What this lesson teaches
I can weigh the benefits and costs of protectionism.
Syllabus 9570, 3.3.1(d). Globalisation, International Trade and Economic Co-operation: Benefits and costs of protectionism
Make a guess
An import quota replaces a tariff, and licences are given free to importers. Who gets the money the tariff used to raise?
- The government, as with a tariff.
- Consumers, because the price falls.
- The importers who hold the licences.
Show the answer
The importers who hold the licences.
The domestic price still rises. With free licences, the gap between the domestic and world price goes to licence holders, not the government.
Quotas, subsidies to local producers and regulations also protect domestic industries, with different effects on who pays.
An import quota limits the quantity that can be imported. Like a tariff, it raises the domestic price. But instead of tariff revenue, the gap between the domestic and world price goes to whoever holds the import licences.
A production subsidy to domestic firms lowers their costs so they produce more. Consumers still pay the world price, but taxpayers fund the subsidy.
Other barriers include strict product standards, complex customs rules and export bans.
Each protects domestic producers, but at a cost to consumers, taxpayers or firms that use imported inputs.
- Quota
- Limits import quantity; licence holders gain.
- Subsidy
- Taxpayers fund it; consumers still pay the world price.
Worked example: A quota versus a subsidy
In the same market, an import quota of 40 units replaces the $1 tariff, with licences given free to importers. Alternatively, the government pays domestic producers a $1 subsidy per unit.
- Quota: the price rises to $5, as with the tariff. Importers keep the $40 that would have been tariff revenue.
- Subsidy: consumers still pay $4 and buy 120 units. Domestic firms produce 60, so 60 are imported.
- The subsidy costs taxpayers $1 x 60 = $60, but consumers do not lose.
- Each option protects producers; they differ in who pays.
Watch out for this
A quota raises revenue for the government like a tariff.
With free licences, the price gap goes to the licence holders. The government collects revenue only if it auctions them.
Check your understanding
A tariff on cars is replaced by a quota that allows the same number of imports, with licences given free to importers. What changes for the government?
- Its revenue is unchanged, because imports and the price are the same as before.
- It gains more revenue, because a quota keeps the domestic price higher.
- It loses the tariff revenue; importers with licences keep that money instead.
Show the answer
It loses the tariff revenue; importers with licences keep that money instead.
Right. The price and imports can be the same as under the tariff, but the gap between the world and domestic price now goes to licence holders.