Economics Micro & Macro (CliffsAP)

Effects of a Quota

A quota has the following effects:

■ Transfer of revenue:A quota transfers revenue from the government to international firms. Quotas are estab-

lished to limit the number of international goods in the economy; they do not yield any revenue to the imposing

government.

■ Higher domestic prices:Much like a tariff, quotas lead to higher domestic prices. Producers are forced to charge

higher prices for goods and services because of the increased tax.

Open and Closed Economies

An open economyis one that considers exports and imports. Economists use the term “open” to describe the inclusion
of trade when analyzing such data as GDP and the price level. An open economy considers consumption, investment,
government, and exports minus imports. Open economies allow trade to flow freely with consumers, who have the
ability to choose among a variety of goods. Open economies are forced to compete with foreign firms for goods and
pricing. The pricing in an open economy is called the world price.

Let’s consider an example involving the production of steel. Once upon a time, steel was produced in the United States
at high levels. Steel companies produced steel to feed world and domestic demand. Over time, the U.S. steel companies
were outbid by European steel companies because they found cheaper ways to produce steel. To protect the steel work-
ers in the United States, the government could have done a couple of things: first, it could have established an import
quota, restricting the amount of imported steel. Or, the government could have used tariffs as a negative incentive for
international steel producers. Let’s take a look at both options in Figure 12-3 and see the difference.

Figure 12-3

As you can see, once the quota has been placed on a specific good, the international supplier is limited to the amount
of good supplied to the U.S. economy. The quota has limited the supply and increased the price, thereby making it less
enticing to domestic consumers.

Meanwhile, domestic producers of steel benefit because demand for their steel increases as a result of the substitution
effect. Domestic consumers see that U.S. steel is cheaper; therefore, demand increases for the domestic steel. With this
increase in demand, producers increase the price for steel.

Price

D

S

Domestic Steel

(^50) Quantity
P^2
P^1
75
Price
Quota
D
S
Imported Steel
(^50) Quantity
P^2
P^1
25
Part III: Microeconomics