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A government-applied tariff results in a price of − , as shown in Figure 10-6,
causing the export supply curve in panel (b) to shift upward by the amount of the tariff
from X to X + , resulting in a new equilibrium (point C) in the export supply and import
demand curves and a new world price at ∗. Foreign buyers now pay this new ∗ price.
For a large country with a downward-sloping demand curve, ∗ is always greater than
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Rise in government revenue: +(c + e)
Net effect on Home welfare: e − (b + d)
Area e represents a terms-of-trade gain, while b + d is a deadweight loss. If e > (b + d),
there is the possibility that Home welfare will have a positive effect, unlike the small-
6 Export Quotas
We have just learned that not only can the country gain from export tariff policies, but the
government receives revenue as well in the process. We will find somewhat similar
results with an export quota, discussed next.
Export quotas limit the amount of a good exported by the Home country. The
Organization of Petroleum Exporting Countries (OPEC) is a great example of a quota
system as its members are limited in the quantities that they may export. But, as this
keeps the price high, the producing firms still benefit, unlike the case with export tariffs,
which harm a producer’s surplus with its taxlike quality.
an increase in Home demand at 2. Total supply by Home firms then is 2+ = 2.
Notice that the free-trade quantity supplied, 1,is greater than 2, illustrating a side
effect of the quota: that Home firms have limited the total quantity supplied.
Comparing the welfare effects on Home consumers and producers, we find that consumer
surplus is the same amount as an export tariff, area , and is due to the lower world prices
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Rise in consumer surplus: +a
Fall in producer surplus: −(a + b + c + d)
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APPLICATION
Chinese Export Policies in Mineral Products
Everyone engages in a wide variety of export strategic policies that often benefits
government revenue and terms-of-trade. China is no exception, and its policies regarding
minerals have garnered international attention as these commodities are in high demand
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was simply attempting to preserve the scarce resource for future needs. But, the WTO
ruled that this was not an appropriate application of such an exception.
This was an important ruling and watched closely worldwide. Many of these minerals are
necessary in the production of high-technology products as well as batteries, lighting, and
An important negative externality is becoming a critical environmental issue. Mining
many of the important minerals needed for the growing demand of high-tech products
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HEADLINES
China Ends Rare-Earth Minerals Export Quotas
Like many nations, China has had many global trade disputes and complaints filed
against it with the WTO. Recent trade complaints have included the alleged violation of
rules regarding rare-earth minerals, car parts, and solar panels. The quota system used in
7 High-Technology Export Subsidies
We now turn to considering subsidies to the high-tech sector. Despite their negative
impact on Home welfare, agricultural subsidies are widely used, in part, because of the
political clout of the domestic farmers. By contrast, governments offer subsidies to high-
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“Strategic” Use of High-Tech Export Subsidies
Although spillover is a strong motive for governments to support high-tech industries
with export subsidies, another is to provide their domestic firm with a strategic
advantage in the international market. This latter argument is particularly compelling
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To keep the analysis simple, we will not consider sales that Boeing and Airbus each make
to their own local markets. This will allow us to ignore Home consumer surplus and
assume that welfare is simply a measure of the profits made by each company. This
permits us to assume that if the subsidy is less than the profits earned due to the subsidy,
Nash Equilibrium The outcome of the game is obtained when each firm makes the best
possible decision given the action of its rival. The strategies corresponding to the best
response for both players is the Nash equilibrium.
Best Strategy for Boeing To determine the equilibrium outcome, we will begin by
determining Boeing’s best response given every possible action that Airbus could take.
Focusing on the left column, where Airbus chooses to produce, Boeing must decide
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reproduction of the payoff matrix.
Best Strategy for Airbus The best response for Airbus is obvious given that the payoffs
are symmetric for the two firms, but we will proceed in steps similar to those for Boeing
Multiple Equilibria The quadrants with the two circles (i.e., the upper-right and bottom-
left quadrants) give each firm’s best response contingent on all possible strategies taken
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by its rival. Therefore, the Nash equilibriums are for Boeing to produce and Airbus not to
produce as well as for Boeing not to produce when Airbus produces. With two Nash
Effect of a Subsidy to Airbus
We know that without a first-mover advantage, Airbus will choose not to produce. To
improve the aircraft producer’s competitive advantage, suppose the European
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Best Strategy for Airbus To uncover the outcome of this new game, we will need to
determine each firm’s best strategy. For Airbus, we see that it will now produce even if
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Best Strategy for Boeing Note that the payoff for Boeing is the same as the original
game because we are assuming that only Airbus receives the subsidy. Therefore,
Nash Equilibrium The new Nash equilibrium is given by the bottom-left quadrant,
where Boeing does not produce while Airbus produces. Notice it is the only Nash
European Welfare In calculating the impact of the subsidy on European welfare, we
find that the gain in producer surplus for Airbus is $125 million because it will produce
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In this case, the subsidy led to an overall increase in European welfare because the gain
in profits for Airbus from producing outweighs the cost.
Subsidy with Cost Advantage for Boeing
In the original game, there were two Nash equilibriums. By assuming that Boeing has a
first-mover advantage over Airbus, we settled on the outcome that Boeing would produce
while Airbus abstains from entering the market. Then with the European subsidy, we get
The payoff matrix reflecting Boeing’s cost advantage is shown below in Figure 10-11,
where the American producer earns a profit of $5 million if both firms produce and a
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Boeing produces while Airbus does not produce.
Once again, we assume that the governments in Europe provide Airbus with a subsidy of
$25 million to help the aircraft producer compete against Boeing. Adding the subsidy to
Airbus’ payoff while maintaining Boeing’s cost advantage gives the following matrix in
Figure 10-12.
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Best Strategy for Airbus With the subsidy, Airbus will now produce to earn the $20
million in profits rather than receiving zero from staying out of the market.
Best Strategy for Boeing
With its cost advantage, Boeing can make a positive profit from producing versus zero if
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it does not participate in the market. Therefore, similar to the case before the subsidy,
Boeing will always choose to produce. By contrast, however, Airbus will also choose to
European Welfare Once Again By summing the effect of the subsidy on Airbus and the
European governments, we can determine the welfare implication of the assistance.
Airbus earns profits of $20 million from producing, which an increase is compared with
Summary The net negative effect follows because although the subsidy succeeded in
allowing Airbus to enter the market, the profits earned by the European producer were
not large enough to cover the cost of the assistance. More specifically, the gains to Airbus
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The lesson to be learned here is that under imperfect competition, governments subsidies
may or may not lead to welfare gains for a country. Much is dependent on whether they
APPLICATION
Subsidies to Commercial Aircraft
Boeing and Airbus have been receiving various types of subsidies from the United States
and Europe, respectively, for many years. In the United States, the government supports
1992 Agreement In recognition of the costly nature of these strategic behaviors, the
United States and European governments reached an agreement in 1992 to limit the use
