Tariffs and Quotas

Without trade restrictions, a country facing a world price below its own equilibrium price imports the gap between what domestic buyers demand and what domestic sellers supply at that price. A tariff adds a per-unit charge on imports, so the price domestic buyers actually pay rises to the world price plus the tariff. At that higher price, domestic quantity supplied rises, domestic quantity demanded falls, and imports shrink to the new gap between them. Domestic producers gain surplus because they sell more at a higher price. The government collects revenue equal to the tariff times the remaining import quantity. Consumers lose surplus, and that loss is bigger than the sum of producer gain and government revenue, because two triangles of deadweight loss open up: one from domestic firms producing units more cheaply made abroad, one from consumers who would have bought at the world price but now go without.

A quota caps the quantity of imports directly instead of taxing them. Picked correctly, a quota can push price up and shrink imports by exactly the same amounts as a tariff. The difference is who captures the money between the world price and the new domestic price: under a tariff the government keeps it as revenue, under a quota whoever holds the import license or does the importing keeps it as pure profit. The deadweight loss triangles look the same either way.

This topic closes the unit's running theme: any policy that pries price away from its equilibrium value, whether a tax, a price ceiling, a price floor, or a trade restriction, shrinks total surplus even when it moves money toward a favored group.