In this situation consumers surplus is p w ab and

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In this situation, consumers’ surplus is P W AB and producers’ surplus is P W DF. Now, suppose a tariff is imposed. The new price for imported cars in the U.S. car market rises to P W + T . At this price, U.S. consumers by Q 4 : Q 3 from U.S. producers and Q 4 – Q 3 from foreign producers in terms of imports. Note that the after tax import is smaller than the pre tax (pre-tariff) import. An effect of tariffs, then, is to reduce imports. At the price of P W + T , consumers’ surplus is (P W + T )AC and producers’ surplus is (P W + T )EF. Because of the tariff, consumers’ surplus is reduced by an amount equal to the areas 1+2+3+4, and producers’ surplus is increased by an amount equal to area 1. The government collects tariff revenues equal to area 3. This area is obtained by multiplying the number of imports (Q 4 – Q 3 ) times the tariff itself, which is the difference between P W + T and P W (P W + T – P W = T) Conclusion: The effects of the tariff are a decrease in consumers’ surplus, an increase in producers’ surplus, and tariff revenues for government. Since the loss to consumers’ (area 1+2+3+4) is greater than the gain to producers (area 1) plus the gain to government (area3), it follows that a net loss results form a tariff. This is the other side of the coin that reads “There is a net gain to free trade.” QUOTAS A quota is a legal limit on the amount of a good that may be imported. Q U.S P D U.S S U.S P W P W + T Q 1 Q 3 Q 2 Q 4 A E C B H G D F 1 2 3 4 Net loss from tariff = Areas 2+4
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Example: The government may decide to allow no more than 100,000 foreign cars to be imported, etc. A quota reduces the supply of a good and raises the price of imported goods to domestic consumers. Once again, consider the situation in the U.S. car market. At a price of P W U.S. consumers buy Q 1 cars from U.S car producers and import Q 2 – Q 1 from foreign car producers. Consumers’ surplus is P W AB and producers; surplus is P W DF. Suppose now that the U.S. government sets a quota equal to Q 4 – Q 3 . Since this is the # of foreign cars U.S. consumers imported when tariff was imposed, the new price of cars rises to P Q (which is the same as P W + T on line tariff graph). At P Q , consumers’ surplus is P Q AC and producers’ surplus is P Q EF. The decrease in consumers’ surplus due to the quota is equal to the areas 1+2+3+4; the increase in producers’ surplus is equal to area 1. What about area 3? Is this area transferred to government, as was the case when a tariff was imposed? No, it is not. This area represents the additional revenue earned by the importers (and sellers) of Q 4 – Q 3 . Without the quota, those importers and sellers of Q 4 – Q 3 sold their imported cars for P W . Their total revenue was therefore P W x (Q 4 – Q 3 ), or the area Q 3 GHQ 4 because of the quota, the price rises to P Q and their total revenue is P Q x (Q 4 – Q 3 ), or the area Q 3 ECQ 4 . The difference between total revenues on Q 4 – Q 3 imports without a quota and with a quota is the area 3.
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