government is gained instead by foreign suppliers.

So in terms of domestic price and total quantity sold, and in particular in terms of the amount of the domestic market you preserve for domestic manufacturers, you can get exactly the same result with a tariff as with a quota.  The key advantage with a tariff is that the government gets revenue, which it gives up with a simple quota.

Why would any sane government use quotas?  Mainly because they provide a greater capacity to fine-tune imports.  If the purpose of a restriction is to stop the decline of an import-threatened domestic industry, itís fairly easy to work out how much that industry wants to sell, how much imports are, and how big a quota you need, and you can adjust that quota from month to month.  Figuring out the tariff that will do the same job requires that you know where the supply and demand curves are, which can be hard to figure out.
 


©1998 Colin Danby.