Today, we're going to compare 
tariffs with quotas
and also show you how to analyze 
quotas using supply and demand.
Let's briefly review
our theory of international trade
with demand and supply.
So if a country can buy as much
as it wants at the world price,
the equilibrium, 
the free trade equilibrium,
has this quantity demanded,
this quantity will be 
supplied domestically.
The difference between 
the quantity demanded
and the quantity supplied 
domestically is imports.
If we now add on a tariff;
that's a tax which shifts 
the world supply curve up;
the new equilibrium is here,
less is demanded 
because the price is higher,
we have domestic production increases.
So our quantity of imports falls.
And our tariff revenues;
that's simply the tariff rate 
times the quantity of imports,
gives us the tariff revenues 
which go to the government.
OK, now lets now apply this to a quota.
OK, so here's our tariff diagram.
We want to compare with a quota,
so let's eliminate, 
let's clean up our diagram.
I'm just going to leave
some faint lines in here
to remind us of where the tariff was
and to remind us of how much
imports were under the tariff.
Now, we want to compare
with a quota, but,
what size quota?
A big one, a small one?
To be fair,
let's compare the tariff with a quota
which brings in exactly 
the same quantity of imports.
So, instead, remember this is 
the imports under the tariff,
so let's compare with a quota 
which has the same quantity of imports.
Now how do we analyze this quota?
Well, what we can think of
the quota as doing as subtracting --
this quantity from 
the domestic demand curve.
So we can think about
the quota as shifting back
the domestic demand curve.
So the domestic suppliers 
will be able to choose
how much to supply out 
of the domestic demand
after the quota has been 
taken out, as it were.
So the domestic demand curve 
is going to shift back
by the amount of the quota.
This distance here is the same 
as this distance here,
just the quantity of the quota.
That means the domestic 
demand curve will go here.
And, now, what do we see?
Well, how much will the domestic 
suppliers choose to produce
from this new domestic demand curve?
Well, we find the equilibrium
where domestic demand 
is equal to domestic supply,
so here is the quantity which 
will be supplied domestically, --
under the quota.
If we add to that, now, --
the amount which is imported;
here is the quantity which is demanded
or consumed under the quota,
and what we see is 
the equilibrium is exactly the same.
The price of the product will be the same,
the amount imported,
by definition, is the same, --
the quantity supplied 
domestically is the same.
The only difference is,
now, there's no revenues,
there's no tariff revenues.
Instead, we have these quota rents.
Notice that --
the cost of producing this good, --
by the world suppliers,
is less than the price 
the good sells for
in the domestic economy.
So, the difference between 
the price and the cost,
times the quantity gives 
what we call these, --
what we call quota rents.
And, now, I want to discuss 
who gets these quota rents?
Where do they go?
Who earns these quota rents?
So let's take a look at that.
So we know that with a tariff,
the domestic government
gets the revenues.
Who gets the quota rents?
There are really three possibilities.
First, a government 
could auction the right
to import to the domestic firms.
That right would give domestic firms
the right to buy the quota amount
on the world market,
at the low world-price,
and sell in the domestic market 
at the high domestic price.
That right is worth quite a bit
because you are buying low 
and selling high.
So if this right were auctioned off,
the auction revenues would 
flow to the government,
and the government would end up
with just as much revenues
as if there were a tariff.
So this situation would be 
perfectly equivalent to a tariff.
Surprisingly, it's rarely used.
Australia and New Zealand
have done this occasionally,
not so much today,
but, around the world,
this is rarely done,
auctioning off the right 
to import is quite rare.
What is more common is to give 
the right to import to domestic firms.
Now, again, remember that 
you're giving these domestic firms
the right to buy low and sell high.
And that's worth a lot.
In fact, Anne Krueger,
in 1974, calculated that in India,
the rents from the import licenses 
were around 5% of GDP,
and in Turkey, the rents from the import 
licenses were about 15% of GDP.
Really big numbers.
Now, if you were giving away 15% of GDP,
that's going to encourage firms 
to really compete to get those rents.
And this, in fact, is where the idea
of rent-seeking comes from.
The idea of rent-seeking 
is competition to obtain rents
which dissipates the rents.
So, in trying to get the rents,
these firms spend 
a lot of money on lobbying,
on paying bribes,
on waiting,
you know, in various capacities
to try and get these rents 
and the renter dissipated away,
wasted away.
Another way that these rents can be 
dissipated is through excess capacity.
So, for example, suppose that 
the government says,
"We're going to give
these rents away in proportion
to how much domestic firms 
are already producing."
In that case,
this gives domestic firms an incentive
to produce overcapacity,
to produce excess capacity.
So you get wasted investment in capacity
which is designed simply 
to grab up those rents.
Third thing which is often done,
is surprisingly again,
but to give the rights, 
not to domestic firms,
but to foreign firms or governments.
This was done by the Reagan administration
in the 1980s for example,
under the so-called 
voluntary export restraints,
under which Japanese automakers
voluntarily agreed
to send fewer cars to the United States.
Now, why would they do that?
Or why would the government?
Of course, this really wasn't voluntary.
Why would the government 
give away these rents to foreign firms,
instead of keeping the rents themselves,
instead of giving the domestic firms,
they give the rents to foreign firms.
Well, one reason is that --
the Japanese automakers 
might have complained bitterly
and might have lobbied 
extensively against a tariff
because that does them 
no good whatsoever.
On the other hand, a quota, --
which is given to the Japanese firms,
gives them the quota rents.
So they're going to be 
much less against protectionism
when it comes in the forms of a quota,
which goes to them,
rather than in the form of --
a tariff, the revenues of which 
would go to the domestic government.
How is the quota divided 
in the foreign country?
Well again, it's the foreign 
government or the foreign firms
which somehow must agree
how to split up the right to import
into the domestic economy,
into, say, the United States.
And this can create foreign rent-seeking.
This is another reason, 
by the way, why --
some large Japanese automakers
who, perhaps, are worried about
some upstart Japanese firms 
undercutting them;
they may again really want a quota,
because it cements their position.
It makes it harder for other firms 
in Japan to compete against them
by coming into the U.S. market because
they have wrapped up that quota,
they've grabbed up that quota.
Okay, those are the main issues 
with the quota rents.
Let's look at a few complications.
When we draw supply and demand curve,
we're implicitly assuming 
that "the good" is well defined.
Something like #2 hard red winter wheat.
Things get more complicated when 
the good could come in different qualities.
When we think about cars, for example,
there's a wide variety of qualities.
And, in this case, not only can tariffs
and quotas be suddenly different,
but the two main types of tariffs, 
their percentage tax or tariff like 10%,
also called an ad valorem tariff,
can have a different effect than 
the unit tax or the unit tariff,
the $10 tariff.
For example, --
let's suppose that the good costs $100.
If it's very well-defined, 
than a 10% tax, or tariff,
it's going to have the same effects
as a $10 per unit tariff.
However, if the good comes 
in a variety of qualities,
then these two tariffs 
can have different effects.
To understand this, let's think about 
quality as being more stuff.
So think about a higher 
quality car like a Lexus
as simply being twice 
the car that a Corolla is.
The Lexus has twice 
as much car-ness in it.
Well, in this case, --
if we have a 10% tax, --
well, the Lexus is twice as much --
of 10%, is twice as much car,
so there's no real difference 
between importing two Corollas,
paying two taxes of 10%,
or one Lexus and paying one tax of 10%.
Those are the same thing,
so there's really no bias.
On the other hand, suppose 
that we have a per car tax.
Well, in that case, a per car tax 
of $1000, let's say;
that's a much bigger increase 
in the price of a Corolla
than it is in the price of a Lexus.
So a per unit tax,
a per car tax will tend 
to encourage suppliers
to supply the higher-quality goods,
because the percentage increase 
in the price to the consumer will be less.
With the quota,
this is even more the case.
So imagine that we have, --
we're only allowed to import 1000 cars.
Well, in this case, you'd much rather
import the Lexuses than the Corollas.
One way of thinking about this is that, --
by importing the Lexuses, in a way,
you're almost evading the quota
because you're only allowed
a thousand cars,
but since the Lexus is twice a Corolla,
has twice as much car-ness,
it's like you're importing more.
It's like sneaking under the quota.
So what will happen is that 
a quota will tend to --
encourage the suppliers,
in this case the automakers, 
to supply more high-quality goods.
And in fact, what we had in the 1980s,
the voluntary export restraints 
against Japanese automobiles,
this is precisely the time 
that the Japanese suppliers
started to move into 
the higher quality production,
started to produce 
the Lexuses and so forth.
So a quota, when quality is a variable,
will tend to push the suppliers into
producing higher quality.
So Bhagwati first showed the equivalence 
of tariffs and quotas under competition.
He later showed that there could be
differences under monopoly
or other market structures.
For some of those differences,
you can look at the textbook
by Bhagwati and Srinivasan,
"Lectures on International Trade".
The whole issue of taxes 
and quality is a very large one.
I'm just going to mention
a few classic articles here.
Yoram Barzel's article, "An Alternative 
Approach to the Analysis of Taxation".
Remember that tariff 
is just a tax on imports,
so this literature applies 
both to tariffs and to taxes.
Tyler and I actually wrote a fun related
piece on the Alchian and Allen theorem.
And Kay and Keen have a piece 
looking at product quality --
under a specific or unit taxes 
and ad valorem or percentage taxes.
I pointed out that a quota 
will tend to encourage foreign firms
to invest in more quality,
to ship higher-quality goods,
because it's sort of a way of evading
the quota in some sense.
This is shown empirically
by Robert Feenstra,
looking at the trade restraints 
on Japanese automobiles in the 1980s.
This is a very good piece.
The idea of rent-seeking --
was, the term rent-seeking 
was first coined by Anne Krueger
who had those phenomenal statistics 
on the value of import licenses.
That's in this piece, "The Political Economy
of the Rent-Seeking Society".
The idea of rent-seeking is more general
and was first developed by Gordon Tullock.
Krueger sort of thought that 
rent-seeking only applied to licenses,
Tullock shows it's a much bigger idea.
It applies to tariffs, 
it applies to monopoly,
it applies to many other issues as well.
This is really a very important 
classic article by Tullock.
You can find it in 
the Western Economic Journal, but --
it's also available elsewhere 
on the web as well.
Thanks.
