Question

Concerns raised by a group of small leather jacket manufacturers about the declining U.S. jacket industry and unfair labor practices in foreign factories lead the Congress and President to impose a quota on jacket imports from abroad. Show the effects of such a quota on a graph below.

Answer 1

Effect of quota can be depcited in following graph.

In following graph, AB and CD are domestic demand and domestic supply curves.

Pre-trade (autarky) equilibrium is at point E with price P1 and quantity Q1.

With free trade, world price is P* at which domestic consumption is Q2 and domestic production is Q3, so imports equal (Q2 - Q3).

Consumer surplus (CS) = Area between demand curve and world price = Area AFP*

Producer surplus (PS) = Area between supply curve and world price = Area CGP*

An import quota equal to (Q4 - Q5) will increase the domestic price of the good to Pt, at which domestic consumption is Q4 and domestic production is Q5.

With import quota,

New CS = Area AHPt

New PS = Area CJPt.

Decrease in CS = Area PtHFP*

Increase in PS = Area PtJGP*

Quota rent = Area PtHLP*

Deadweight loss = Area FHL + Area GJK