Quota
Limit to the quantity of a certain good that can be imported over a particular period of time
Quotas have similar effects to tariffs, excluding the revenue generation for governments.
Quota Diagram
Trade Protection
When the government intervenes in international trade by imposing restrictions to reduce free imports.
Observing the diagram, before the quota, the economy is in free trade and operates at the world price $P_w$ which is below the domestic price $P_d$ that existed without free trade.
- The quantity supplied by domestic producers is $Q_1$ and quantity demanded by consumers is $Q_4$.
- The excess demand $Q_4 - Q_1$ is the initial quantity of imports.
- The government sets a quota, granting domestic producers more competitiveness as this causes imports of a limited quantity of foreign goods, denoted by $Q_3 - Q_2 = quota$.
- This creates a new supply curve $S_{d2}$ which is shifted to the right of $S_{d1}$ by the quantity of the quota imposed.
This new supply curve shows that the quantity that consumers can purchase at each price level is equal to the amount produced plus the quota.
- Therefore at $P_q$, even though the quantity domestic producers are willing to produce is $Q_2$, the imposition of the quota allows them to increase their supply by the limited amount of imports set by the quota ($Q_3 - Q_2 = quota$).
- Hence, with the new quota, the new domestic supply curve ($S_{d2}$) is met by the domestic demand curve $D_d$ at quantity $Q_3$ and price $P_q$ (price post-quota).
- So, even though domestic producers buy the foreign imports at $P_w$, they sell them at $P_q$. Hence, those domestic producers that have been awarded the quota licenses enjoy an extra revenue (quota revenue) equal to this difference in prices times the quantity imported $(P_q - P_w) \times (Q_3 - Q_2)$.
For the new supply curve, the price starts at the free world trade price of $P_w$ as it is the price at which producers buy imports (no producer will sell an imported good at a price lower at which they bought it).
As a result of the quota, at the new price $P_q$, the quantity supplied is $Q_3$ and the quantity demanded is $Q_3$. There is equilibrium.
Common MistakeThe price at which domestic producers buy the imported goods is still $P_w$.
However, due to the restricted limit on imports, the prices increase to $P_q$ to remove excess demand and the producers now will sell the goods at $P_q$ and earn higher profits.
The Effects of a Quota
The effects are almost identical to tariffs, except there is no revenue earned by the government.
Winners
Domestic Producers in possession of the quota licenses
- These domestic producers are supplying more ($Q_3$ instead of $Q_1$) at a higher price ($P_q$), earning higher revenues.
- Producer surplus increases by the area marked as $c$, indicating the gain from the new prices and trade restriction.
Producer surplus
The difference between the price sellers receive and the lowest price that they are willing and able to accept.
Workers
As domestic producers now produce and sell a larger quantity, the employment in the industry would be protected and increase as well.
Neutral
Unlike the tariff, the government doesn't earn revenue, but their budget isn't affected negatively either, leaving them neither better nor worse.
Losers
Consumers
- Consumers lose as they pay a higher price for the good ($P_q$).
- Hence, they can only purchase a lower quantity ($Q_3$ instead of $Q_4$).
- This causes the consumer surplus to fall by $c + d + e + f$.
Consumer surplus
The difference between the highest price consumers are willing and able to pay for a good or service and the actual price they end up paying.
Income Distribution
- Even though quotas do not involve a tax, the shift in price $P_q - P_w$ has the same effect upon the economy as the tax.
- Therefore, the price increase is regressive since it takes up a higher proportion of low-income individuals.
- This increases the disparity between incomes (3.4.9).
Inefficiency of Production
- The reason world price $P_w$ is smaller than domestic price without trade $P_d$ is because foreign producers are more efficient.
- The increase in quantity supplied from $Q_1$ to $Q_3$ represents the increase in domestic production that is inefficient as there is a waste of scarce resources by producing at $P_q$ instead of $P_w$.
Foreign Producers
- Foreign producers now supply fewer goods ($Q_4 - Q_3$ instead of $Q_2 - Q_1$), causing their quantity sold to decrease.
- However, the rise in price from quota could earn them extra revenues of $P_q - P_w$.
- Depending on which effect (the rise in price or import limit) is more impactful, they are either better or worse off.
Welfare Effects
The welfare effects are different to tariffs due to no government revenue.
Initially, before the quota is imposed:
- The producer surplus is the area marked by $g$ and the consumer surplus is the area marked by $a + b + c + d + e + f$.
- Thereby the social surplus was $a + b + c +d+e+f+g$.
Social surplus
The sum of consumer surplus and producer surplus. Maximised in the free market, when the market operates at its equilibrium point.
Remember:
- the producer surplus is the area below the price they earn and above the supply curve up till the quantity sold.
- the consumer surplus is the area above the price they pay and below the demand curve up till the quantity bought.
After the quota was imposed:
- The producer surplus increased by $c$ such that it is $c +g$ now.
- The consumer surplus fell by $c+d+e+f$ down to only $a+b$ now.
- Therefore the social surplus is $a + b + c +g$.
The change in social surplus is a decrease of: $$ a + b+c+d+e+f+g - (a+b+c+g) = d+f +e$$
This change leads to a welfare loss of the area $d+f+e$ due to the misallocation of resources where:
- The area $d$ welfare loss occurs due to inefficient production by domestic firms.
- The area $f$ welfare loss occurs due to the decreased consumption of consumers.
When evaluating quotas with tariffs:
- There is no area $e$ because the revenue that would be gained by the government is lost to foreign producers.
- This leads to a higher welfare loss for the economy as the government is now neutral rather than gaining a positive impact from the protectionism policy.
Hence, quotas usually lead to higher welfare losses than tariffs.
Common MistakeWhen analyzing welfare loss, remember that it represents the net loss to society, not just a transfer between stakeholders.
Calculating the Effects of Quota (HL Only)
The figure above showcases a quota diagram with numerical values this time for calculation.
Quota
- The quota can be calculated by finding the horizontal (or vertical) shift between the two supply curves.
- Consider any price and find the difference between the quantities in the domestic supply curve $S_{d1}$ and the domestic curve plus quota $S_{d2}$.
At $P_w = 10$:
- The quantity supplied by domestic is $5000$.
- The quantity supplied by domestic plus quota is $8000$.
- Therefore, the difference is $8000-5000=3000$
Thus the quota is a quantity of $3000$ units.
Price after quota
By finding the intersection point of the supply curve plus quota $S_{d2}$ and the demand curve, we can find the new price.
ExampleIn this case, by using the equation of a line, the demand and supply with quota curves intersect at $P=13$, which is the price after quota.
Imports Quantity
Before the quota, the imports can be calculated by finding the excess demand at world price $P_w$.
ExampleAt $P_w = \$ 10$:
The quantity imported was $12500 - 5000 = 7500$
Hence, $7500$ units of the good were imported initially.
Then after the quota, the imports will be equal to amount of the quota.
ExampleIn this case $3000$ units is the quota set for the good.
Hence, the imports decreased by $4500$ units.
Import Expenditure
- By multiplying the import quantity before the quota and after the quota by world price.
- You can find the expenditure on imports before & after the quota respectively.
Before:
$7500 \times 10 = \$ 75000$
After:
$3000 \times 10 = \$ 30000$
Hence import expenditure fell by:
$ 75000 - 30000 = \$ 40000$
Consumer Expenditure
- For consumer expenditure before quota we multiply the world price by initial quantity demanded.
- After quota, we multiply the price after quota with new quantity demanded (equilibrium quantity of $S_{d2}$ and demand).
Before:
Expenditure is $12500 \times 10 = \$ 125,000$
After:
Expenditure is $11000 \times 13 = \$ 143,000$
Hence in this specific case, consumer expenditure rises by $\$ 18000$.
Even if the consumer expenditure fell, they are still worse off as less individuals can buy the good due to scarcity and because it is expensive.
NoteConsumer expenditure can be both higher or lower after the quota (just like a tariff). However, they're still worse off either way due to lower consumption.
Consumer Surplus
- Before the quota, consumer surplus is the area of the triangle above the world price and below the demand curve, up till the quantity bought.
- After the quota, consumer surplus is the area of the triangle above the new equilibrium price and below the demand curve, till the new quantity bought.
Consumer surplus depends on how much is actually bought, not just demanded. In this case, as excess demand (worth the quota) is covered by imports, they are equivalent.
ExampleBefore:
$P_w = 10, Q_d = 12.5$ thousand and $P_{max} = 35$
Therefore we can calculate:
$$ CS = \frac{(35-10)\times 12500}{2} = \$156,250 $$
Hence the consumer surplus was $\$ 156,250$.
After:
$P_2 = 13, Q_d = 11000$ and $P_{max} = 35$
Therefore we can calculate:
$$ CS = \frac{(35-13)\times 11,000}{2} = 121,000$$
Hence the consumer surplus was $\$ 121,000$.
Therefore, the change in consumer surplus is a decrease of $\$ 35,250$.
Producer Revenue (Domestic)
For (domestic) producer revenue:
- Before the quota, we multiply world price by initial quantity supplied
- After quota you multiply new equilibrium price (of $S_{d2}$ and demand) with new quantity supplied.
- As both price and quantity supplied increase, producers always earn more revenue.
Before:
The revenue is $5000 \times 10 = \$ 50,000$
After:
The revenue is $8000 \times 13 = \$ 104,000$
Hence., the revenue of domestic producers increased by:
$ 104,000 - 50,000 = \$ 54,000$
Producer Surplus
- Before the quota, producer surplus is the area of the triangle below the world price and above the supply curve, up till the quantity sold.
- After the quota, producer surplus is the area of the triangle below the new equilibrium price and above the supply curve, till the quantity sold.
Before:
$P_w = 10, Q_s = 5000$, and $P_{min} = 5$
Therefore we can calculate:
$$ PS = \frac{(10-5)\times 5,000}{2} = 12,500$$
Hence, producer surplus was $\$ 12,500$.
After:
$P_2= 13, Q_s = 8000$ and $P_{min} = 5$
Therefore we can calculate:
$$ CS = \frac{(13-5)\times 8,000}{2} = 32,000$$
Hence, producer surplus was $\$ 32,000$.
Therefore, the change in producer surplus was an increase of $\$ 19,500$.
Government Revenue
There is no government revenue by implementing the quota.
Welfare Loss
The areas of triangles and rectangle $d + e + f$ showcase the welfare loss where:
- The first triangle can be calculated by multiplying the change in quantity supplied by the change in price (then dividing by two).
- The second triangle can be calculated by multiplying the change in quantity demanded by the change in price (then dividing by two).
- The rectangle can be calculated just like how government revenue is in tariffs, by the quota times the change in price.
First triangle:
$$ \frac{3,000 \times 3}{2} = \$ 4,500 $$
Second triangle:
$$ \frac{1,500 \times 3}{2} = \$ 2,250 $$
Rectangle:
$$ 3000 \times 3 = \$ 9000 $$
Hence, the total welfare loss is:
$$ \$ 15,750$$
Foreign Producers
- Their revenues will fall proportional to the amount import expenditure falls by.
- However, they will gain revenue from the quota licenses (the area $e$).
From previous example:
- The fall in income expenditure was $\$ 45,000$.
- The area of $e$ was $\$ 9000$.
Therefore the total loss faced by foreign producers is:
$45,000 - 9000 = \$ 36,000$.
Hence, they did lose revenue, but the loss itself was reduced by the increase in price.
Self review- Explain how quota works using a diagram.
- Discuss the impact on certain stake holders.
- Compare the differences between the effects of tariffs and quotas.
Are quota licenses truly a reason for tariffs? How much can we trust the government's intervention considering that quotas are still used today?
Case studyIndia's Import Quota on Palm Oil (2020)
Context:
In 2020, India, the largest importer of palm oil, imposed import quotas and restrictions on refined palm oil, particularly from Malaysia, following political tensions and to protect its domestic refining industry.
Effects of the Import Quota:
- Boost to Domestic Refining Industry:
- By restricting refined palm oil imports, the quota encouraged Indian companies to process crude palm oil locally, providing a boost to domestic refineries.
- This created jobs and increased value addition within the country.
- Increased Costs for Consumers:
- Limiting imports of refined palm oil reduced its supply, leading to higher prices in the domestic market. This impacted households and businesses reliant on affordable edible oils.
- International Trade Relations:
- Malaysia, a major exporter of palm oil, faced economic losses due to reduced access to the Indian market.
- This led to diplomatic efforts to repair trade relations between the two nations.
Questions:
- How did the import quota on refined palm oil impact the balance between protecting domestic industries and ensuring affordability for consumers?
- What are the long-term risks of using import quotas to manage trade, particularly in terms of international relations and market efficiency?
