Questions: Tariffs, Import Quotas, and the Welfare Effects of Trade Policy

Question 1

Domestic demand for steel is Qd = 100 − P and domestic supply is Qs = P. The world price is 20. The country imposes a tariff of 10 per unit. How many units are imported after the tariff?

• A. 60
• B. 50
• C. 40
• D. 30

Answer: (C)

With the tariff the domestic price becomes 20 + 10 = 30. Demand is 100 − 30 = 70 and domestic supply is 30, so imports are 70 − 30 = 40. Before the tariff imports were 80 − 20 = 60.

Question 2

In the same steel market, what is the deadweight loss from the tariff?

• A. 50
• B. 100
• C. 400
• D. 750

Answer: (B)

The production-side triangle is ½ × 10 × (30 − 20) = 50, from extra high-cost domestic output. The consumption-side triangle is ½ × 10 × (80 − 70) = 50, from purchases that no longer happen. Total deadweight loss is 100. As a check, consumers lose 750, producers gain 250, and the government collects 10 × 40 = 400, so the net loss is 750 − 250 − 400 = 100.

Question 3

For a small country that cannot affect the world price, a tariff raises total surplus because it adds government revenue.

• T. True
• F. False

Answer: False

The tariff revenue is a transfer from domestic consumers and adds no surplus of its own. Consumers lose more than the sum of producer gains and revenue, so total surplus falls by the deadweight loss.

Question 4

Who receives the area that would have been tariff revenue when a country uses an import quota instead of a tariff, and why does that matter?

Model answer: It goes to the holders of the import licenses, who can buy at the world price and sell at the higher domestic price. If the licenses are given to foreign exporters or domestic importers rather than auctioned, the government loses that revenue, so the country's net loss can be larger than under an equivalent tariff.

This gap between world and domestic prices times the quota quantity is called the quota rent. Auctioning licenses would make a quota and a tariff equivalent in welfare terms.