Question

A small country’s demand curve is given by Q=10-(P/2) and its supply curve is given by Q=P-5. Assume the world is currently in free trade and that the price under free trade is $7. What is the size of the import quota that, when introduced, would be equivalent (i.e. have the same impact on price and quantity) to the introduction of a $2 specific import tariff?

Answer 1

At a price of $7, Qs = 7 - 5 = 2 units and Qd = 10 - 7/2 = 6.5 units. Imports are now 6.5 - 2 = 4.5 units.

At a after tariff price of $2 + $7 = $9, Qs = 9 - 5 = 4 units and Qd = 10 - 9/2 = 5.5 units. Imports are now 5.5 - 4 = 1.5 units. Imports are reduced by 3 units when tariff of $2 is imposed

Hence tariff results in total quantity traded at 5.5 units and price is $9.

The required size of the import quota that would be equivalent to the introduction of a $2 specific import tariff is 1.5 units.

This makes domestic supply function with quota after P = 7 as Qs = P - 5 + 1.5 or Q = P - 3.5.

P - 3.5 = 10 - 0.5P

1.5P = 13.5

P = $9

Q = 10 - 0.5*9 = 5.5 units

Hence a quota of 1.5 units would be equivalent (i.e. have the same impact on price and quantity) to the introduction of a $2 specific import tariff