International Trade - Theory and Policy, 2010a

Next, consider the effects in this market when there is an increase in domestic supply, represented by a
rightward shift of the supply curve. A supply increase could arise because of falling production costs or
due to improvements in productivity.
With a tariff in place initially, the increase in domestic supply will leave the domestic price unaffected.
Because this is a small country, the world price does not change and thus the domestic tariff-inclusive
price remains at PT = PFT + T. However, because domestic supply is now higher at every price, at the
price PT, supply equals domestic demand of DT. This means that with the tariff, imports are reduced to
zero.
With a quota in place initially, the increase in domestic supply causes the domestic price to fall back to the
free trade level in order to maintain the import level at the levelQT (the lower blue line segment).
Domestic supply will rise to S′Q with the decrease in price, while domestic demand also will rise to D′Q.
Since the domestic price rises more with the tariff in place than with the quota, domestic producers will
enjoy a larger supply (DT vs. S′Q) and consequently a higher level of producer surplus (not shown). Thus
the tariff is more protective than a quota in the face of an increase in domestic supply.
A Decrease in the World Price
Again, consider a small importing country. In Figure 7.30 "Effects of a World Price Decrease", PFT is the free
trade price. If a tariff of T is put into place, the domestic price rises to PT and imports equal DT − ST. A
quota set equal to QT (the blue line segment) would generate the same increase in price to PT and the
same level of imports. Thus the tariff T and quota QT are said to be equivalent to each other.
Figure 7.30 Effects of a World Price Decrease
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