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2.4 Import Quota
The benefits of free trade have been emphasized in this course. Free markets and free
trade are based on voluntary, mutually-beneficial transactions that make both trading
partners better off. The global economic gains from free trade have been enormous, as
they enhance efficiency of resource use. Comparative advantage and gains from trade
allow each individual, firm, or nation to “do what they do best, and trade for the rest.”
Not everyone wins from trade, however. The overall net benefits are positive, but there
are winners and losers from trade. Specifically, producers in importing nations and
consumers in exporting nations lose due to price changes that negatively affect them.
Like all public policies, free trade has winners and losers.
Trade barriers are most often erected to protect domestic producers from imports.
Sugar is produced in the United States, but at higher production costs than sugar
production in tropical climates found in Cuba, the Dominican Republic, and Haiti. If
free trade prevailed, all sugar consumed in the USA would be imported, since it is
cheaper to buy sugar than to produce it domestically. Sugar producers are interested in
maintaining sugar production in the USA, as this is how they make their living.
Agricultural trade policy has limited sugar imports to a much smaller amount than the
free trade level, through a sugar quota, demonstrated in Figure 2.11.
In a closed economy, market forces ensure that supply and demand are equal (Qs = Qd).
If the USA were a closed economy, the price of sugar would be very high, well above
the world market price of sugar Pw. Suppose that the USA is a “small nation” purchaser
of sugar: this means that the USA is a “price taker,” facing a constant world price of
sugar for all quantities purchased. This is represented as a horizontal line at Pw in
Figure 2.11. At the world price of Pw, the USA would produce Qs domestically and
consume Qd. The difference between quantity demanded and quantity supplied is
imports (Qd – Qs). The equality of domestic supply and demand has been broken by the
ability to import less expensive sugar from other nations.
Domestic sugar producers lobby the government for protection, and receive it in the
form of a sugar quota, meaning a maximum amount of sugar imports. The right to
import sugar is auctioned off to the highest bidder, who pay for the right to import
sugar. Suppose that the quota is set at Qd’ – Qs’. This level of imports is the horizontal
distance between Qd’ and Qs’ in Figure 2.11. At this quota level, the price of sugar
increases to P’, since the quantity of sugar in the market is reduced from free market
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levels. At this high price (P’), quantity supplied increases from Qs to Qs’, and quantity
demanded decreases from Qd to Qd’. These changes are due to the quota, which
decreases the amount of sugar allowed into the country. Sugar producers are pleased
with this policy, since the price is higher and domestic quantity supplied larger.
2.4.1 Welfare Analysis of an Import Quota
The welfare analysis of the import quota identifies the changes in economic surplus of
producers, consumers, and the government. The government gains from selling the
import quota permits to the sugar importers. These firms will compete with each other
to win the right to import sugar. The firms will bid up the price in an auction until the
price is equal to the market value of the quota. In this case, the market value is equal to
(P’ – Pw), since this is the gain from importing one pound of sugar into the USA. The
complete welfare analysis is:
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ΔCS = – A – B – C – D,
ΔPS = + A,
ΔG = + C,
ΔSW = – B – D, and
DWL = B + D.
Producers gain, but at large costs to consumers. The government gains from the sale of
the quota permits to sugar importers. Sugar consumers are made much worse off from
this policy. The area B is called the “production loss” of the policy. This area is equal to
the losses of using scarce resources to produce sugar in the USA instead of buying it at
the world price. Area B represents the production costs, since it is the area under the
supply curve, and above the price. These resources could be more efficiently used
producing something other than sugar. Area D is called the “consumption loss” of the
import quota. This is the area under the demand curve and above the world price,
which represents the extra dollars spent by US consumers buying domestic sugar
instead of low-cost imported sugar. Areas B and D represent the loss in social welfare,
or the deadweight loss of the government intervention. Free markets and free trade
would provide efficiency of resource use and lower costs to consumers.
In the USA, sugar prices are typically one to two times higher than the world price,
resulting in billions of dollar losses to sugar consumers. This policy also has an
interesting unintended consequence. High fructose corn syrup (HFCS) is a perfect
substitute in consumption for sucrose (sugar made from sugar cane or sugar beets).
Corn producers lobby to maintain the sugar import quota, to keep the price of sugar
high. When sugar price is high, buyers of sugar (Coca Cola, Pepsi, Mars, etc.) switch out
of sucrose and into fructose. Corn farmers are among the largest supporter of the sugar
import quota!
2.4.2 Quantitative Welfare Analysis of an Import Quota
Suppose that the inverse demand and supply of sugar are given by:
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P = 100 – Qd, and
P = 10 + Qs,
Where P is the price of sugar in USD/lb, and Q is the quantity of sugar in million
pounds. Suppose also that the world price of sugar is given by Pw = 20 USD/lb, as
shown in Figure 2.12. In a closed economy, market equilibrium would be found where
supply equals demand:
Qe = 45 million pounds of sugar and Pe = 55 USD/lb.
This is a high price of sugar relative to the world price. If imports are allowed, the USA
can break the equality of production and consumption through imports of less
expensive sugar. If we assume that the USA is a “small nation” in sugar trade, then the
USA is a price taker, and can import as much or as little sugar as it desires at the world
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price. Note that a “large nation” means that a country is a price maker, and has enough
market power to influence the price of the imported good.
The free market equilibrium in an open economy can be calculated by substitution of
the world price into the inverse supply and demand functions. At the world price, Q s =
10 m lbs sugar and Qd = 80 m lbs sugar. Imports are equal to Qs - Qd = 70 m lbs sugar.
Social welfare is maximized at this free trade equilibrium, since sugar is produced by
the lowest cost producers. Ten m lbs are produced by domestic producers along the
supply curve below the world price, and 70 m lbs are produced by foreign sugar
producers at the world price of 20 USD/lb.
Now assume that a sugar import quota is implemented, equal to 50 m lbs of sugar.
Since this is less than the free trade import level, it will decrease the amount of sugar
available in the USA, and cause price to increase. The sugar price that results from the
quota (P’) can be calculated using the inverse supply and demand curves and the
import quota:
Qd’ - Qs’ = 50,
P’ = 100 – Qd’, and
P’ = 10 + Qs’.
Rearranging the first equation: Qd = 50 + Qs. Substitution of the first equation into the
inverse demand equation yields:
P’ = 100 – (50 + Qs’) = 50 - Qs’.
This equation can be set equal to the inverse supply equation:
P’ = 50 - Qs’ = 10 + Qs’.
Solving for Qs’:
2Qs’ = 50 – 10, or Qs’ = 40/2 = 20 m lbs sugar.
Substituting this into the import equation and the inverse supply function yield:
P’ = 30 USD/ lb, and
Qd’ = 70 m lbs sugar.
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These values are all shown in Figure 2.12. Notice that quantity supplied has increased
and quantity demanded has decreased due to the import quota and the resulting higher
price. The welfare analysis can now be conducted by calculation of the areas in the
graph.
ΔCS = – A – B – C – D = - 750 USD million
ΔPS = + A = + 150 USD million
ΔG = + C = + 500 million
ΔSW = – B – D = - 100 USD million
DWL = B + D = + 100 million
The government gains area C by auctioning off the permits that allow firms to import
sugar. Taxes are analyzed in the next section.
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