IB Economics 4.2.2 Quota Notes

How a Quota Restricts Trade

1. Free trade lets goods cross borders with no government barriers, and countries trade on their comparative advantage.

1. Governments restrict this with trade protection, and a quota is one such tool.

1. A quota sets a maximum quantity of a good that may be imported over a period, capping how much can come in.

1. Because it caps imports below the free-trade level, a quota lets domestic producers sell more at a higher price.
2. Unlike a tariff, a quota raises no tax, so the government earns no revenue from it.

The Quota Diagram: How a Quota Works

1. Read the diagram in two stages, starting in free trade at the world price $P_w$, which sits below the domestic no-trade price, so the country imports.
2. At $P_w$, domestic firms supply $Q_{s1}$ and consumers demand $Q_{d1}$, and imports fill $Q_{d1} - Q_{s1}$.
3. Now impose the quota: the government allows only a fixed quantity of imports, so above the world price the only extra supply is that capped quota.
4. The effective supply becomes domestic supply shifted right by the quota, the $S + \text{quota}$ line, and the domestic price rises to $P_q$, where $S + \text{quota}$ meets demand.
5. Domestic supply rises from $Q_{s1}$ to $Q_{s2}$ and demand falls from $Q_{d1}$ to $Q_{d2}$, and the remaining imports, $Q_{d2} - Q_{s2}$, are exactly the size of the quota.

1. Each lettered area on the diagram maps to a welfare measure.
   1. Consumer surplus kept after the quota: $a + b$.
   2. Loss in consumer surplus: $c + d + e + f$.
   3. Gain in producer surplus: $c$.
   4. Quota rent to the licence holders: $e$.
   5. Deadweight welfare loss: $d + f$.
   6. Original producer surplus before the quota: $g$.

The Winners: Domestic Producers and Licence Holders

1. Two groups gain from a quota, each for a different reason.
   1. Domestic producers gain $c$: they supply $Q_{s2}$ instead of $Q_{s1}$ at the higher price $P_q$, so producer surplus grows and the extra output supports jobs.
   2. Licence holders gain the quota rent $e$: they buy each permitted unit at $P_w$ and resell it at the higher price $P_q$, so the rent is $(P_q - P_w) \times \text{quota}$.
2. The quota rent is a transfer, not new wealth, and it goes to the licence holders rather than the government, which collects nothing.

The Losers: Consumers and Foreign Producers

1. Two groups lose, and one loses in a way that depends on who holds the licences.
   1. Consumers lose $c + d + e + f$: they pay the higher price $P_q$ and buy less, so consumer surplus shrinks, and the burden is regressive, a link back to subtopic 3.4.9.
   2. Foreign producers lose sales, selling only $Q_{d2} - Q_{s2}$ instead of the larger free-trade volume.
2. If foreign exporters hold the licences they capture the quota rent $e$ on the units they still sell, which softens the blow, but if domestic importers hold them, foreign producers simply lose the sales with no rent.

Society: The Welfare Loss

1. A quota destroys some value outright, and may cost the country more depending on where the rent goes.
2. The deadweight welfare loss is $d + f$: the production triangle $d$ from extra output $Q_{s1}$ to $Q_{s2}$ made by less efficient firms, and the consumption triangle $f$ from buyers priced out.
3. The quota rent $e$ is a transfer, but where it lands matters for the country.
   1. If domestic importers hold the licences, the rent stays in the country, so the net loss is just $d + f$.
   2. If foreign exporters hold the licences, the rent $e$ leaves the country, so the economy loses $e$ on top of $d + f$.
4. Either way the government gains nothing, which is the key contrast with a tariff.

Tariff or Quota: Who Wins and Who Loses

1. On the diagram the two tools look almost identical and split the winners and losers the same way.
   1. Domestic producers win under both, through higher surplus and protected jobs.
   2. Consumers lose the most under both, paying more and buying less, with the heaviest burden on lower-income households.
   3. Foreign producers lose sales under both.
2. The decisive difference is who receives the rectangle $e$, which is the same size on both diagrams.
   1. Under a tariff, $e$ is government revenue.
   2. Under a quota, $e$ is quota rent for the licence holders, and the government gains nothing.
3. So if the licence holders are foreign, the country can end up worse off under a quota than under an equivalent tariff.