Question

Graph the effects of tariffs and quotas on prices, output, and consumption as well as analyze and diagram their effects on resource allocation and income distribution including in light of further trade opening and net welfare costs.

Answer 1

Effects of raising tariffs and quota have same effect, it is just the government who chooses which policy for their economy.

Initially the level of equilibrium is at point E where aggregate demand = aggregate supply. Prices are Ph in home country and Pw in all over the world. When prices in world level is less, people in your home country will demand products from rest of the world as prices are less in all over the world. When world prices are low, total demand is E and supply is F in the economy with home prices. Rest everything A-B is imports as prices are low. Refer to the lower diagram, when a country imposes tariffs, prices level rises to some level higher than world prices and lower than home prices to restrict the import level in the country. Raising the prices by imports tariffs will raise the prices of world goods in home country which will reduce imports(AC and BD) and total imports level now is CD.

Quotas are same as tariffs and can be represented by same diagram. Refer to the above diagram, we can restrict import quota to the level of CD level of import which was the same effect after imposing tariffs.

Output level, consumption level effect of both are reduced and same and the difference is just area of revenue. Tariffs raises revenue for government while quotas generate no revenue and producers get the benefit of all this.

Quotas have the tendency to distort international trade much more than tariffs since its effects are more effective. Net welfare cost cannot be said as increased or declined as the increased revenue in tariffs of government will be spended for society, increased prices for customers have negative impact on welfare while increased revenue for societal increases the welfare.