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c10competitive markets applications.qxd 7/15/10 4:58 PM Page 425

10.5 IMPORT QUOTAS AND TARIFFS 425
What is the impact of free trade? Domestic consumer surplus will be the area
(consumer surplus areas A B C E
below the demand curve and above P w
F G H J K ), domestic producer surplus will be the area above the
supply curve and below that price (producer surplus area L), the domestic net ben-
efits will be the sum of domestic consumer surplus and domestic producer surplus (net
benefits areas A B C E F G H J K L), and there will be no
deadweight loss. Thus, domestic consumer surplus is much greater than it is with a
trade prohibition, but domestic producer surplus is much smaller.
Since domestic producers stand to lose with free trade, they often attempt to re-
strict or even eliminate imports. We have seen how the complete elimination of im-
ports through a trade prohibition benefits producers. Now let’s examine the impact of
a partial restriction on imports, through a quota that allows the import of some max-
imum number of units per year.
Suppose the government wants to support a domestic price of $6 per unit (as a
sort of compromise, say, between the interests of domestic consumers, who would
enjoy a low price of $4 with free trade, and the interests of domestic producers, who
would benefit from a high price of $8 with no trade). To accomplish this, the govern-
ment can set a quota of 3 million units per year. To see why, note that the equilibrium
price in the domestic market will be the one that clears the market—that is, the price
that makes total supply (domestic and foreign) equal to domestic demand. At a price
of $6, consumers will demand Q 7 million units per year (at the intersection of that
4
price with the demand curve), but domestic producers will be willing to supply only
4 million units per year (at the intersection of the price with the supply curve). Thus,
to satisfy domestic demand at that price, 3 million units per year would have to be im-
ported (7 million units demanded domestically 4 million units supplied domesti-
cally 3 million units imported).
What is the impact of this quota? Domestic consumer surplus will be the area
below the demand curve and above the price of $6 (consumer surplus areas A B
C E), domestic producer surplus will be the area above the supply curve and
below that price (producer surplus areas F L), the domestic net benefits will be
the sum of domestic consumer surplus and domestic producer surplus (net benefits
areas A B C E F L), and the deadweight loss will be the difference be-
tween net benefits with free trade and net benefits with the quota (deadweight loss
areas G H J K ). In addition, foreign suppliers enjoy a producer surplus of their
own under the quota, because they can sell the good at a price of $6 when they would
have been willing to sell it at a price of $4.
In sum, with a quota, domestic consumer surplus is less than it is with free trade
but more than with a trade prohibition, while domestic producer surplus is more than
with free trade but less than with a trade prohibition, and foreign suppliers gain some
producer surplus.

TARIFFS
A tariff is a tax on an imported good. Like a quota, a tariff restricts imports, and the
government can use a tariff to achieve the same objective achieved with a quota—to
support the domestic price of the good. For instance, in the market we have been
discussing, the government could eliminate imports (as it could do with a trade
prohibition—i.e., a quota of zero) by charging a tariff of $5 per unit. This would raise
the domestic price of the imported good to $9 per unit (P of $4 tariff of $5 $9).
w
In that case, no quantity of the good would be imported because no consumers would