Question

When the government of Tradeland decides to impose arn import quota on foreign cars, three proposals are sug gested: (1) Sell the import licences in an auction. (2) Distribute the licences randomly in a lottery. (3) Let peo- ple wait in line and distribute the licences on a first- come, first-served basis. Compare the effects of these policies. Which policy do you think has the largest deadweight losses? Which policy has the smallest deadweight losses? Why? (Hint: the government's other ways of raising tax revenue themselves all cause dead- weight losses.)

Answer 1

When the government of Trade land decides to impose an import quota on foreign cars, three proposals are suggested: (1) Sell the import licences in an auction.

(2) Distribute the licences randomly in a lottery.

(3) Let people wait in line and distribute the licences on a first- come, first-served basis.

When we compare the effects of these policies, the basic objective of all three policies is to restrict the domestic supply of cars produced in foreign countries. This lead to higher price of foreign cars in home country due to import quota. Even though all three polices can be used by the government as import quota on foreign cars, But the effect of each of three polices on deadweight losses would be different. It is possible that one policy has largest deadweight losses and other have smallest deadweight losses.

The policy which has largest deadweight losses is:

• Sell the import licences in an auction.

Explanation

When government accept proposal-1, Who get import licences in an auction (Highest Bidders), has entire right to sell foreign cars in domestic country. It cause greater variation in the price at which foreign cars are imported and price at which it available for sell in the domestic country. Therefore, Sell the import licences in an auction has largest deadweight losses.

Where as, The policy which has smallest deadweight losses is:

• Let people wait in line and distribute the licences on a first- come, first-served basis.

Explanation

As we see in above case, the largest deadweight losses are mainly due to greater difference in import price from foreign and selling price in domestic country. Where as in the case of Let people wait in line and distribute the licences on a first- come, first-served basis, is much more suitable option from the welfare point of view of the economy.It crates less deadweight losses as compared to Sell the import licences in an auction. Basically, Proposal-3 cause less losses in consumer surplus and hence, has the smallest deadweight losses. Therefore, Let people wait in line and distribute the licences on a first- come, first-served basis has smallest deadweight losses.