States and occurs in addition to the deadweight loss of area +.
4 Import Tariffs for a Large Country
We now understand that for small countries, which take world prices as given, tariffs create deadweight
losses for them and these countries are always harmed by tariffs. Is this also true for a large country
whose actions may influence world prices? We turn to this large country case now and assume the
Foreign Export Supply
Contrary to the situation for the small country, the Foreign export supply will no longer be horizontal
when we examine a large Home country, because the importer can influence the free–trade price by the
amount it imports in the world market. To derive the Foreign export supply curve, we will refer to panel
(a) of Figure 8-8, which shows the Foreign demand and supply curves, denoted by D* and S*,
respectively. Without trade, the Foreign equilibrium price, PA*, occurs at point A* in panel (a) or is
Effect of the Tariff
We assume that Home imposes a tariff in the amount of t dollars on Foreign imports. Due to the tariff,
the export supply curve shifts up by the amount t, as illustrated in panel (b) of Figure 8-9. The
intersection of the new export-supply curve, X* + t, with the import-demand curve, M, at point C gives
the new equilibrium price, P* + t, faced by Home consumers. At the higher price, the quantity demanded
Terms of Trade Recall that a country’s terms of trade is defined as the ratio of its export price to its
import price. With the fall in the import price relative to the initial world price, PW, Home experiences a
gain in its terms of trade.
Home Welfare To examine whether the gain in the terms of trade leads to an increase in welfare at
Home, we will analyze the impact of the tariff on consumers, producers, and the government in detail.
From panel (a) of Figure 8-9, we see that the loss in consumer surplus due to the higher Home price is
given by the areas (a + b + c + d). The benefit to producers arising from the price increase is the gain in
producer surplus denoted by area a. Lastly, the benefit to the government is equal to the amount of the
tariff t multiplied by the amount of Home imports, M2. = D2 − S2. The tariff revenue, t × M2, is
represented by the areas (c + e). Summing up the loss of the consumers with the gains of the producers
and government gives the overall impact of the tariff as follows:
Fall in consumer surplus: −(a + b + c + d)
As in the small-country case, the triangle (b + d) indicates the deadweight loss due to the tariff.
However, contrary to the small country, the large country gains area e because it is able to shift part of
Foreign and World Welfare By contrast to Home, exporters in Foreign suffer a loss given by (e + f) in
panel (b). Although the terms-of-trade gain for Home is offset by the terms-of-trade loss by Foreign (i.e.,
Optimal Tariff for a Large Importing Country We have found that a large importer might gain by
imposing an import tariff but have not yet determined what level of tariff a country should apply in order
Optimal Tariff To clearly calculate the effect of the tariff on U.S. welfare, we will need to incorporate
the concept of the optimal tariff, the duty that maximizes the increase in welfare for the importing
country. To begin with, our theory tells us that a large importing country can increase its welfare by
Optimal Tariff Formula The formula for the optimal tariff is
Optimal tariff =
where E*X is the elasticity of export supply, which measures the percentage change in the quantity
exported due to a percentage change in the world price of export. Thus, according to the formula, a
APPLICATION
U.S. Tariffs on Steel Once Again
We will reexamine the effect of the steel tariff on U.S. welfare, assuming that it is a large country.
Namely, the United States has an impact on the Foreign export price because it is a large importer of
Optimal Tariffs for Steel With the established formula, we can now determine the impact of the tariffs
on the steel industry using the export supply elasticities presented in Table 8-2.
For the steel products classified under iron and non-alloy steel flat–rolled products and iron and steel
5 Import Quotas
After more than three decades from its inception in 1974, the system of import quotas known as the
Multifibre Arrangement (MFA) came to an end on January 1, 2005. In an effort to protect their
domestic industries, the arrangement allowed Canada, the United States, and Europe to restrict the
amount of textiles and apparel products that they imported from garment-producing countries. However,
H E A D L I N E S
Sugar Could Sweeten U.S.‒Australia Trans-Pacific Trade Talks
In an effort to protect American farmers from import competition, the United States has imposed import
quotas on foreign sugar. As a result of the restriction, the domestic sugar price was roughly double the
world price until about 5 years ago. However, the sugar program may need to change under the current
negotiations for the Trans–Pacific Partnership (TPP). Australia has asked the United States to reconsider
this quota and allow more exports from Australia.
Import Quota in a Small Country
In this section, we will examine the differences between tariffs and import quotas on Home, Foreign,
and world welfare. Although the effect of an import quota on a small country is similar to that of a tariff,
Free–Trade Equilibrium We begin the analysis of an import quota in a small country with the Home
demand and supply curves shown in panel (a) of Figure 8-11. The quantity demanded at Home given the
free-trade world price of PW is D1 and the quantity supplied is S1. Thus, the amount imported is M1 = D1
− S1. The equilibrium of the import demand curve, M, and the horizontal export supply curve, X*, is
given by point B in panel (b).
Effect of the Quota If Home imposes an import quota of M2 < M1, then the exports may not exceed this
amount. We can represent the limitation with a vertical export supply curve, , as shown in panel (b).
Given the Home import demand curve and the new restricted export supply curve, the equilibrium price
Effect on Welfare The welfare effect of an import quota on producers and consumers is similar to that
of a tariff. More specifically, in Figure 8-11 the loss in consumer surplus due to the quota is area (a + b
+ c + d), whereas the gain in producer surplus is the area a. However, the similarity ends with the
1. Giving the Quota to Home Firms The first possibility is for the quota licenses to be given directly to
the Home firms. Namely, the Home firms are given the right to import the amount M2 at the world price
of PW and to sell it in the domestic market at the price of P2. Therefore, the rents earned by the Home
firms are M2 • (P2 − PW). Summing up the losses and gains due to the quota gives
2. Rent Seeking The second possibility also involves the quota licenses to be given to the Home firms
but not directly. As a result, firms engage in rent-seeking behaviors. Namely, they employ inefficient
activities to obtain the rights to import the product at the world price of PW. For example, a firm may
overproduce if the license distribution is based on production in the previous year. If the resources
3. Auctioning the Quota The third possibility is for the Home government to auction off the quota
licenses. Assuming that the value the government accrued from the auction is equal to area c, then the
net effect of the quota is the same as that of a tariff, as given by the following:
Fall in consumer surplus: a + b + c + d
4. “Voluntary” Export Restraint The fourth possibility is the case in which the Foreign country
initiates the quota. Namely, Foreign voluntarily puts limits on the amount it exports to Home. These
self–imposed restrictions are referred to as “voluntary” export restraint (VER) or “voluntary”
restraint agreement (VRA). Because the quota rents are collected by foreign producers, the loss in
Home welfare is greater than a tariff as the summation of the losses and gains below shows:
Costs of Import Quotas in the United States
Estimates of U.S. deadweight loss and quota rents due to import quotas on five industries are presented
in Table 8-3 for 1985. The sum of the deadweight loss for these industries ranged from $8 to $12 billion
annually, with textiles and apparel contributing about $5 to $6 billion of the total. The net welfare loss is
APPLICATION
China and the Multifiber Arrangement
The longstanding MFA came to an end on January 1, 2005. The system of import quotas protected the
apparel industry in industrialized countries by specifying the amount of each product the developing
countries could export. The end of the MFA meant that exporters no longer needed to hold back their