Question

Suppose a country wants to limit the amount of imported quantity of a certain good to protect its own industry. Use the welfare analysis framework to decide whether it should implement an import quota or a tariff. Explain why your choice is better than the other policy from the perspective of consumer surplus, producer surplus, government revenue, and total social welfare?

Answer 1

If we use the concept of welfare anayisis then the import can be reduced to the extent of 2 to 3 % and it signifies trade between countries in which benefits and costs of free trade and restrictions to trade can be analysed. The model assumes a linear relationship in all of its components and the existence of a general equilibrium in prices in the post-trade markets determined by the world market price. Though the following situations are not examined in the note, the derived framework can be used to examine changes in social welfare from trade restrictions in the two countries, such as from a tariff or a quantity restriction on exports and imports and reciprocity, as well as industry subsidies, favourable production laws, lowering of environmental standards, and favourable corporate taxation.

Imports are the goods and services that are purchased from the rest of the world by a country's residents, rather than buying domestically produced items.
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GDP = C + I + G + X – M

1. C = Consumer expenditure.
2. I = Investment expenditure.
3. G = Government expenditure.
4. X = Total exports.
5. M = Total imports.

Net Exports Formula

Value of Exports = Total value of foreign countries spending on the goods and services of the home country. Value of Imports = Total value of spending of the home country on the goods and services imported from foreign countries.

Suppose that there are only two trading countries: one importing country and one exporting country. The supply and demand curves for the two countries are shown in Figure 7.13 "Welfare Effects of a Tariff: Large Country Case". PFT is the free trade equilibrium price. At that price, the excess demand by the importing country equals excess supply by the exporter.

The quantity of imports and exports is shown as the blue line segment on each country’s graph. (That’s the horizontal distance between the supply and demand curves at the free trade price.) When a large importing country implements a tariff it will cause an increase in the price of the good on the domestic market and a decrease in the price in the rest of the world (RoW). Suppose after the tariff the price in the importing country rises to PTIM and the price in the exporting country falls to PTEX.

Tariff effects on the importing country’s producers. Producers in the importing country experience an increase in well-being as a result of the tariff. The increase in the price of their product on the domestic market increases producer surplus in the industry. The price increases also induce an increase in the output of existing firms (and perhaps the addition of new firms); an increase in employment; and an increase in profit, payments, or both to fixed costs.

a) Consumer Surplus is the difference between the price that consumers pay and the price that they are willing to pay. On a supply and demand curve, it is the area between the equilibrium price and the demand curve.

b) Producer surplus is the difference between how much a person would be willing to accept for given quantity of a good versus how much they can receive by selling the good at the market price. The difference or surplus amount is the benefit the producer receives for selling the good in the market.It has a huge impact on export and import function also

c) Total welfare, also known as economic or total surplus, is equal to the sum of both consumer and producer surpluses. It can be understood as the surplus of society, since both consumers and producers are getting something from the exchanges taking place in the market.

d) Government revenue is the money received by a government from taxes and non-tax sources to enable it to undertake government expenditures. Government revenue as well as government spending are components of the government budget and important tools of the government's fiscal policy.