ubol/econ 541 Quota Analysis artial Equilibrium by Alan V. Deardorff University of Michigan 2016
Outline erfect Competition Small country Large country Monopoly 2
Small country Assumptions throughout Markets perfectly competitive roduct homogeneous There are no distortions (externalities, etc.) Supply and demand curves linear Just for simplicity Special assumption for small country case World price is given (country too small to influence it) 3
erfect Competition Small country Quota sets a maximum quantity of imports, not price rice must adjust to whatever level reduces excess demand to the permitted quantity If excess demand (i.e., desired imports) is already less than the quota, then quota has no effect. It is not binding. 4
Small country quota aut 1 = W t eq 0 = W Rent M Q =M 1 S D Effects of a binding quota, starting from free trade rice rises (by t eq = tariff equivalent of quota ) Quantity supplied rises Quantity demanded falls Quantity of imports falls (to M Q ) Tariff revenue? No Instead there is is quota rent S 0 S D 1 D 1 0 M 0 Q t eq M Q Import Quota M Q 5
erfect Competition Small country Who gets the quota rent? Depends on how the rights to import under the quota are allocated First-come, first-served Whoever wins the race to the border Import licenses sold by home government Government revenue, just like tariff Import licenses granted to domestic people or firms They get the rents, which stay in the country Import licenses granted to foreign people, firms, or government Foreigners get the rents Most common 6
Small country quota, Rents domestic aut 1 = W +t t eq 0 = W a b c S d Welfare effects of a quota, starting from free trade with quota rights domestic Suppliers gain +a Demanders Lose (a+b+c+d) Rents +c Country loses (b+d) M Q =M 1 S 0 S D 1 D 1 0 M 0 D Q (Same as tariff) Import Quota M Q 7
Small country quota, Rents foreign aut 1 = W +t t eq 0 = W a b c M Q =M 1 S d D Welfare effects of a quota, starting from free trade with quota rights foreign Home: Suppliers gain +a Demanders Lose (a+b+c+d) Country loses (b+c+d) Foreign: Rents +c S 0 S D 1 D 1 0 M 0 Q Import Quota M Q (Worse than tariff for Home) 8
Outline erfect Competition Small country Large country Monopoly 9
Large country quota, Rents foreign 1 a t b eq c d * 1 M Q World Market Home is Importer Foreign (*) is Exporter M 1 =X* 1 M 0 =X* 0 XS* MD M,X* Welfare effects of a largecountry quota with rents allocated to foreign Home: rivate sector (S&D) loses (a+b) Country must lose Foreign (a+b) rivate sector (S&D) loses (c+d) Quota rents +(a+c) Country may gain or lose: World loses +a d (b+d) Now area a is a transfer from home to foreign, reflecting an improved terms of trade for foreign.
Outline erfect Competition Small country Large country Monopoly 11
Monopoly, Small Country Assumptions roduct homogeneous World price is given (country too small to influence it) Home market has only a single producer Firm has increasing marginal cost Without trade, firm is a monopoly With free trade it has no market power, as it takes world price as given 12
Monopoly in a closed economy M MC Recall Monopolist cares about marginal revenue Selects quantity Q M where MR=MC Then charges the price M at which this quantity is demanded MR D Q M Q 13
Monopoly in Free Trade The firm can t charge above W M MC It produces Q F where MC = W Since D F >Q F, the country imports W Q F Q M MR M F D F D Q (Had W been enough higher, the firm and country would export.) 14
Monopoly with Tariff M MC Now the firm can charge up to W +t, and it will, as long as W +t < M It produces Q T where MC = W +t W +t W Q F Q M Q T MR M T D T D F D Q If D T >Q T, the country imports M T (If t were higher, imports would be zero and we re back to monopoly.) 15
Monopoly with Quota A quota M Q means that for prices above W, demand faced by the monopolist is reduced (shifted left) by M Q. D To D And marginal revenue becomes MR W MR M Q D Q 16
Monopoly with Quota: M Q = M T M Q T = W +t W MR Q F Q M Q T Q Q M T D T MC D F D Q Now the firm can charge a higher price, and it will It produces Q Q where MC = MR and charges price Q. Result: Imports are the same as under the tariff, but price is higher and quantity lower. The quota has given back to the firm some monopoly power. 17