Price Effects of a Quota: Large Country Case
Suppose Mexico, the importing country in free trade, imposes a binding import
quota on wheat. The quota will restrict the flow of wheat across the border.
As a result, the supply of wheat to the Mexican market will fall and if
the price remained the same it would cause excess demand for wheat in the
market. The excess demand will induce an increase in the price of wheat.
Since wheat is homogeneous and the market is perfectly competitive the price
of all wheat sold in Mexico, both Mexican wheat and US imports will rise
in price. The higher price will, in turn, reduce demand and increase domestic
supply causing a reduction in Mexico's import demand.
The restricted wheat supply to Mexico will shift supply back to the US market. Since Mexico is
assumed to be a "large" importer, the supply shifted back to the US market will generate excess
supply in the US market at the original price and cause a reduction in the US price. The lower
price will, in turn, reduce US supply, raise US demand and cause a reduction in US export supply.
These price effects are identical in direction to the price effects of an import tax, a voluntary
export restraint and an export tax.
A new quota equilibrium will be reached when the following two conditions are satisfied.
where 
is the quantity at which the quota is set, 
is the price in Mexico after the quota,
and
is the price in the US after the quota.
The first condition says that the price must change in Mexico such that import demand falls to the
quota level 
. In order for this to occur the price in Mexico rises. The second condition says
that the price must change in the US such that export supply falls to the quota level 
. In order
for this to occur the price in the US falls.
The quota equilibrium is depicted graphically on the adjoining graph. The Mexican price of wheat
rises from PFT to
which is sufficient to reduce its import demand from QFT to 
. The US
price of wheat falls from PFT to
which is
sufficient to reduce its export supply also from
QFT to 
.
Notice that there is a unique set of prices which
satisfies the equilibrium conditions for every
potential quota that is set. If the quota were set
lower than 
, the price wedge would rise
causing a further increase in the Mexican price
and a further decrease in the US price.
At the extreme, if the quota were set equal to
zero then the prices in each country would revert to their autarky levels. In this case the quota
would prohibit trade.
International Trade Theory and Policy - Chapter 90-12: Last
Updated on 8/20/04
