The Protective Effect of an Import Quota

Abstract

We argue that at the level of the national economy, an import quota transforms national welfare in the form of government revenues and consumer surplus into producer surplus to the domestic monopolist protected by the quota. An import quota confers substantial market power to the local monopolist and is likely the result of rent seeking and lobbying in the importing economy, rather than national interest and strategic trade policies. Firms with greater market power, bigger and more inelastic domestic demand losing significant rents would be more likely to solicit import quotas to tariffs or free trade. An import quota causes substantive welfare losses to the importing economy imposing it. We demonstrate graphically that under the equivalence of a quota and a tariff, quota rents substantially exceed tariff revenue to the government. Using a simple geometrical approach and a linear market demand curve, we show that the quota price and output provide maximum profits to the domestic monopolist compared to the free trade point or that under the tariff.