Import Quota

Import quotas are an important legal aspect to consider when conducting International Business.   They involve a restriction on the quantity of goods that can be imported.   This type of import control is usually accomplished by issuing a license to a company. 

Table of Contents:

Effects on International Business

1. raises prices of product in domestic market (always)...prices will raise by same amount as would occur if there was a tariff.
2. Unlike with a tariff, however, a government will not receive revenue from a quota, instead the money is collected by the individual firms (whoever has the license)
3. License holders can buy cheap exports and sell at a higher price domestically...receiving "quota rents"...or, additional unearned revenues.
4. If the "rents" goes to foreign governments (because they hold the licenses), then quotas are a very bad deal.

Examples:

USA

1.  import quota on foreign cheese.  Certain companies are given the right to sell a certain quantity, based on how much they sold the previous year.

sugar, clothing... licenses given directly to forign governments for quantity they can sell in the USA

2.  Sugar example:

3.  Multifibre Arrangement (MFA) for textiles:  governed textile trade from 1974-2004 with a series of import quotas

Compare with (other systems of trade barriers)

                                         Price impact                                                  Impact on local                                        Net Impact on

                            for importers         for exporters             Consumers         Producers        Government                Country as whole

tariff                      increases              decreases*                large loss            small gain        large gain                depends on size of terms of trade gain

export subsidy       decreases             increases                    small loss            large gain        massive cost            negative (always)

import quota           increases             decreases                   large loss            small gain         none**                  depends on size of terms of trade gain

* only if importer is large country that can influence world prices, and terms of trade

** quota benefit goes to foreigners who benefit from quota rents...excess profits from holding import quota licenses

Video

Quotas and Protectionism - The most amazing home videos are here

Definition from Wikipedia

An import quota is a type of protectionist trade restriction that sets a physical limit on the quantity of a good that can be imported into a country in a given period of time. For example, a country might limit sugar imports to 50 tons per year. Quotas, like other trade restrictions, are used to benefit the producers of a good in a domestic economy at the expense of all consumers of the good in that economy.

Critics say quotas often lead to corruption (bribes to get a quota allocation), smuggling (circumventing a quota), and higher prices for consumers.

From an economics perspective, quotas are thought to be less economically efficient than tariffs which in turn are less economically efficient than free trade.

Economic analysis

An import quota works by reducing amount of foreign goods a country may import. In a competitive market, the equilibrium point which determines the price and quantity produced of a good is where the demand curve and the domestic supply curve intersect. In the case of a purely domestic market, this point is at P* and Q* (see Figure 1). When international trade is introduced into the market, this equilibrium may change. Let us assume that the price of a certain good is below P* when imported from abroad than when produced domestically. We will also assume that the world economy can supply more goods at that price.In this case, the international supply curve is a horizontal line at P2, which is the price of that imported good. In this case, the equilibrium price lowers to P2, and the equilibrium quantity produced increases from Q* to Q4. Domestic producers will actually produce less (Q1), while the balance (the difference between Q1 and Q4) will be supplied by imports.

When free international trade is introduced, consumers benefit significantly. In a purely domestic market, the consumer surplus is represented by the area A. With free international trade, this surplus increases to include B, C, D, E, F, G, H, and I because they only have to pay price P2 for the good instead of the higher price P*, and they are able to purchase the quantity Q4 instead of the quantity Q*. On the other hand, domestic producers of the good are adversely affected. In a purely domestic market, the domestic producer surplus is represented by areas B, E, and J. With the introduction of free international trade, they lose areas B and E to consumers because they can only get the price P2 for their goods instead of the price P*. Finally, the economy on the whole benefits by areas C, D, F, G, H, and I, as these are areas of surplus that did not exist before the introduction of free trade. As is evident, all of the economic benefit goes to consumers.

Because of the adverse effects of free trade on domestic producers, those producers may attempt to petition the government to enact an import quota. When this happens, the government will restrict the quantity of a good that can be imported in order to increase the price and allow producers to recover some of their lost surplus. If the government restricts total imports to the difference between Q2 and Q3, three things will happen. First, producers will increase output from Q1 to Q2. Second, imports will decline from the difference between Q1 and Q4 to the difference between Q2 and Q3. Third, the price will rise to reflect the new total quantity consumed, which is now Q3.

The effect of an import quota on domestic producers is to allow them to recover the producer surplus in area E, which they take away from consumers. The effect on international producers is that they now obtain areas G and H as a surplus. The effect on consumers is that they lose E, F, G, H, and I. The effect on the total world economy is that areas F and I are lost in what is called a deadweight loss. F represents consumer surplus which is lost by goods consumed but not at a surplus to producers. I represents consumer surplus which is lost as these goods are not consumed at all. The effect on the domestic economy is that E is gained, but F, G, H, and I are lost. The following table summarizes the effect on the various stakeholders of an import quota.

To summarize, free international trade represents the highest net benefit for consumers, the world economy, and the domestic economy. Purely domestic trade represents the least beneficial situation for domestic consumers, the world economy, and the domestic economy, but the most beneficial situation for domestic producers. An import quota is the most beneficial to foreign producers and somewhat beneficial to domestic producers, but is somewhat harmful overall to consumers, the world economy, and the domestic economy.

Other issues that deserve consideration are whether the international producers which obtain the quota rights are the most efficient producers or not. If they are not, this represents an additional deadweight loss to the world economy and a reduced benefit to those producers. Tariffs are generally seen as a more advantageous way to protect domestic producers without creating as much damage to the world economy as a whole.