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The graph to the left shows the effect of foreign imports in a market. If the economy were closed then the equilibrium price would be P* with an output of Q*. If the economy were open then an imported price of PW would exist. The new quantity provided would be Q2. Therefore only Q1 would be produced by domestic producers (because between 0 and Q1 the domestic producers will supply at a cheaper price than the world price) and Q2-Q1 would be imported. Theoretically if the domestic market were large enough its demand for the imported good may result in the price increasing, but this is ignored to make the analysis simpler. Because domestic suppliers are providing less they may lobby the government to introduce a tariff. The effect of a tariff would be to increase the price of imported goods. This is shown below. PW is the world price, however the tariff has caused the price to rise to PT. Now Q1 will be supplied by domestic firms (which is a greater quantity than before), Q2-Q1 will be imported. With the tariff only Q2 will be demanded (which is less than before) this means that allocative efficiency is occurring. The government gain revenue from the tariff (which acts like a tax) which is shown by the green rectangle (Q1Q2*(PT-PW)). The blue trapezium is a redistribution of consumer surplus to producer surplus (for the domestic suppliers). The yellow triangle shows welfare loss, this is productive inefficiency as the domestic suppliers are more inefficient than the foreign producers. The pink triangle also represents welfare loss which is the loss of consumer surplus and also represents a loss of allocative efficiency as the price is further away from the marginal cost.

The tariff results in the government subsidising (in effect) inefficient domestic producers whilst forcing consumers to pay a higher price. It could be argued that this is beneficial as it retains jobs which may be lost if the domestic firms had to compete with foreign firms on price. By imposing a tariff the government may delay structural change, this may allow it time to gradually retrain workers into more productive areas of employment and let the inefficient firms ‘die’ slowly. This reduces the detrimental effect of structural unemployment and means the government won’t see an increase in benefit claims in the short run (on the contrary taxes will have increased, ceteris paribus).

If the domestic firms have this benefit of a higher price then it may lead to x-inefficiencies, this is because they aren’t competing with foreign firms, they also won’t have the ability to compete in the global market which may lead to narrow revenues.

Instead of issuing tariffs a country may instead chose to limit the number of imports in terms of volume. This limit is known as a quota or as a VER (voluntary export restraint).
The diagram to the left shows the effect of imposing quotas. The demand function represents domestic demand for the good and S1 shows domestic supply. S2 shows domestic supply plus the permitted number of imports allowed into the economy from another country. 
PW shows the world price of the good which is lower than the domestic price (it is not shown but this would be the point where D1 and S1 intersect). Therefore without a quota (or tariff) in place Q1 would be supplied by domestic producers, Q2 will be demanded by consumers, therefore Q2-Q1 is the amount that is imported from abroad. By imposing a quota a new supply curve (S2) exists which is the total supply from both domestic producers and the quota (as this is a fixed value). The difference between S2 and S1 is the value of the quota.
With the quota in place demand will now be Q3 with Q4 being supplied by domestic producers, therefore Q3-Q4 will be imported (with the quota being fulfilled, i.e. there is no further supply from foreigners permitted). 
The quota allows domestic producers to sell at a higher price than the world price (P1) and therefore consumer surplus is transferred to producer surplus as shown by the blue trapezium. The foreign producers also gain as they are selling their good at a higher price, therefore the green rectangle shows their gained producer surplus (again this is converted from consumer surplus). The 2 triangles represent welfare loss, the yellow triangle shows productive inefficiency and the red triangle shows allocative inefficiency. 
Like a tariff, quotas can lead to X-inefficiency in domestic firms and keep workers employed in unproductive sectors where the country doesn’t have a comparative advantage. Quotas also acts as an effective subsidy for foreign firms as they receive more money through the quota system than they would have had their not been a quota in place.
Non-Tariff Barriers
Another way to limit trade from foreign producers is to introduce non-tariff barriers which usually consist of rules and regulations on the standards of product in order to put off foreign producers and to prevent them importing into a country.
Non-tariff barriers are hard to identify as some rules and regulations are put in place for sensible and practical reasons, to protect consumers and the environment. However some exist merely as a barrier to foreign producers, for example having strict specification on the size and colouring of goods in order to make it hard for foreign producers to comply with the rules.
Some producers in less developed countries may find it difficult to comply with an rules and regulations as this requires expensive testing and designing, as well as a legal team to ensure that the firm is up-to-date with all the new rules.
Page last updated on 15/04/14