Transcript Import Tariffs and Quotas Under Perfect Competition

8
IMPORT TARIFFS AND
QUOTAS UNDER
PERFECT COMPETITION
1
A Brief History of the
World Trade
Organization
2
The Gains from Trade
3
Import Tariffs for a
Small Country
4
Import Tariffs for a
Large Country
5
Import Quotas
6
Conclusions
Introduction
• During the 2000 presidential campaign, President
George W. Bush promised to consider
implementing a tariff on the imports of steel.
• This was a political move to secure votes in large
steel-producing states as the tariffs would
“protect” the domestic producers of steel.
• The steel tariff is an example of a trade policy—a
government action meant to influence the amount
of international trade.
© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor
2 of 136
Introduction
• Because gains from trade are unevenly spread,
producers often feel the government should help
them limit losses due to competition from trade.
• Trade policy can include the use of import tariffs
(taxes on imports), import quotas (limits on
imports), and subsidies for exports.
• We will assume that firms are perfectly
competitive. They produce a homogeneous good
and are small compared to the market.
 Firms are price takers
© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor
3 of 136
The Gains from Trade
• We will now demonstrate the gains from trade using
Home demand and supply curves, together with the
concepts of consumer surplus and producer
surplus.
• Consumer and Producer Surplus
 Figure 8.1 (a) shows the Home demand curve D where
consumers face a price of P1.
 Remember, CS is the difference between the price the
consumer is willing to pay and the actual price.
 Part (b) of figure 8.1 illustrates producer surplus.
 Remember that PS is the difference between MC and
price, where the supply curve represents a firm’s MC.
© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor
4 of 136
The Gains from Trade
Figure 8.1 (a)
Price
Total Consumer
surplus, CS
Adding
up all curve
the individual
The demand
gives us the
surplus
for each
on the
consumer’s
valuepoint
for each
unit of
A consumer
who
demand
gives
us total D2
the
good.curve
Given
Ppurchases
1, consumers
has buy
a value
of P
only
has
consumer
surplus—the
area
will
a total
of2,Dbut
1.
to pay P1the
– that
gives and
surplus
between
demand
the
equalpaid—up
to (P2-P1)to the quantity
price
sold
P2
P1
Surplus for
consumer
purchasing quantity
D2
D
D2
D1
Quantity
© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor
5 of 136
The Gains from Trade
Figure 8.1 (b)
Price
Total Producer
surplus, PS
S
The supply
curve
gives
us athe
A
producer
who
sells
S0 has
Adding
up all
the
individual
consumer’s
valuePpoint
for each
unit of
MC
of P0, but
gets
surpluses
for each
on the
1. That
the surplus
good.
producers
gives
equalPus
to
(P
1, total
supply
curveGiven
gives
1-P0)
will sell surplus—the
a total of S1. area
producer
between the supply and the price
received—up to the quantity sold.
P1
P0
Surplus for firm producing
quantity S0
S0
S1
Quantity
© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor
6 of 136
The Gains from Trade
APPLICATION
• No trade equilibrium
Price
Figure 8.2
No-trade equilibrium
• Total Home welfare can be
measured by adding up
consumer and producer
surplus.
S
CS
A
PA
PS
D
Q0
• Again we consider the
world of two countries,
Home and Foreign, with
producers and consumers.
• We will compare the
welfare in Home in notrade and free-trade
situations.
Quantity
© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor
7 of 136
The Gains from Trade
• Free Trade for a Small Country
 Suppose Home can now engage in trade.
 The world price PW is determined by the supply and
demand in the world market (shown in in figure 8.2 (b)).
 Suppose Home is a small country.
 Price taker in the world market
 Faces a fixed price at PW
 Assume PW is below the Home no-trade price PA.
 At the lower price, Home will be an importer of the
product at the world price.
© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor
8 of 136
The Gains from Trade
Figure 8.2
At lower world price,
consumer surplus increases
to a+b+d  an increase of
b+d from no-trade
(b) Free Trade
Price
S
At lower world price,
producer surplus falls to c
 a decrease of b from
no-trade
a
PA
b
Gain in trade is triangle d
with area equal to
½(M1)(PA-PW)
d
PW
c
D
S1
D1
Quantity
Imports, M1
© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor
9 of 136
The Gains from Trade
• Home Import Demand Curve
 We can derive the import demand curve, shown in
figure 8.3
 The relationship between the world price of a good and the
quantity of imports demanded by Home consumers.
 At the no-trade equilibrium, there are zero imports
 This is shown as point A′ in panel (b).
 At the world price of PW, the quantity demanded is
greater than quantity supplied, and we import M1.
 This is point B in panel (b).
 Joining A′ and B gives import demand curve M.
© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor
10 of 136
The Gains from Trade
Figure 8.3
(b)
(a)
Price
No-trade
equilibrium
Price
S
A'
PA
Each point on the import
demand curve is a point
that corresponds to Home
imports at a given Home
price
A
B
PW
Import demand
curve, M
D
S1
Q0
D1
Quantity
M1
Imports
Imports, M1
© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor
11 of 136
Import Tariffs for a Small Country
• Free Trade for a Small Country
 Since Home is a small country, the tariff does not affect
world prices.
 The Foreign export supply curve X* is horizontal at the
world price PW.
• Effect of the Tariff
 The new export supply curve shifts up to X*+t.
 Quantity demanded falls while quantity supplied rises
 However, as firms increase the quantity produced, the
marginal costs of production rise.
 The domestic price will equal the import price.
© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor
12 of 136
Import Tariffs for a Small Country
Figure 8.4
Home price rises by the amount
of the tariff.
No-trade
equilibrium
Price
Price
S
Home supply increases and
Home demand decreases 
Imports fall to M2
A
C
PW+t
X*+t
B
Foreign export
supply, X*
PW
D
S1 S2
D2
M2
D1
Quantity
M
M2
M1
© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor
Imports
13 of 136
Import Tariffs for a Small Country
• Effect of the Tariff on Consumer Surplus
 With the tariff, consumers now pay the higher price,
PW+t, and their surplus is the area under the demand
curve and above the higher price, PW+t.
 The fall in consumer surplus due to the tariff is the area
in-between the two prices and to the left of Home
demand, (a+b+c+d) in panel (a.1) of figure 8.5.
 This area is the amount that consumers lose due to the
higher price caused by the tariff.
© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor
14 of 136
Import Tariffs for a Small Country
Figure 8.5 (a.1)
No-trade
equilibrium
Lost consumer surplus due
to the higher price with the
tariff is equal to the shaded
area (a+b+c+d)
Price
S
A
b
d
PW+t
a
c
PW
D
S1
S2
D2
D1
Quantity
M2
© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor
15 of 136
Import Tariffs for a Small Country
• Effect of the Tariff on Producer Surplus
 With the tariff, producer surplus is the area above the
supply and below the higher price, PW+t.
 Since the tariff increases Home price, firms can sell
more goods, and producer surplus increases
 This area, a in figure 8.5 (a.2), is the amount that Home
firms gain due to the higher price caused by the tariff.
 Increases in producer surplus can benefit Home
workers but at the expense of consumers.
© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor
16 of 136
Import Tariffs for a Small Country
Figure 8.5 (a.2)
No-trade
equilibrium
The gain in producer
surplus due to the higher
price with the tariff is equal
to the shaded area (a)
Price
S
A
b
d
PW+t
a
c
PW
D
S1
S2
D2
D1
Quantity
M2
© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor
17 of 136
Import Tariffs for a Small Country
• Effect of the Tariff on Government Revenue
 In addition to the tariff’s impact on consumers and
producers, it also affects government revenue.
 The amount of revenue collected is the tariff t times the
quantity of imports (D2 – S2).
 In figure 8.5 panel (a.3), the revenue is shown by area
c.
 The collection of revenue is a gain for the government
in the importing country.
© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor
18 of 136
Import Tariffs for a Small Country
Figure 8.5 (a.3)
The gain in government
revenue due to the tariff is
equal to the shaded area
(c)
No-trade
equilibrium
Price
S
This equals the tariff, t,
times the quantity of
imports, M2
A
b
d
PW+t
a
c
PW
D
S1
S2
D2
D1
Quantity
M2
© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor
19 of 136
Import Tariffs for a Small Country
• Overall Effect of the Tariff on Welfare
• Note, we do not care whether the consumers facing higher
prices are rich or poor, and do not care whether the
specific factors in the industry earn a lot or a little.
• The overall impact of the tariff in the small country can be
summarized as follows:
Fall in consumer surplus
Rise in producer surplus
Rise in government revenue
Net effect on Home welfare
-(a+b+c+d)
+a
+c
-(b+d)
• The areas b and d in figure 8.5 (a) correspond to the
triangle (b+d) in figure 8.5 (b) and is the net welfare loss.
 We refer to this area as a deadweight loss—it is not offset by a
gain elsewhere in the economy.
© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor
20 of 136
Import Tariffs for a Small Country
Figure 8.5 (a)
The deadweight loss is the
loss to Home that is not
offset by a corresponding
gain
No-trade
equilibrium
Price
S
a is a transfer from consumers
to producers
A
b
c is a transfer from consumers
to government
d
PW+t
a
(b+d) is deadweight loss—
losses not offset by other gains
c
PW
b = production distortion
D
S1
S2
D2
D1
d = consumption distortion
Quantity
M2
© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor
21 of 136
Import Tariffs for a Small Country
Figure 8.5 (b)
Price
Dead weight loss
due to tariff, b+d
X*+ t
C
X*
M
M2
M1
Imports
© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor
22 of 136
Why are Tariffs Used?
• Why do so many countries use tariffs if they
always lead to deadweight losses?
 One idea is that developing countries do not have any
other source of revenue.
 Import tariffs are “easy-to-collect” relative to income taxes.
 However, to the extent that developing countries recognize that
tariffs have a higher deadweight loss, we would expect that
over time they will shift away from such “easy-to-collect” taxes.
 A second reason is politics.
 The might government care more about producer surplus than
consumer surplus.
 The benefits to producers (and their workers) are typically more
concentrated on specific firms and states than the costs to
consumers, which are spread nationwide.
© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor
23 of 136
U.S. Tariffs on Steel
APPLICATION
• We will estimate the deadweight loss due to the
U.S. steel tariff in place from March 2002 to
December 2003.
• President Bush requested that the U.S.
International Trade Commission (ITC) initiate a
Section 201 investigation into the steel industry.
• The tariffs varied across products, ranging from
10 to 20%—shown in Table 8.1—then falling over
time to be eliminated after 3 years.
2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor
24 of 136
U.S. Tariffs on Steel
APPLICATION
• President Bush took the recommendation of the
ITC but applied even higher tariffs, ranging from
8% to 30%.
• Knowing the U.S. trading partners would be upset
by this, President Bush exempted some countries
from the tariffs.
 These included Canada, Mexico, Jordan, and Israel,
which all have free trade agreements with the U.S., and
100 small developing countries that were exporting only
a very small amount of steel to the U.S.
2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor
25 of 136
U.S. Tariffs on Steel
APPLICATION
Table 8.1
2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor
26 of 136
U.S. Tariffs on Steel
APPLICATION
• Deadweight Loss due to the Steel Tariff
 We need to estimate the areas of triangle b+d we found in figure
8.5(b).
 The base is the change in imports, ΔM, and the height is the
increase in domestic price, ΔP = t.
 Deadweight loss then equals DWL = ½ t ΔM.
 It is convenient to measure the deadweight loss relative to the
value of imports, which is PW*M.
 We will also use the percentage tariff, t/PW, and the percentage
change in the quantity of imports, % ΔM = ΔM/M.
2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor
27 of 136
U.S. Tariffs on Steel
APPLICATION
Figure 8.5 (b)
Price
We can measure DWL
with the area of the
triangle b+d from figure
8.5 (b)
Deadweight loss due
to the tariff, b+d
DWL = ½ t ΔM
PW+t
c
t
PW
M
M2
M1
Imports
ΔM
2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor
28 of 136
U.S. Tariffs on Steel
APPLICATION
• Using these definitions, the deadweight loss
relative to the value of imports can be rewritten
as:
DWL  1  tM
1 t 
  W
  W %M
W
P M 2 P M 2 P 
• The most commonly used products had a
tariff of 30%, so the percentage increase in
the price is t/PW = 0.3, leading to %ΔM = 0.3.
2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor
29 of 136
U.S. Tariffs on Steel
APPLICATION
• This leads to a DWL of
DWL 1  t
  W
W
P M 2 P
1

%M  (0.3)(0.3)  4.5%
2

• The value of steel imports affected by the tariff
was about $4.7 billion prior to March 2002 and
$3.5 billion after March 2002.
 Average imports over the two years were $4.1 billion.
• The dollar magnitude of deadweight loss is equal to $185
million.
2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor
30 of 136
Import Tariffs for a Large Country
• Under the small country assumption that we have
used so far, the importing country is always
harmed due to the tariff.
 The small country is a world price taker.
• If we consider a large enough importing country or
a large country, however, then we might expect
that its tariff will change the world price.
 Its imports are large enough that it can affect world
price with a change in its imports.
© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor
31 of 136
Import Tariffs for a Large Country
• Foreign Export Supply
 If the Home country is large, then the Foreign export
supply curve X* is no longer horizontal at the world
price PW.
 We construct the Foreign export supply curve in a
fashion similar to the import demand curve.
 In panel (a) of figure 8.6, we show the Foreign demand
curve D* and supply curve S*, giving price of PA* at A*.
 At this point, Foreign exports are zero. Suppose the world price
is PW above PA*.
 At the higher price, there is a Foreign excess supply of
X1* = S1* - D1*, which will be exported at the price of
PW at point B*.
© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor
32 of 136
Import Tariffs for a Large Country
Figure 8.6
(b) World Mkt
(a) Foreign Mkt
Pric
e
World price increases to PW,
increasing exports to X1*
This gives us our Foreign
export supply curve for the
large country
Price
At the world price, PA*,
exports are zero at A*’
Foreign export
supply, X*
S*
D*
B*
PW
Home import
demand, M
PA*
A*'
A*
D1*
S1*
Quantity
X1*
Exports
Foreign exports, X1*
© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor
33 of 136
Import Tariffs for a Large Country
• Effect of the Tariff
 Figure 8.7 we show the effect when Home applies a
tariff of t dollars on imports.
 Foreign export supply curve shifts up by exactly the
amount of the tariff, shifting from X* to X*+t.
 The Home price rises by less than t, and the Foreign
producers receive, P*, which is less than PW.
 The tariff drives a wedge between what Home
consumers pay and what foreign producers receive,
with the difference, t, going to the Home government.
© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor
34 of 136
Import Tariffs for a Large Country
Figure 8.7
(without welfare effects)
(a) Home market
(b) Foreign market
Price
Price
No-trade
equilibrium
X*+t
S
A
X*
t
C
P*+t
t
t
PW
P*
B*
C*
D
M
S1 S2
D2 D1
Quantity
M2
M1
Imports
M2
M1
© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor
35 of 136
Import Tariffs for a Large Country
• Home Welfare
Fall in consumer surplus
Rise in producer surplus
Rise in government revenue
Net effect on Home welfaree
-(a+b+c+d)
+a
+(c + e)
– (b+d) + (e)
• The triangle (b+d) is the deadweight loss due to
the tariff.
• Area e offsets part of the loss.
• If e > (b+d), then Home is better off.
• If e < (b+d), then Home is worse off.
© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor
36 of 136
Import Tariffs for a Large Country
Figure 8.7
(with welfare effects)
If the gain of e is greater than the loss of (b+d), Home gains
(a) Home market
(b) Foreign market
No-trade
equilibrium
Price
Price
X*+t
S
b+d
A
t
X*
C
P*+t
a
c
b
PW
P*
d
e
B*
e
D
C*
M
S1 S2
D2 D1
Quantity
M2
M1
© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor
Imports
37 of 136
Import Tariffs for a Large Country
• Home welfare may improve, but it comes at the expense of
foreign exporters.
• Foreign and World Welfare
 The Foreign loss, measured by (e+f) also in figure 8.7, is the loss in
Foreign producer surplus from selling fewer goods to Home at a
lower price.
 The area e is the terms-of-trade gain for Home (P*<PW) but an
equivalent terms-of-trade loss for Foreign.
 Additionally, there is an extra deadweight loss in Foreign of f, giving
a combined total greater than the benefits to Home.
 Therefore, it is sometimes called the “beggar thy neighbor” tariff.
• There is a world welfare loss = b + d + f
© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor
38 of 136
Import Tariffs for a Large Country
Figure 8.7
(with welfare effects)
Foreign loses (e+f) as loss of Foreign producer surplus,
from selling fewer goods at a lower price
(a) Home market
(b) Foreign market
No-trade
equilibrium
Price
Price
X*+t
S
b+d
A
t
X*
C
P*+t
a
c
b
PW
P*
d
e
B*
e
D
C*
f
M
S1 S2
D2 D1
Quantity
M2
M1
© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor
Imports
39 of 136
U.S. Tariffs on Steel Once Again
APPLICATION
• Optimal Tariff
 Compute the deadweight loss (area b+d) and the terms-oftrade gain (area e) for each imported steel product.
 Rather than do all these calculations, however, we can use
the concept of the optimal tariff.
 The tariff that leads to the maximum increase in welfare for the
importing country.
 We have shown that for a small tariff, a large country can
gain. But if the tariff is too large, the country will still lose.
 Figure 8.8 graphs Home welfare against the level of the tariff.
2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor
40 of 136
U.S. Tariffs on Steel Once Again
APPLICATION
The Optimal tariff maximizes
the Importer’s welfare, Point C
Figure 8.8
Terms of trade gain
exceeds deadweight
loss
Importer’s
Welfare
Too high of a tariff will decrease
importer’s welfare and can
increase to the point where
there is no trade
C
Terms of trade gain is
less than deadweight
loss
B'
Free Trade
B
A
No Trade
Optimal
Tariff
Prohibitive
Tariff
Tariff
2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor
41 of 136
U.S. Tariffs on Steel Once Again
APPLICATION
• Optimal Tariff Formula
 The optimal tariff depends on the elasticity of Foreign
export supply, EX*.
• Optimal Tariff Formula
Optimal Tariff = 1/EX*.
 For a small importing country, the elasticity of Foreign
export supply is infinite, and so the optimal tariff is zero.
 As the elasticity of Foreign export supply decreases,
Foreign export supply curve is steeper, the optimal tariff
is higher.
2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor
42 of 136
U.S. Tariffs on Steel Once Again
APPLICATION
• Optimal Tariffs for Steel
 If we apply this formula to the U.S. steel tariffs, we can
see how the tariffs applied compare to the theoretical
optimal tariff.
 Table 8.2 shows various steel products along with their
respective elasticities of export supply to the U.S.
 We can compare the actual tariff to the optimal tariff to
see where there were gains and where there were
losses from the tariffs.
 But what about retaliation?...
2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor
43 of 136
U.S. Tariffs on Steel Once Again
APPLICATION
Table 8.2
2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor
44 of 136
Import Quotas
• On January 1, 2005, China was poised to become
the world’s largest exporter of textiles and
apparel.
 On that date, the Multifibre Arrangement (MFA) was
abolished.
 Under the MFA, import quotas restricted the amount of
nearly every textile and apparel product that was
imported to Canada, Europe, and the U.S.
 The quotas were to protect their own domestic firms
producing those products.
 The threat of import competition from China led the
U.S. and Europe to negotiate new quotas with China.
© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor
45 of 136
Import Quotas
• Import Quota in a Small Country
 Suppose the import quota of M2<M1 is imposed.
 This essentially gives us a vertical supply curve, X in
panel b (at prices above PW).
 Fixes the import quantity at M2, price rises to P2.
 Qty supplied rises to S2 and qty demanded falls to D2.
 For every level of import quota, there is an equivalent
import tariff
 Has the same price and quantity effects as the quota.
 The equivalent tariff is: t = P2 – PW
© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor
46 of 136
Import Quotas
Figure 8.9
Consumers
loseshigher
surplus
of (a+b+c+d),
theQuota,
new
price
Pexport
The
new
Export
Supply
curve
2,
WithAt
the
the Foreign
Always
have
a
deadweight
producers
gain
(a). increases
Home
Supply
to quota
crosses
the
Import
Demand
curve
at
supply
becomes
vertical
loss of (b+d) like the
tariffat the
S2,price
Demand
decreases
towhat
aquantity
new
and depends
quantity
of
Welfare
of
Home
onimports
D2 and
imports
fall to
M2 rents.
happens
to (c),
the total
quota
(with quota)
No-trade
equilibrium
S
Price
Price
A
d
b
C
P2
a
c
c
b+d
B
PW
Home import
demand, M
D
S1 S2
D2 D1
(a) Home market
Foreign export
supply, X*
Quantity
M2
M1
Imports
(b) Import market
© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor
47 of 136
Import Quotas
•
There are four possible ways these rents can be
allocated.
1. Giving the Quota to Home Firms:

Quota licenses can be given to Home firms

Permits to import the quantity allowed under the quota system.

The net effects on Home welfare due to the quota are then as
follows:
Fall in consumer surplus
-(a+b+c+d)
Rise in producer surplus
+a
Quota rents earned at Home
+c
Net effect on Home welfare: -(b+d)


This is the same loss we saw with a tariff.
(b+d) is still a deadweight loss associated with the quota.
© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor
48 of 136
Import Quotas
2. Rent Seeking
 Because of the gains associated with owning a quota
license, firms have an incentive to engage in
inefficient activities in order to obtain them.
 How licenses are allocated matters.
a. If licenses are allocated in proportion to each firm’s
production, Home firms will likely produce more than they
can sell just to obtain the import licenses for the following
year.
b. Firms might engage in bribery or other lobbying activities to
obtain the licenses.
© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor
49 of 136
Import Quotas
 Some suggest that the waste of resources devoted to
rent seeking could be as large as the value of the rents
themselves, c.
 If rent seeking occurs, welfare loss of quota is:
Fall in consumer surplus
Rise in producer surplus
Net effect on Home welfare:
-(a+b+c+d)
+a
-(b+c+d)
 This loss is larger than a tariff.
 It is thought rent seeking is worse in developing
countries.
© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor
50 of 136
Import Quotas
3. Auctioning the Quota

The government of the importing country to auction
off the quota licenses.

In a well-organized, competitive auction, the revenue
collected should exactly equal the value of the rents.
Fall in consumer surplus
Rise in producer surplus
Auction revenue earned at Home
Net effect on Home welfare:

-(a+b+c+d)
+a
+c
-(b+d)
This is the same loss as the tariff.
© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor
51 of 136
Auctioning Import Quotas in
Australia and New Zealand
APPLICATION
• During the 1980s, Australia and New Zealand
both auctioned the quota licenses to import
specific goods.
• Table 8.3 shows the value of imports covered by
quotas curing 1981–1987.
• In 1988, New Zealand announced plans to phase
out import quotas as part of a liberalization of
trade, and all quota licenses were eliminated by
1992.
2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor
52 of 136
Auctioning Import Quotas in
Australia and New Zealand
APPLICATION
• Table 8.3 also shows the value of bids for the
quota licenses.
 These are estimates of rents.
• If we take the ratio of the value of bids to the
value of imports covered by the quota, we obtain
an estimate of the tariff equivalent to the quota.
 These are shown in the final column of table 8.3
• Since there was no penalty from not following
through, some firms decided not to purchase the
licenses after all.
2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor
53 of 136
Auctioning Import Quotas in
Australia and New Zealand
APPLICATION
Table 8.3
2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor
54 of 136
Auctioning Import Quotas in
Australia and New Zealand
APPLICATION
• The government therefore did not collect all the
winning bids as revenue.
• For those that did buy their licenses, they could
be resold and some were at much higher prices.
• This makes it appear that the government was not
collecting all of the rents in area c.
2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor
55 of 136
Import Quotas
4. “Voluntary” Export Restraint
 The importing country can give authority for
implementing the quota to the exporting government.
 This is often called a “voluntary” export restraint (VER)
or a “voluntary” restraint agreement (VRA).
 In the 1980s the U.S. used this type of arrangement to
restrict imports of Japanese automobiles.

The Japanese government told each Japanese firm how much
it could export to the U.S.
© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor
56 of 136
Import Quotas
• With VERs, quota rents are earned by foreign
producers, making Home welfare:
Fall in consumer surplus
Rise in producer surplus
Net effect on Home welfare:
-(a+b+c+d)
+a
-(b+c+d)
• This is a higher net loss than with a tariff.
• Why would an importing country do this?
 It is typically political—the exporting country is less
likely to retaliate since they gain the area c.
 This can often avoid a tariff or quota war.
© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor
57 of 136
Import Quotas
• Costs of Import Quotas in the U.S.
 Table 8.4 presents some estimates of Home
deadweight losses and quota rents for some major U.S.
quotas in the 1980’s.
 In all cases except Dairy, the rents were earned by
Foreign exporters.
 Adding up the costs in the table, the total U.S.
deadweight loss due to these quotas ranged from $8–
$12 billion annually.
 Quota rents transferred another $7–$17 billion to
foreigners.
 Some, but not all, of these costs are relevant today
since many of the quotas are no longer in place.
© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor
58 of 136
Import Quotas
Table 8.4
© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor
59 of 136
China and the Multifibre Arrangement
APPLICATION
• One of the principles of GATT was that countries should
not use quotas to restrict imports.
• The MFA was a major exception to that which allowed the
industrialized countries to restrict imports of textile and
apparel products from the developing countries.
• Organized under GATT, importing countries could join the
MFA and arrange quotas bilaterally or unilaterally.
• Under the Uruguay round of WTO, developing countries
were able to negotiate an end to this system of import
quotas.
• Some developing countries and large producers in
importing countries were concerned with the potential of
Chinese exports on their economies.
2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor
60 of 136
China and the Multifibre Arrangement
APPLICATION
• Growth in Exports from China
 Immediately after January 1, 2005, exports of textiles
and apparel from China grew rapidly.
 In 2005, China’s textile and apparel imports to the U.S.
rose by more than 40% compared to 2004.
 Figure 8.10 (a) shows the change in the value of
exports of textiles and apparel from different countries.
Note China.
 The increases from China came at the expense of
some higher-cost exporters, some of whose exports to
the U.S. declined by 10 to 20%.
2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor
61 of 136
China and the Multifibre Arrangement
APPLICATION
Figure 8.10
2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor
62 of 136
China and the Multifibre Arrangement
APPLICATION
• Panel (b) of figure 8.10 shows the percentage
change in the prices of textiles and apparel
products from each country, depending on
whether the products were subject to the MFA
quota before January 1, 2005, or not.
• China had the largest drop in the prices from 2004
to 2005.
• Many other countries had a substantial fall in their
prices due to the end of the MFA quota.
2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor
63 of 136
China and the Multifibre Arrangement
APPLICATION
Figure 8.10
2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor
64 of 136
China and the Multifibre Arrangement
APPLICATION
• Welfare Cost of the MFA
 Given the drop in prices in 2005, it is possible to
estimate the welfare loss due to the MFA.
 Using the price drops from figure 8.10, the welfare loss
for the U.S. (b+c+d), is estimated at $6.5 to $16.2
billion in 2005 from the MFA.
 Averaging out all losses and dividing among
households gives an estimate of $100 per household,
or 7% of total annual spending on apparel.
2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor
65 of 136
China and the Multifibre Arrangement
APPLICATION
• Import Quality
 Quotas are set on the quantity, not the quality of items imported.
 Selling a higher value good for the same quantity will still meet the
quota limit but will bring more money back home.
 Incentive to export higher quality products.
 Prices dropped the most for the lower- priced items.
 An inexpensive T-shirt had a greater drop in price than a more
expensively priced item.
 U.S. demand shifted towards the lower-priced items imported from
China: there was “quality downgrading” in the exports from China.
 When a quota like the MFA is applied, there is an effect on quality.
2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor
66 of 136