Question

1. (4.0 pts) Describe why an import quota is far worse than an equivalent tariff in terms of welfare effect if the demand for the quota-constrained product increases over time. Do your analysis under two scenarios: (1) tariff, (2) quota. Do NOT draw a graph.

Answer 1

A quota restricts quantity while a tariff is a tax that works on price . If the demand for quota constrained product increases over time then the company selling the product in domestic market gains a monopoly power . As the demand increases , the company can raise the price of this product in order to gain higher profits but the government has no benefit out of it . This causes higher welfare loss .

But if equivalent tariff is imposed and the demand for the product increases over time then government revenue increases due to tariff . Also since there is no import quota over quantity so supply of the product can also rise if other foreign firms start supplying the product . Hence there is less chance of monopolization by a single large foreign firm .