Tariffs and Quotas
You are shopping for sneakers and the price tag is $\$15$ higher than last year. The store manager says, "New tariffs." Who set that price, who actually pays it, and who benefits? In this page you will build the graph that answers those questions, and you will see why an AP® Microeconomics FRQ almost always asks you to draw it.
Free trade: the world price decides
Without trade, a country's domestic market clears where domestic demand meets domestic supply. That is the no-trade equilibrium price.
Now open the market to the world. If the country is small, it cannot change the world price, so it is a price taker and treats the world price ($P_W$) as given. Whether the country buys or sells abroad depends on how $P_W$ compares with the no-trade price:
| World price compared with no-trade price | Domestic firms… | Country is an… |
|---|---|---|
| $PW <$ no-trade price | cannot compete at the higher domestic price, so they produce less | importer |
| $P_W >$ no-trade price | can sell abroad at a better price, so they produce more | exporter |
At the world price, find the quantity demanded ($Q_d$) and the quantity supplied by domestic firms ($Q_s$):
$$\text{Imports} = Q_d - Q_s \qquad\qquad \text{Exports} = Q_s - Q_d$$The domestic market for T-shirts has the demand curve $Q_d = 1{,}000 - 50P$ and the supply curve $Q_s = 100P - 200$, where $P$ is dollars and $Q$ is thousands of shirts.…
The domestic market for T-shirts has the demand curve $Q_d = 1{,}000 - 50P$ and the supply curve $Q_s = 100P - 200$, where $P$ is dollars and $Q$ is thousands of shirts. The world price is $\$6$ per shirt, and the country is small so it takes the world price as given.
(a) Find the domestic equilibrium price and quantity without trade.
(b) With free trade at $\$6$, find the quantity demanded, the quantity supplied domestically, and the quantity imported.
(c) Is the country an importer or an exporter? Explain how you know.
Tariffs: a tax on imports
A tariff is a tax on imported goods. The government charges it per unit as the good crosses the border. It does not apply to goods made at home.
A tariff on an importable good works like this:
-
The domestic price rises to $P_W + t$, where $t$ is the tariff per unit. Foreign sellers still receive $P_W$. The tariff is the difference.
-
Consumers buy less ($Q_d$ falls along the demand curve).
-
Domestic producers supply more ($Q_s$ rises along the supply curve).
-
Imports fall, because $Q_d - Q_s$ shrinks.
Read the figure with a $\$3$ tariff:
-
Consumers lose the whole region between the two prices to the left of demand: $G + X + R + Y$.
-
Domestic producers gain region $G$ (a higher price on every unit they sold anyway, plus the extra units).
-
The government collects region $R$ = tariff $\times$ imports.
-
Deadweight loss (DWL) is $X + Y$. Triangle $X$ is the production distortion: domestic firms make units that cost more than the world price. Triangle $Y$ is the consumption distortion: buyers give up units they value more than the world price.
Define a tariff in your own words. Then say whether a tariff on imported steel raises or lowers the domestic price of steel, and whether it helps or hurts domestic steel…
Define a tariff in your own words. Then say whether a tariff on imported steel raises or lowers the domestic price of steel, and whether it helps or hurts domestic steel producers.
Match each effect to the group it describes after the United States imposes a tariff on imported bicycles: (i) domestic consumers, (ii) domestic producers, (iii) the…
Match each effect to the group it describes after the United States imposes a tariff on imported bicycles: (i) domestic consumers, (ii) domestic producers, (iii) the federal government.
Effects: (A) Gain from higher prices and a larger quantity supplied. (B) Receive tariff revenue. (C) Lose consumer surplus because they pay higher prices.
Using the T-shirt market from the previous setup (demand $Q_d = 1{,}000 - 50P$, supply $Q_s = 100P - 200$, quantities in thousands, world price $\$6…
Using the T-shirt market from the previous setup (demand $Q_d = 1{,}000 - 50P$, supply $Q_s = 100P - 200$, quantities in thousands, world price $\$6$), the government imposes a tariff of $\$1$ per shirt.
(a) Find the new domestic price, the quantity demanded, the quantity supplied by domestic firms, and the quantity imported.
(b) Calculate the tariff revenue.
(c) Calculate the deadweight loss, which is the sum of two triangles: the production distortion and the consumption distortion.
Quotas: a limit on quantity
A quota is a legal limit on the quantity of a good that can be imported in a period (for example, a year). The sugar quota is a well-known US example.
A quota restricts the quantity, not the price. But it pushes the domestic price up in the same way a tariff does:
-
With imports capped, the domestic price rises until $Q_d - Q_s$ equals the quota.
-
At that higher price, consumers buy less and domestic firms produce more, just as with a tariff.
-
The importers who are allowed to bring in the good buy at $P_W$ and sell at the higher domestic price. That gap is called the quota rent.
The government usually issues import licenses and the license holders keep the rent. If the licenses go to foreign firms, the rent leaves the country. If the government auctions the licenses, it can collect the rent, and then the quota matches a tariff.
The United States allows free trade in sugar, and the world price of sugar is lower than the domestic no-trade price. Is the United States an importer or an exporter of…
The United States allows free trade in sugar, and the world price of sugar is lower than the domestic no-trade price. Is the United States an importer or an exporter of sugar in this case? Now suppose the government adopts a quota that limits imports of sugar to a fixed quantity per year. Explain in two sentences what a quota is and what it does to the domestic price compared with free trade.
A small country imports tomatoes at the world price of $\$2.00…
A small country imports tomatoes at the world price of $\$2.00$ per pound. At that price, domestic consumers buy 90 million pounds and domestic farmers supply 30 million pounds. The government replaces free trade with an import quota of 40 million pounds. As a result, the domestic price rises to $\$2.50$ per pound, domestic farmers supply 40 million pounds, and consumers buy 80 million pounds.
(a) Verify that the quantity demanded minus the quantity supplied equals the quota.
(b) The right to import at the world price and sell at the domestic price creates quota rents. Calculate the total quota rents.
(c) Who receives these rents if the government gives import licenses to foreign exporters, and how does that differ from a tariff that gives the same domestic price?
Putting it together: who wins, who loses, and by how much
Policy debates about trade are really debates about this graph. Lawmakers may say a tariff on imported steel or solar panels "saves jobs." The model says three things:
-
The gain to domestic producers is concentrated in one industry, so it is easy to see.
-
The loss to consumers is spread across millions of buyers, so it is easy to overlook, and it is always larger than the producers' gain.
-
The country's net loss is the DWL. If you divide the DWL (or the consumers' loss) by the number of jobs protected, you get a cost per job. That is how economists test claims like "this tariff saves jobs."
A small country imports washing machines. The domestic demand is $P = 1{,}200 - 2Q$ and the domestic supply is $P = 200 + 3Q$, where $P$ is in dollars and $Q$ is…
A small country imports washing machines. The domestic demand is $P = 1{,}200 - 2Q$ and the domestic supply is $P = 200 + 3Q$, where $P$ is in dollars and $Q$ is thousands of machines. The world price is $\$600$.
(a) Find the no-trade equilibrium and show that the country imports at the world price.
(b) Compute consumer surplus, producer surplus, and total surplus under free trade.
(c) The government imposes a tariff of $\$100$ per machine. Find the new domestic price, quantities demanded and supplied, and imports.
(d) Compute the change in consumer surplus, the change in producer surplus, the tariff revenue, and the deadweight loss. Verify that the changes add up consistently.
(e) Suppose instead that the government uses a quota that sets imports equal to the quantity under the tariff. Explain which outcomes (price, quantity, producer surplus, deadweight loss) are the same, and what could differ depending on who gets the import licenses.
Lawmakers are debating a tariff on imported solar panels. Domestic panel manufacturers argue that the tariff will save jobs in the industry. Consumer groups argue that…
Lawmakers are debating a tariff on imported solar panels. Domestic panel manufacturers argue that the tariff will save jobs in the industry. Consumer groups argue that it will raise the cost of installing rooftop solar. Assume the United States is a small country in the solar panel market, with a world price of $\$300$ per panel. At that price, domestic consumers buy 50 million panels and domestic producers supply 10 million. A tariff of $\$60$ per panel raises the domestic price to $\$360$, so consumers buy 44 million panels and domestic producers supply 16 million.
(a) Calculate the change in consumer surplus, the change in producer surplus, the tariff revenue, and the deadweight loss. (Use trapezoid and triangle areas with the linear segments between the points given.)
(b) Write a short argument (4-6 sentences) evaluating the claim that the tariff benefits the country as a whole. Use your results from part (a).
(c) Suppose the tariff protects 2,000 jobs. Using your deadweight loss and the tariff revenue, compute the deadweight loss per job protected, and explain whether this number alone settles the policy debate.