Chapter 66: HL extension – calculations of effects of tariffs,
quotas and subsidies (3.1)
HL extensions
 Calculating changes in prices, consumer and supplier surplus, domestic
and foreign producer revenue, government costs/revenue, efficiency
loss, net surplus loss, deadweight loss (Rory, we need to get this
heading down to about three words. Your call!)
o Tariff
o Quota
o Subsidy
•
Calculate from diagrams the effects of imposing a tariff on imported goods on the
stakeholders, including domestic producers, foreign producers, consumers and the
government
•
Calculate from diagrams the effects of setting a quota on foreign producers, on the
stakeholders, including domestic producers, foreign producers, consumers and the
government
•
Calculate from diagrams the effects of giving a subsidy to domestic producers on
the stakeholders, including domestic producers, foreign producers, consumers and
the government
No Blue Sheet here! Just be prepared to calculate the ‘areas’.

Calculating changes in prices, consumer and supplier surplus, domestic and foreign producer revenue,
government costs/revenue, efficiency loss, net surplus loss, deadweight loss
The diagrams in figure 66.1 represent the effects of a tariff, quota and subsidy. All the diagrams are indexed in price/quantity at
original imports and the areas resulting from protectionism are lettered. I have altered the PED and PES in the diagrams so at to
enable you to differentiate between the numerical values….and of course to force you to do additional calculations. Calculate the
areas and check your answers with the cheat-sheet given in the end of chapter revision.
I: Tariff calculations
II: Quota calculation
P
P
III: Subsidy calculation
P
Sdom
Sdom
Sdom
Sdom + subsidy
120
Sworld + tariff 110
110
100
A
B
E
10
C
D
F
30
Sworld
G
70
100
D
Q/t
Quota
100 A
B
C
E
F
10 25
D
G
75 100
Sworld 100
D
Q/t
A
B
Sworld
C
10
QD0
D
40
D
100
Q/t
o Tariff
The tariff is 10% in figure 66.1 (diagram I). Calculate both the area and the numerical values for:
1) Gross loss of consumer surplus
2) Increase in domestic suppliers’ revenue
3) Loss of foreign supplier’s revenue
4) Remaining foreign suppliers’ revenue
5) Efficiency loss due to tariff (e.g. units produced post-tariff where domestic suppliers’ MC > MCworld)
6) Net loss of consumer surplus
7) Dead weight loss
8) Government tax revenue
o Quota
The quota in figure 66.1 (diagram II) has similar effects – with one exception worthy of mentioning, namely that there is no
government revenue. Instead there is a windfall gain to foreign suppliers, e.g. an unexpected increase in revenue. (Note: this is not
necessarily a net increase in foreign suppliers’ revenue! It depends on how large areas E and G are.) Calculate
1) The size of the quota (e.g. units rather than money values)
2) Gross loss of consumer surplus
3) Increase in domestic suppliers’ revenue
4) Loss of foreign supplier’s revenue
5) Remaining foreign suppliers’ revenue
6) Efficiency loss due to quota (e.g. units produced post-tariff where domestic suppliers’ price > MCworld)
7) Net loss of consumer surplus
8) Dead weight loss
9) Windfall gain
o Subsidy
The subsidy in figure 66.1 (diagram III) shifts the supply-curve and results in a new equilibrium point. Recall the law of incidence
“…new equilibrium point  old supply curve  go home….”. Calculate:
1) The subsidy per unit and the total cost of the subsidy to government
2) Increase in domestic suppliers’ revenue
3) Loss of foreign supplier’s revenue
4) Remaining foreign suppliers’ revenue
5) Efficiency loss due to subsidy (e.g. units produced post-tariff where domestic suppliers’ MC > MCworld)
Before you continue it bears asking; did you actually do the calculations for the diagrams above or did you blow through them using
a hair-drying to turn the pages? That is correct; you need to do the calculations rather than glance through them. Bruce Lee did not
master the front-kick by reading how to do it, he did it. A lot.
Rory; I’d really like to stick an “Eight point Evaluation List” in the beginning of the book somewhere so I may refer to it
periodically. Basically a check-list for students on how to aim for evaluation marks in exams. It looks like this:
1. Winners and losers (this deals with how different stakeholders – firms, consumers, governments…etc – are
affected)
2. Short run and long run (the negative effects might not be seen immediately or might change over time – for
example the long run Phillips curve and the LRAS curve)
3. Different possible outcomes/scenarios (it is quite possible that the same variable can lead to different outcomes,
for example how increasing inflation can lead to increased consumption due to the expectations effect but also to
decreased consumption due to the real balance effect)
4. Empiricism (which means that we know from – repeated – experience that a theory does not stand up in reality,
for example, there is little evidence that lower income tax rates cause households to increase their supply of
labour)
5. Different schools of thought (e.g. the Keynesian-monetarist debate)
6. Use of core economic theory/concepts (deadweight loss and consumer surplus is a core evaluative expression in
economics)
7. Trade-offs (an excellent way to get evaluation marks in your exams is to point out and explain why a given
alternative or choice results in some for of trade-off, for example that growth and lower unemployment can lead to
higher inflation)
8. Finally, I always ask the question “does it work?” (do marginal taxes indeed even-out incomes…do tariffs save
jobs in the LR…have pollution permits lowered CO2 and SO2…etc)
This is one of those areas where I am frequently asked “Which one is best?” You know the answer; it depends! It
depends on how we define “best” and for whom. Here are a few brief points worthy of pondering…
 In all cases we can see that domestic suppliers have increased their revenues and that domestic supplier surplus increases
 Consumers would probably prefer the subsidy since the price and quantity remains the same – some of spending simply
switched to domestic producers. In tariffs and quotas there is a loss of consumer surplus but not in the subsidy.
 There is mis-allocation taking place in all three examples as illustrated by the deadweight losses due to tariffs and quotas
and the efficiency loss due to subsidies.
 Government gains the most in tariffs and the least in subsidies – the tariff brings in revenue and the subsidy costs the
government money.
 Foreign suppliers lose…but there is ‘loss’ and ‘loss’. A good with low PED for imports might result in a net gain (windfall
gain) for foreign suppliers when a quota is levied on imported goods.
I often put forward the following three points:
1. Weak governments use tariffs since it is the easiest way to collect taxes. No census or complex administration of
citizens is needed register income tax. Also, ports, roadblocks at borders and airports are easy to control militarily
– giving said weak governments a very inexpensive way to provide the military upon which many of them base
their power) ample opportunities for bribes to pad dismally low wages.
2. Strong governments increasingly use subsidies. There are some cunning – albeit not very morally appealing –
arguments for this. Firstly they can be very sneaky and difficult to prove (such as building new roads next to
industrial areas and providing R&D facilities in universities next to technology firms) so this form of
protectionism doesn’t invite retaliation. Secondly, citizens are fooled into thinking that the subsidies benefit their
consumption whilst saving some jobs. Well, true, but not all citizens buy the goods being subsidised and the
subsidy does in fact ultimately have to be paid for by taxpayer monies. Thirdly, the WTO has not been able to
implement rules and regulations regarding subsidies – this is part of the dismal failure of the Doha Round of
3.
negotiations (not) taking place since 2001. Finally, there is an element of the ‘tragedy of the commons’ involved,
where governments ‘counter-subsidise’ industries knowing that governments in other countries will do so too.
This is largely what is going on in the US and EU within the larger duopoly in passenger airline construction,
Boeing and Airbus.
My final point is rather cynical but can be reasonably substantiated empirically (ask your TOK teacher) by reading
the newspaper on a daily basis. Politicians looking to get into office or re-elected often find that loud
proclamations of being ‘dumped upon’ are real crowd pleasers. Thus there is an incentive for politicians to out-do
each other by promising wide-scale protection of jobs in industries and regions by implementing very visible
barriers to trade. Basically I am putting forward the opinion that protectionism is often strongly politically slanted
rather than based in economic reasoning. I mean, let’s face it; the US embargo (= ban on imports) against Cuban
goods has been in place since 1960 and has little or nothing to do with economics.
Summary and revision
1. Tariff (see figure 66.1 (diagram I) Rory; check my use of brackets…and calculations!
1) Gross loss of consumer surplus: Areas A to D. Calculated as ($10 x 70) + [($10 x 30) / 2)] = $850
2) Increase in domestic suppliers’ revenue: Areas A, B and E. Calculated as TR post-tariff ($110 x 30 =
$3,300) minus original TR ($100 x 10 = $1,000) = $2,300.
3) Loss of foreign supplier’s revenue: Areas E and G. $100 x 20 + $100 x 30 = $5,000.
4) Remaining foreign suppliers’ revenue: Area F. $100 x 40 = $4,000.
5) Efficiency loss due to tariff: Area B. Each unit between 10 and 30 has a higher marginal cost (MC)
domestically than at Sworld. This is an efficiency loss of (20 x $10) / 2 = $100.
6) Net loss of consumer surplus: Area D. The area is (30 x $10) / 2 = $150.
7) Dead weight loss: Sum of areas B and D; $250.
8) Government tax revenue: Tariff times the imports post-tariff, i.e. $10 x 40 = $400.
2. Quota (see figure 66.1 (diagram II)
1) The size of the quota (e.g. units rather than money values): Imports post-quota are 50 units.
2) Gross loss of consumer surplus: Areas A to D. Calculated as ($10 x 75) + [($10 x 25) / 2)] = $875
3) Increase in domestic suppliers’ revenue: Areas A, B and E. Calculated as TR post-tariff ($2,750) minus
original TR ($1,000) = $1,750.
4) Gross loss of foreign supplier’s revenue: Areas E and G. $100 x 15 + $100 x 25 = $4,000.
5) Remaining foreign suppliers’ revenue: Area F and C. $110 x 50 = $5,500. There has been a net loss in
foreign suppliers’ revenue of $3,500 ($9,000 - $5,500).
6) Efficiency loss due to quota: Area B. Each unit between 10 and 25 has a higher marginal cost (MC)
domestically than at Sworld. This is an efficiency loss of (15 x $10) / 2 = $75.
7) Net loss of consumer surplus: Area D. The area is (25 x $10) / 2 = $125.
8) Dead weight loss: Sum of areas B and D; $200.
9) Windfall gain: Area C. $10 x 50 = $500.
3. Subsidy (see figure 66.1 (diagram III)
1) The subsidy per unit and the total cost of the subsidy to government: Subsidy per unit is $20 and quantity
post-subsidy is 40, areas A and B. Total cost of subsidy to government is $800.
2) Increase in domestic suppliers’ revenue: Areas A, B and C. New TR is $120 x 40 = $4,800 and pre-subsidy
TR is $100 x 10 = $1,000. The increase in TR for domestic suppliers due to the subsidy is $3,800.
3) Loss of foreign supplier’s revenue: Area C. $100 x 30 = $3,000.
4) Remaining foreign suppliers’ revenue: Area D. $100 x 60 = $6,000.
5) Efficiency loss due to subsidy: Area B. Each unit between 10 and 40 has a higher marginal cost (MC)
domestically than at Sworld. This is an efficiency loss of (30 x $20) / 2 = $300.