Comparing Import Tariffs and Quotas
Explain the difference between an import tariff and an import quota and consider why a government would choose an import tariff rather than an import quota as a tool of protection in international trade. [8]
Both import tariff and import quota are a form of trade protectionism a country can choose to employ. However the mechanism and implementation of the policies differ.
An import tariff is an indirect tax imposed on imported goods. Figure 1 illustrates its impact on specific imported goods. Prior to the tariff, the price is at PW, and the market consumes Q4, with the quantity imported ranging from Q1 to Q4. As tariffs are implemented, the market price increases from PW to PW+t, diminishing the competitiveness of imported goods and redirecting some demand to domestic producers. Consequently, the quantity imported decreases from Q2 to Q3, and the government gains revenue, represented by the area e. This revenue can be directed towards enhancing the country's export competitiveness through improved infrastructure and skills.
Primary beneficiaries of the tariff are domestic producers, experiencing higher prices and increased quantities sold, thereby improving their revenue. However, consumers bear the brunt of reduced consumer surplus, as depicted in the area b+c+d+e+f. The overall economy faces losses due to the inefficiency of resource allocation, leading to deadweight loss (area d+f).
In contrast, an import quota restricts the quantity of goods that can be imported into a country within a specified period. This restriction can be imposed through numerical quotas (limiting the quantity of imports) or value quotas (limiting the total value of imports). Figure 2 shows the price increase from P to P1 after the imposition of a quota, with the equilibrium quantity decreasing from Q to Q1. Similar to tariffs, producers are the primary beneficiaries of quotas, witnessing an increase in surplus. However, consumers experience a decline in consumer surplus as price increases. Unlike tariffs, the government does not gain any tax revenue. Resource allocation remains inefficient, akin to the effects of a tariff as shown by the deadweight loss area a+b.
Government would choose tariff over quota due to its ability to generate revenue for the government. Governments can potentially reduce their dependency on other sources of funding, such as income taxes or borrowing. This diversification of revenue streams can enhance financial stability and increase the tools available for better economic policy management. Additionally, tariff is flexible compared to quota as the rate can be adjusted based on the current economic conditions such as inflation, recession, or changes in currency exchange rates. If certain industries require more protection due to increased competition or changing market dynamics, tariff rates can be raised to provide additional support. Conversely, if protection is deemed excessive, tariff rates can be lowered to allow for more competition.
In conclusion, a government would choose tariff over quota if it is able to provide a balance between competition and protectionism measures. Tariff unike quota still exert competition as goods are not restricted from entering market. Hence, tariffs allow for competition at a higher price, providing a balance between protecting domestic industries and maintaining some level of international trade.