Question: Welfare analysis, such as the one done for tariffs, for the case of quota.

You must
present your analysis as it has been presented in the class analysis. (15 marks)

Answer:

A quota is a government-imposed trade restriction that restricts the number or monetary

value of goods that a country can import or export during a particular period.

For example, Pakistan can introduce a quota on the number of cars that can be imported from
Japan or kgs of wheat it can export to India.

Quotas are used to reduce the imports that leads to the flourishment of the domestic market by
restricting foreign competition. Also, Countries use quotas in international trade to help regulate
the volume of trade between them and other countries. For the foreign market, due to import
quota, as the imports are lessened their sale decreases, however, depending on the type of the
quantity demanded, for example, if is highly inelastic meaning that the increase in price is far
greater than the fall in quantity, than the foreign firms will be earning profitably.

Moreover, few negative features of import quota can be that it will lead to higher domestic prices
as due to less imports, consumers will have less choice of products to consume this will lead to
exploitation by the domestic firms as they increase their products’ prices as per consumers have
no other cheaper substitutes available. A decline in economic welfare will also be observed and
chances of retaliation from the countries by limiting our exports also increases.

Let’s analyze the welfare effects of an import quota on producer, consumer and the license
holder which deserves the quota rent of both the importing country and the exporting country.

A country will only import based on the condition that its domestic price is higher than the world
price. If it’s a small country then import quota will have zero impact changing the world price
but it will raise the domestic price. Another end result would be that it will also bring the
domestic market closer to its equilibrium before trade.
The area D+F shows the fall in total surplus and represents the deadweight loss of the quota.
From this table:

Importing country (Pakistan):

Import quota effects on the importing country’s consumers.

We can see that the consumer surplus has decreased to A+B from A+B+C+D+E+F, this can be
because due to non-availability of cheaper substitutes, regarding this case: cheaper cars, the
purchasing power of the consumer lessens and they get exploited by higher priced domestic cars.
Due to this we can also observe the decrease in the Quantity demanded of the cars from Qd1 to
Qd2.

Import quota effects on the importing country’s producers.

Contrary, the producer surplus has increased from G to G+C as the price (Pw) has changed to
(Pq) in the diagram, hence increasing the domestic price, and as due to lessoned foreign
competition they get incentive to produce more increasing their total output and supply more
hence moving from Qs1 to Qs2.

Import quota effects on the importing country.

The aggregate welfare effect for the country is found by summing the gains and losses to
consumers, producers, and the recipients of the quota rents. The area ‘E’ is gained by the license
holder that gets the quota rent, when a quota is used instead of a tariff, the government receives
no revenue. Instead, revenue accrues to license holders (through quota rents). From this, we see
the change in the number of imports from Qs1 and Qd1 to Qs1 to Qd2 after quota is being
imposed. However, this will result in the deadweight loss of D+F indicating the loss of total
surplus. This decrease in total surplus hints at the decrease in economic loss.

Overall, we can see the decrease in the economic welfare as the decrease in the consumer surplus
–(C+D+E+F) is far greater than the increase in the producer surplus(+C).

Now onto the exporting country (Japan):

Import quota effects on the exporting country’s consumers.

They experience an increase in the consumer surplus as their domestic price falls increasing their
wellbeing.

Import quota effects on the exporting country’s producers.

They experience a well-being as their products’ prices fall, this results in decreased producer
surplus therefor inducing a low output as their incentive to produce more for-profit maximization
decreases. However, if the demand is highly inelastic and they will be able to sell higher priced
cars that surpasses the quantity of cars in greater deal than they will earn profitably increasing
their welfare.

Import quota effects on the exporting country.

National welfare in the exporting country falls when an importing country implements an
import quota if the aggregate sum of the consumer, producer surplus comes out to be
negative.