Question

Suppose that the Malaysian government is considering whether to impose an import tariff or quota to protect domestic automobile industry. As an advisor, what are your advice to the government? Please analyse the similarities and differences between import tariff and import quota when there is a reduction in supply for the product. Use appropriate diagram/s to demonstrate your answers.

Answer 1

My advice to the government is to impose import quota. An import quota sets a maximum amount of automobiles which can be imported by the Malaysian government. This means no matter what the demand in the market for imported vehicle is, the supply for the same is fixed by the government (i.e. quota).

On the other hand, what does an import tariff do? When an import tariff is imposed, the prices of these imported automobiles increase thereby not attracting the domestic consumers to buy these vehicles. This conceded well with the law of demand: as price increases the demand decreases. But we must understand here, that the demand decreases but doesn't reach the null value. With the wealthiest 20% contributing close to 58% of Malaysia's wealth, these Affluent consumers can still afford to buy these automobiles no matter how much tariff the government imposes. So, the very reason for an import tariff is kind of defeated in this case. If the consumer wishes to buy the car at any cost, he can do so by paying extra, thereby causing a downturn for domestic manufacturers and a net welfare loss to the domestic consumers as well (i.e. reduction in consumer surplus is more than the increase in producer surplus)

Let's see the supply curve after a tariff is imposed.

P1 is the price when imports were allowed without the tariff. Due to cheaper imports, the price is less than the equilibrium price P and thus demand increases from Q to Q2. As a result, share of domestic producers' fall from Q to Q1 as shown in the figure above. After a tariff imposition, the market share of domestic suppliers increases from Q1 to Q4. Although this doesn't bring back the original market share Q of the domestic suppliers.

Let's take a view at the supply curve after an import quota is imposed by the Malaysian government.

As you can see, the market share of the domestic consumers increase from Q2 before import Quota to Q4 - (Q3 - Q2) after import quota. The quota for imports is Q3 - Q2 in this case. The market share considerably increases when compared to the tariff system, that to with little to no welfare loss for consumers, but of course a loss in tax revenue for the government. But as far as the agenda of improving market share of domestic markets is concerned, import quotas will be a viable option.

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