Chapter 5
5-1
CHAPTER 5
Exploring Further
5.1
The welfare effects of tariff-rate quotas have been
briefly discussed in this chapter. Let us further
examine these welfare effects.
Figure EF 5.1 illustrates the welfare effects of
a hypothetical tariff-rate quota on sugar. Assume
that the U.S. demand and supply schedules for
sugar are given by DU.S. and SU.S., and the equilibrium (autarky) price of sugar is $540 per ton.
Assuming free trade, suppose the United States
faces a constant world price of sugar equal to
$400 per ton. At the free-trade price, U.S. production
equals 5 tons, U.S. consumption equals 40 tons,
and imports equal 35 tons.
To protect its producers from foreign competition, suppose the United States enacts a tariff-rate
import quota of 5 tons. Imports within this limit
face a 10 percent tariff, but a 20 percent tariff
applies to imports in excess of the limit.
Because the United States initially imports an
amount exceeding the limit as defined by the tariffrate quota, both the within-quota rate and the
over-quota rate apply. This two-tier tariff causes
FIGURE EF 5.1
TARIFF-RATE QUOTA WELFARE EFFECTS
S U.S.
540
Price (Dollars)
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Tariff-Rate Quota Welfare Effects
480
S W + 20%
d
440
c
f
e
g
a
S W + 10%
b
SW
400
D U.S.
0
5
10
15
20
25
30
35
40
Sugar (Tons)
The imposition of a tariff-rate quota leads to higher product prices and a decrease in consumer surplus for domestic
buyers. Of the tariff-rate quota’s revenue effect, a portion accrues to the domestic government, while the remainder
accrues to domestic importers or foreign exporters as windfall profits.
Nontariff Trade Barriers
the price of sugar sold in the United States to rise
from $400 to $480 per ton. Domestic production
increases to 15 tons, domestic consumption falls to
30 tons, and imports fall to 15 tons. Increased sales
allow the profits of U.S. sugar producers to rise by
an amount equal to area e ($800). The deadweight
losses to the U.S. economy, in terms of production
and consumption inefficiencies, equal areas f ($400)
and g ($400), respectively.
An interesting feature of the tariff-rate quota is
the revenue it generates. Some of it accrues to the
domestic government as tariff revenue, but the
remainder is captured by businesses as windfall
profits—a gain to businesses resulting from sudden
or unexpected government policy.
In this example, after enactment of the tariff
quota, imports total 15 tons of sugar. The U.S. government collects area a ($200), found by multiplying the within-quota duty of $40 times 5 tons. Area
b þ c ($800), found by multiplying the remaining
10 tons of imported sugar times the over-quota
duty of $80, also accrues to the government.
Area d ($200) in the figure represents windfall
profits. Under the tariff-rate quota, the domestic
price of the first 5 tons of sugar imported is $440,
reflecting the foreign supply price of $400 plus the
import duty of $40. Suppose U.S. import companies can obtain foreign sugar at $440 per ton. By
reselling the 5 tons to U.S. consumers at $480 per
ton, the price of over-quota sugar, U.S. importers
would capture area d as windfall profits. But this
opportunity will not last long, because foreign
sugar suppliers will want to capture the windfall
gain. To the extent that they can restrict sugar
exports to the United States, foreign producers
could force up the price of sugar and expropriate
profits from U.S. importing companies. Foreign
producers conceivably could capture the entire
area d by raising their supply price to $480 per
ton. The portion of the windfall profit captured
by foreign sugar producers represents a welfare
loss to the U.S. economy.
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5-2
Chapter 5
5.2
Exploring Further
low-cost producer, and SG denotes the supply
schedule of Germany.
Referring to Figure EF 5.2(a), the price of
autos to the U.S. consumer is $20,000 under free
trade. At that price, U.S. firms produce one auto,
and U.S. consumers purchase seven autos, with
imports from Japan totaling six autos. Note that
German autos are too costly to be exported to the
United States at the free-trade price.
FIGURE EF 5.2
WELFARE EFFECTS
OF AN
EXPORT QUOTA
(a) Japanese Export Quota
(b) Japanese Export Quota with German Exports
S U.S.
S U.S. + Q
30,000
25,000
Price (Dollars)
S U.S.
Price (Dollars)
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Export Quota Welfare Effects
Typical orderly marketing agreements have involved
limitations on export sales administered by one or
more exporting nations or industries. What are the
welfare effects of export quotas?
Figure EF 5.2 illustrates these effects in the
case of trade in autos between the United States,
Japan, and Germany. Assume that SU.S. and DU.S.
depict the supply and demand schedules of autos
for the United States. The SJ denotes the supply
schedule of Japan, assumed to be the world’s
S U.S. + Q + N
30,000
h
a
20,000
i
c
b
j
k
d
e
l
SG
f
g
SJ
25,000
h
a
20,000
j
i
c
b
l
k
d
e
SG
f
g
SJ
D U.S.
0
1
2
3
4
5
6
Quantity of Autos
7
8
D U.S.
0
1
2
3
4
5
6
7
5-3
8
Quantity of Autos
By reducing the available supplies of a product, an export quota (levied by the foreign nation) leads to higher prices
in the importing nation. The price increase induces a decrease in consumer surplus. Of this amount, the welfare loss
to the importing nation equals the protective effect, the consumption effect, and the portion of the revenue effect that
is captured by the foreign exporter. To the extent that nonrestrained countries augment shipments to the importing
nation, the welfare loss of an export quota decreases.
Nontariff Trade Barriers
Suppose that Japan, responding to protectionist sentiment in the United States, decides to
restrain auto shipments to the United States rather
than face possible mandatory restrictions on its
exports. Assume that the Japanese government
imposes an export quota on its auto firms of two
units, down from the free-trade level of six units.
Above the free-trade price, the total U.S. supply of
autos now equals U.S. production plus the export
quota; the auto supply curve thus shifts from SU.S. to
SU.S.+Q in Figure EF 5.2(a). The reduction in imports
from six autos to two autos raises the equilibrium
price to $30,000. This price leads to an increase in
the quantity supplied by U.S. firms from one auto to
three autos and a decrease in the U.S. quantity
demanded from seven autos to five autos.
The export quota’s price increase causes consumer surplus to fall by area a þ b þ c þ d þ e þ
f þ g þ h þ i þ j þ k þ l, an amount totaling
$60,000. Area aþh ($20,000) represents the transfer to U.S. auto companies as profits. The export
quota results in a deadweight welfare loss for the
U.S. economy equal to the protective effect, denoted
by area b þ c þ i ($10,000), and the consumption
effect, denoted by area f þ g þ l ($10,000). The
export quota’s revenue effect equals area d þ e þ
j þ k ($20,000), found by multiplying the quotainduced increase in the Japanese price times the
volume of autos shipped to the United States.
Remember that under an import quota, the
disposition of the revenue effect is indeterminate:
It will be shared between foreign exporters and
domestic importers, depending on the relative
concentration of bargaining power. But under an
export quota, it is the foreign exporter who is
able to capture the larger share of the quota revenue. In our example of the auto export quota, the
Japanese exporters, in compliance with their government, self-regulate shipments to the United
States. This supply-side restriction, resulting from
Japanese firms behaving like a monopoly, leads to a
scarcity of autos in the United States. Japanese
automakers then are able to raise the price of
their exports, capturing the quota revenue.
For this reason, it is not surprising that exporters
might prefer to negotiate a voluntary restraint pact
in lieu of facing other protectionist measures levied
by the importing country. As for the export quota’s
impact on the U.S. economy, the expropriation of
revenue by the Japanese represents a welfare loss in
addition to the deadweight losses of production
and consumption.
Another characteristic of a voluntary export
agreement is that it typically applies only to the
most important exporting nation(s). This is in contrast to a tariff or import quota, which generally
applies to imports from all sources. When voluntary limits are imposed on the chief exporter, the
exports of the nonrestrained suppliers may be
stimulated. Nonrestrained suppliers may seek to
increase profits by making up part of the cutback
in the restrained nation’s shipments. They may also
want to achieve the maximum level of shipments
against which to base any export quotas that might
be imposed on them in the future. For example,
Japan was singled out by the United States for
restrictions in textiles during the 1950s and in
color television sets during the 1970s. Other nations
quickly increased shipments to the United States to
fill in the gaps created by the Japanese restraints.
Hong Kong textiles replaced most Japanese textiles,
and TV sets from Taiwan and Korea supplanted
Japanese sets.
Referring to Figure EF 5.2(b), let us start again
at the free-trade price of $20,000, with U.S. imports
from Japan totaling six autos. Assume that Japan
agrees to reduce its shipments to two units. However, suppose Germany, a nonrestrained supplier,
exports two autos to the United States in response
to the Japanese cutback. Above the free-trade price,
the total U.S. supply of autos now equals U.S. production plus the Japanese export quota plus the
nonrestrained exports coming from Germany. In
Figure EF 5.2(b), this is illustrated by a shift in
the supply curve from SU.S. to SU.S.+Q+N. The reduction in imports from six autos to four autos raises
the equilibrium price to $25,000. The resulting
deadweight losses of production and consumption
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5-4
© Cengage Learning. All rights reserved. No distribution allowed without express authorization.
Chapter 5
inefficiencies equal area b þ g ($5,000), less than
the deadweight losses under Japan’s export quota
in the absence of nonrestrained supply. Assuming
that Japan administers the export restraint program, Japanese companies would be able to raise
the price of their auto exports from $20,000 to
$25,000 and earn profits equal to area c þ d
($10,000). Area e þ f ($10,000) represents a
trade-diversion effect, which reflects inefficiency
losses due to the shifting of two units from Japan,
the world’s low-cost producer, to Germany, a
higher-cost source. Such trade diversion results in
a loss of welfare to the world because resources are
not being used in their most productive manner.
The overall welfare of the United States thus
decreases by area b þ c þ d þ e þ f þ g under
the export-quota policy.
When increases in the nonrestrained supply
offset part of the cutback in shipments that occurs
under an export quota, the overall inefficiency loss
for the importing nation (deadweight losses plus
revenue expropriated by foreign producers) is less
than that which would have occurred in the
absence of nonrestrained exports. In the preceding
example, this reduction amounts to area i þ j þ
k þ l ($15,000).
5-5