Question

Consider a small country that imports good X. Some of the total quantity of X domestically consumed is supplied by domestic producers and the rest of it is imported. Then suppose that the government imposed a quota on the importation of X, so that the quantity of X imported is reduced to a quantity of Q. Draw a demand and supply diagram that shows the effect of the quota. On your diagram clearly label the quantity of imports before the quota is introduced and after the quota is introduced. Also on your diagram, shade in the area that represents the quota rent. Then provide an explanation for why we call this area the quota rent.

Answer 1

There is high demand in the economy corresponding to supply, this is the reason economy imports goods from abroad markets. When government imposes quota, they limit the amount of import a country can order. Initially the import quantity was AB where demand > supply. When government fixes the quota, they raise the prices of the imported good by (P1-P) which is effective supply. Then the imported quantity falls to CD.

Quota rent is the economic rent received by the owner of the imported good that is subject to the quota. To calculate quota rent, first calculate the economic rent, which is the positive difference between the domestic price of the good and the free market price from around the world. Here the quota rent is (P1-P) price level * CD(quantity)