What is the effect of imposing a quota on imports?

There are two types of protection; Tariffs, which are taxes, or duties, on imported goods designed to raise the price to the level of, or above the existing domestic price, and non-tariff barriers, which include all other barriers, such as:

Quotas

A quota is a limit to the quantity coming into a country.

With no trade, equilibrium market price in the country will exist at the price which equates domestic demand and domestic supply, at P, and with output at Q. However, the world price is likely to be lower, at P1, than the price in a country that does not trade. If the country is opened up to free trade from the rest of the world, the world supply curve will be perfectly elastic at the world price, P1.

The new equilibrium price is P1 and output is Q1. The domestic share of output is now Q2,compared with Q, the self-sufficient quantity. The amount imported is the distance Q2 to Q1.

Imposing a quota

In an attempt to protect domestic producers, a quota of Q2 to Q3 may be imposed on imports.

This enables the domestic share of output to rise to 0 to Q2, plus Q3 to Q4.

The quota creates a relative shortage and drives the price up to P2, with total output falling to Q4. The amount imported falls to the quota level. It is this price rise that provides an incentive for less efficient domestic firms to increase their output.

One of the key differences between a tariff and a quota is that the welfare loss associated with a quota may be greater because there is no tax revenue earned by a government. Because of this, quotas are less frequently used than tariffs.

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Tariffs

Tariffs, or customs duties, are taxes on imported products, usually in an ad valorem form, levied as a percentage increase on the price of the imported product. Tariffs are one of the oldest and most pervasive forms of protection and barrier to trade.

The impact of tariffs

The imposition of tariffs leads to the following:

Higher prices

Domestic consumers face higher prices, which also means that there is a loss of consumer surplus. However, there is a gain in domestic producer surplus as producers are protected from cheap imports, and receive a higher price than they would have without the tariff. However, it is likely that there is an overall net welfare loss.

Without trade, the domestic price and quantity are P & Q.

If a country opens up to world supply, price falls to P1, and output increases from Q to Q2. As a result, domestic producers’ share falls to Q1 and imports now dominate, with the quantity imported Q1 to Q2.

The imposition of a tariff shifts up the world supply curve to World Supply + Tariff.

The price rises to P2, and the new output is at Q3. Domestic producers share of the market rise to Q4, and imports fall to Q4 to Q3. The result is that domestic producers have been protected from cheaper imports from the rest of the World.

Given that domestic consumers face higher prices, they also suffer a loss of consumer surplus. In contrast, domestic producers increase their producer surplus as they receive a higher price than they would have without the tariff.
Increased market share also means that jobs will be protected in the domestic economy.

Welfare loss

However, the reduction in consumer surplus is greater than the increase in producer surplus. Even when adding the tariff revenue (area K,L,M,N) there is still a net loss. The net welfare loss is represented by the triangles X and Y.

Distortion

There is a potential distortion of the principle of comparative advantage, whereby a tariff alters the cost advantage that countries may have built up through specialisation.

Retaliation

There is the likelihood of retaliation from exporting countries, which could trigger a costly trade war.

However, in the short run tariffs may protect jobs, infant and declining industries, and strategic goods. Tariffs may also help conserve a non-renewable scarce resource. Selective tariffs may also help reduce a trade deficit, and reduce consumption.

"That's enough! No more!" That's basically what a government is saying to foreign producers when they place quotas on imports. Maybe you have heard the words "quota" and "tariff" tossed around in the media and political sphere, but are not quite sure what they mean, or that a quota is not the same thing as a tariff. Good thing for you that you have come to the right place! If you want to know about import quotas, what they have to do with international trade, their pros and cons, and much more, grab some tea or coffee, and let's get rolling.

Concept of Import Quotas

What is the concept of import quotas? Import quotas are basically a way to protect domestic producers from foreign competition. An import quota is a limit on how many of a specific good or a type of good can be imported into the country in a certain time period. Import quotas are a form of protectionism that governments use to support and protect their domestic industries.

An import quota is a limit on how much a specific good or type of good can be imported into the country in a certain time period.

Oftentimes, developing countries will impose protectionist measures such as quotas and tariffs to protect their fledgling industries from cheaper foreign alternatives to help reduce income losses to foreign countries and keep prices higher for domestic producers.

The point of an import quota is to limit how much of a foreign product can be imported into a country. The quota works by only allowing those with permission either through licensing or government agreement to bring in the quantity specified by the agreement. Once the quantity specified by the quota is reached, no more of the goods can be imported for that period.

To learn more about other forms of protectionist measures, take a look at our explanation - Protectionism

Import Quota vs Tariff

What is the difference between an import quota vs a tariff? Well, an import quota is a limit on the quantity or the total values of the goods that can be imported into a country while a tariff is a tax that is placed on imported goods. While a quota limits the number of goods coming into a country, a tariff does not. A tariff serves to discourage imports by making them more expensive and, at the same time, provides a source of revenue to the government.

With an import quota in place, the domestic importers who are able to import under the quota can earn quota rents. Quota rent is the additional revenue earned by those who are allowed to import goods. The amount of the rent is the difference between the world market price at which the importer bought the goods and the domestic price at which the importer sells the goods. The quota rent can sometimes also go to the foreign producers who are able to export under the quota to the domestic market when the import licenses are given to foreign producers.

A tariff is a tax that is placed on imported goods.

The quota rent is the additional revenue that the domestic importers are able to earn on the imported goods because of the import quota. The quota rent can sometimes also go to the foreign producers who are able to export under the quota to the domestic market when the import licenses are given to foreign producers.

The domestic price is higher than the world market price since a quota would be unnecessary if domestic prices were the same or lower than the world price.

While quotas and tariffs are two different protectionist measures, they are both means to the same end: reducing imports. An import quota, however, is more effective since it is more restrictive than a tariff. With a tariff, there is no upper limit on how much of a good can be imported, it just means the good will be more expensive to import. A quota will set a limit on how much of a good can come into a country, making it more effective in restricting international trade.

Import QuotaTariff

• Limits the quantity or the total values of a good imported.
• The government does not earn revenue from quotas.
• Domestic importers (or foreign producers) earn quota rents.
• Keeps domestic prices high by limiting foreign supplies in the market.

• No limit on the quantity or the total values of goods imported.
• Revenue collected from the tariff goes to the government.
• Domestic importers and foreign producers do not profit from tariffs.
• Tariffs increase prices because the producers who have to pay the tax will transfer this burden onto consumers by raising sales prices.

Fig. 1 - An import quota regime

Figure 1 above shows the impact of an import quota on the price and quantity demanded of a good. The import quota is the quantity (Q3 - Q2). The domestic supply curve shifts to the right by this quota allowance. The new equilibrium price is at PQ. Under free trade, the price would be at PW, and the equilibrium quantity demanded is Q4. Of this, the domestic producers only supply a quantity of Q1, and the quantity of (Q4 - Q1) is made up of imports.

Under the import quota, the domestic supply increases from Q1 to Q2, and the demand decreases from Q4 to Q3. The rectangle represents the quota rent that goes to the importers who are allowed to import under the quota. This is the price difference (PQ - PW) multiplied by the imported quantity.

Fig. 2 - An import tariff regime

Figure 2 shows the impact of a tariff. As can be seen, the tariff causes the price to increase from PW to PT which causes a decrease in both the quantity demanded and supplied. Under free trade, the price would be at PW, and the equilibrium quantity demanded is at QD. Of this, the domestic producers supply a quantity of QS. A benefit of a tariff is that it generates tax revenue for the government. This is one reason that a tariff may be preferable to a quota.

Import Quotas in International Trade

Import quotas in international trade can have several uses and effects. These effects also depend on the type of import quota. There are two main types of import quotas which can be broken down into more specific types:

• Absolute Quotas
• Tariff-rate Quotas

An absolute quota is a quota that sets the amount of the specified goods that can be imported in a specified time period. Once the quota is reached, imports are capped. Absolute quotas can be applied universally so that imports can come from any country and count towards the quota limit. An import quota can also be set on a specific country meaning that the domestic country will only accept a limited quantity or total values of the specified goods from the specified foreign country but may accept more of the goods from a different nation.

A tariff-rate quota incorporates the concept of a tariff into a quota. Goods may be imported at a reduced tariff rate until a specified quota amount is reached. Any goods imported after that are subject to a higher tariff rate.

Import Quotas: Objectives

There are several objectives behind import quotas. Let's take a look at why governments may choose to use import quotas as a tool for controlling international trade.

1. First and foremost, the main objective of an import quota is to protect domestic industries from cheaper foreign goods.
2. Import quotas can serve to stabilize domestic prices by reducing foreign imports.
3. They help reduce the trade deficit by adjusting the negative balance of payments by increasing exports and reducing imports.
4. Import quotas can be set to encourage the use of scarce foreign exchange resources on more necessary items rather than "waste" them on unnecessary or luxury goods.
5. Governments may choose to set an import quota on luxury goods to discourage the consumption of these goods.
6. Governments can use import quotas as a form of retaliation against foreign governments as a response to trade or other policies.
7. Import quotas can be used to improve a country's international bargaining power.

Import Quotas Examples

To better understand import quotas, let's take a look at some import quota examples.

In the first example, the government has set an absolute quota on the amount of salmon that can be imported.

The U.S. government wants to protect Alaska's salmon industry which is being jeopardized by cheap salmon coming in from countries like Norway, Russia, and Chile. To address this, the U.S. government decides to place an absolute quota on the amount of salmon that can be imported. The total demand for salmon in the U.S. is 40,000 tons at the world price of $4,000 per ton. The quota is set at 15,000 tons of imported salmon per year.

Fig. 3 - An import quota for salmon

In Figure 3, we see that with the import quota in place, the domestic equilibrium price of salmon increases to $5,000 per ton, which is $1,000 higher than the world price. Compared to the case of free trade, this allows domestic suppliers to increase their quantities of salmon sold from 5,000 tons to 15,000 tons. Under the import quota, domestic producers supply 15,000 tons of salmon, and a further 15,000 tons are imported, meeting the domestic demand for 30,000 tons of salmon at $5,000 per ton.

In this next example, we will look at an absolute quota where the government awards a license to specific importers, making them the only ones who can import a specific good.

Cheap foreign coal has been driving down the domestic coal price. The government has decided to set an absolute quota on imported coal. Additionally, to import coal, you have to have 1 out of the 100 licenses distributed among importers. If the importers were lucky enough to attain a license, they can import up to 200,000 tons of coal. This limits the entire quantity of imported coal to 20 million tons per quota period.

In this last example, the government has set a tariff-rate quota on the number of computers that can be imported.

To keep domestic prices of computers high, the U.S. government sets a tariff-rate quota on the import of computers. The first 5 million computers are subjected to a tax of $5.37 per unit. Every computer that is imported after that is taxed at $15.49 per unit.

Disadvantages of Import Quotas

There are both advantages and disadvantages to import quotas. Import quotas are a form of trade protectionism. They are intended to keep domestic prices high to enable domestic producers to maintain a decent market share. Another common argument for quotas is that they can protect fledgling industries from already established foreign suppliers that have lower production costs.

That being said, there are some major disadvantages to import quotas. One drawback of an import quota is that the government does not gain any revenue from it as it would from a tariff. The price difference on the imported units goes to domestic importers (or foreign producers) in the form of quota rents.

Another major issue with protectionist policies like import quotas is the cost it places on the domestic consumer and producers who rely on imported inputs for their production. Since import quotas increase the prices of goods, the consumer bears the burden of the increased cost. Even though the domestic producers whose products are covered by the quotas benefit from the higher prices, the cost of the import quota to the economy in the form of higher prices is consistently greater than the benefit to the producer. This disparity results in a net efficiency loss (deadweight loss) for the nation's economy because the costs of the import quota outweigh its benefits.

From the importer's standpoint, not every importer is treated equally under a quota. It might be that while some importers receive licenses, others do not. Or maybe the government gives state-owned importers a higher quota allowance, and private importers have to make do with a lower one. This also opens the possibility of corruption. Those who are responsible for allocating licenses are subject to bribery from importers who want to obtain the licenses at all costs to make money.

In economics, import quotas and other forms of trade protection such as tariffs are generally seen as costly to the economy for the protection they offer domestic producers and result in net efficiency loss.