Question

Assume the market for plastic kitchenware in your country has the demand curve P = 2000 – 0.01Q, and the domestic supply curve P = 500 + 0.02Q. For simplicity, we ignore the exchange rate and currency difference here.

1. Now suppose the government decides to eliminate tariff but imposes an import quota instead. The total amount of import is limited at 60,000 (assume the foreign producers can actually deliver so many unites).
   1. Solve for the domestic demand, domestic supply, and market price under the quota?
   2. Calculate the National Welfare under the quota.

Answer 1

Given,

Domestic Demand P = 2000 – 0.01Q

Domestic Supply P = 500 + 0.02Q

A country faces a much lower price than it's own domestic equilibrium price is free trade. Assuming that the price the country incurred during free trade was at level P_0. Imposing Import quotas will now limit the importing quantity and reduce it from Q₂ to Q₄, Q₄ being 60000 units. As a result the prices will now go upto P₁ due to a fall in foreign imports. Since the prices have risen in the domestic market the following will be the implications:

1. Domestic demand will decrease due to a rise in prices from Q₂ to Q₄.

2. Domestic producers will now produce more since they can now get a higher price for their good. Import quotas also prove to protect the interest of domestic producers as a result of which the domestic supply will increase from Q₁ to Q_3.

Domestic demand:

The domestic demand has now fallen to level Q₄ which is 60000 units at price 1400.

Domestic supply:

The domestic supply will now increase from Q₁ to Q₃ which is 45000 units at the price 1400.

Market Price:

The equilibrium price for the market without free trade was at level 1500 but due to the existing tariffs the price level had fallen to a much lower level at P₀. Since the government imposed import quotas, the price level for the domestic market rose from P₀ to P₁ where prices are at 1400.

National Welfare:

The total welfare of the country can be seen by adding the negative production efficiency loss (area B) and the negative consumption efficiency loss (area D) and area C. The national welfare change for this country consists of these negative impacts therefore the total welfare effect of the quota will be a negative effect.