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# Quotas

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Some people are familiar with the term "quota" and its general definition but that's about it. Did you know there are different types of quotas? Have you ever wondered what impact quotas have on the economy? Can you explain the differences between a quota and a tariff? These are just some of the questions that this explanation will answer. We will also go over some examples of quotas and the disadvantages of setting quotas. If that sounds interesting to you, stick around, and let's get started!

## Quota Definition in Economics

Let's start with the quota definition in economics. Quotas are a form of regulation that is usually set in place by the government to limit the quantity of a good. Quotas can be used to regulate prices and restrict the amount of international trade in an economy.

A quota is a regulation set in place by the government that restricts the quantity of a good over a certain period.

Deadweight loss is the combined loss of consumer and producer surplus due to the misallocation of resources.

Quotas are a type of protectionism meant to keep prices from falling too low or rising too high. If the price of a good falls too low it becomes difficult for producers to remain competitive and might force them out of business. If the price is too high, consumers will not be able to afford it. A quota can be used to regulate or restrict trade by limiting the number of imports and exports of a certain good. Quotas can also be used to limit the production of a good. By regulating the quantity produced, the government can influence the price level.

Since quotas interfere with a market's natural level of price, demand, and production, they are often seen as hurting trade and the economy even if domestic producers enjoy higher prices. Much like a price floor, the quota prevents the market from reaching its natural equilibrium by keeping domestic prices above the global market price. This creates deadweight loss, or net efficiency loss, which is the combined loss of consumer and producer surplus due to the misallocation of resources.

The government may choose to set a quota for several reasons.

1. To limit the amount of a good that can be imported
2. To limit the amount of a good that can be exported
3. To limit the amount of a good produced
4. To limit the amount of a resource being harvested

There are different types of quotas to achieve these different results.

Does deadweight loss seem like an interesting topic to you? It is! Come check out our explanation - Deadweight Loss.

## Types of Quotas

A government may choose from several types of quotas to accomplish different results. An import quota will limit the amount of a good that can be imported while a production quota can limit the quantity produced.

 Type of Quota What it does Production Quota A production quota is a supply restriction that is used to increase the price of a good or service above the equilibrium price by creating a shortage. Import Quota An import quota is a limit on how much a specific good or type of good can be imported into the country in a certain time period. Export Quota An export quota is a limit on how much of a specific good or type of good can be exported out of a country in a certain time period.

Table 1 shows three main types of quotas, however, there are many more types of quotas depending on the industry. For example, fisheries are an industry that is often subject to the limits set by quotas as a way of protecting fish populations. These types of quotas are called Individual Transferable Quotas (ITQ) and are distributed in the form of quota shares that give the shareholder the privilege to catch their specified portion of that year's total catch.1

### Production Quota

A production quota can be set by a government or organization and set on a country, industry, or firm. A production quota can both increase or decrease the price of a good. Limiting the quantity of the goods produced drives prices up, while setting higher production goals will put downward pressure on prices.

When quotas limit production, pressure is put on consumers and causes some of them to be priced out of the market resulting in deadweight loss.

Fig. 1 - Effect of a production quota on price and supply

Figure 1 shows when a production quota is set and reduces the supply of a good by shifting the curve from S to S1, the price increases from P0 to P1. The supply curve also changes from an elastic state to a perfectly inelastic state which results in a deadweight loss (DWL). The producers benefit by gaining the producer surplus from P0 to P1 at the cost of consumer surplus.

Elastic? Inelastic? In economics, elasticity measures how responsive demand or supply is to a change in the market price. There's more on the topic here!

- Elasticities of Demand and Supply

### Import Quota

An import quota will limit the amount of a certain good that can be imported. By placing this restriction, the government can prevent the domestic market from being flooded with cheaper foreign goods. This protects domestic producers from having to lower their prices to remain competitive with foreign producers. However, while domestic producers whose products are covered by the quotas benefit from the higher prices, the cost of the import quota to the economy in the form of higher prices is consistently greater than the benefit to the producer.

Fig. 2 - An Import Quota Regime

Figure 2 shows the effect of an import quota on the domestic economy. Before the import quota, domestic producers produced up to Q1 and imports satisfied the rest of domestic demand from Q1 to Q4. After the quota is set, the number of imports is limited to Q2 to Q3. This increases domestic production up to Q2. However, since supply is now reduced the price of the goods increases from P0 to P1.

#### Two Main Types of Import Quotas

 Absolute Quota Tariff-Rate Quota An absolute quota sets the amount of a good that can be imported in a period. Once that amount is reached, no more can be imported until the next period. A tariff-rate quota combines the concept of a tariff into the quota. A limited number of goods may be imported at a reduced tariff or tax rate. Once that quota is reached, the goods are taxed at a higher rate.
Table 2 - Two Types of Import Quotas

A government may choose to implement a tariff-rate quota over an absolute quota because with the tariff-rate quota they earn tax revenue.

### Export Quota

An export quota is a limit on the amount of a good that can be exported out of a country. A government might elect to do this to support the domestic supply of goods and control prices. By keeping domestic supply higher, domestic prices can be kept lower, benefiting consumers. The producers end up earning less since they are forced to accept the lower prices and the economy suffers reduced export revenue.

Imports and exports don't end with quotas. There is so much more to learn about both topics! Have a look at our explanations:

## Difference Between Quotas and Tariffs

What exactly is the difference between quotas and tariffs? Well, where a quota limits the number of goods available, a tariff does not. Quotas also do not generate revenue for the government while a tariff makes people pay taxes on the goods they import. A tariff is also only applied to imported goods whereas quotas can be found in other parts of the economy.

A tariff is a tax that is applied to imported goods.

We cannot say that quotas do not generate any revenue at all. When quotas are put in place, the price of the goods rises. This increase in the revenue that foreign producers earn as a result of the higher prices after a quota has been set is called quota rent.

Quota rent is the additional revenue foreign producers earn as a result of the domestic price increase associated with a reduced supply.

 Quota Tariff Limits the number or total value of goods that can be imported, exported, or producedIncreases prices if it creates an artificial shortage in the market, reduces prices if it creates an artificial surplus in the marketWith import quotas, foreign producers gain revenue in the form of quota rents Do not limit the number of goods being imported Increases prices because the tax burden incurred by importers is transferred to consumers through increased sales pricesThe government earns revenue in the form of tariff revenueForeign producers and domestic importers do not profit from tariffs
Table 3 - Difference Between Quotas and Tariffs

When the goal is to reduce the number of goods in a market, a quota is a more effective route since it caps the quantity of a good available by limiting its production, imports, or exports. In this case, tariffs serve as more discouragement to consumers from buying the goods since they are the ones who pay the higher price. If a government is looking to earn revenue from a good, they implement tariffs, because the importing party must pay the tariff to the government when they are bringing the goods into the country. However, to avoid reduced profits, the importing party will increase the sales price of the goods by the amount of the tariff.

In terms of protecting domestic industries, quotas are a better option than tariffs since import quotas are a more reliable method of actually reducing competition with imported goods.

In the end, both quotas and tariffs are protectionist measures that reduce the number of goods in a market and cause domestic consumers to experience price increases. The higher prices result in some consumers being priced out of the market and produce a deadweight loss.

Do you think you understood everything about tariffs? Make sure by reading our explanation on them to be sure! - Tariffs

## Examples of Quotas

It's time to look at some examples of quotas. If you are not the one doing the producing, importing, or exporting, quotas can sometimes fly right over our heads. As a population, we are used to inflation and taxes causing prices to rise, so let's see how a production quota might push prices up.

An example of a production quota is the Organization of Petroleum Exporting Countries (OPEC) assigning minimum oil production quotas to its member countries to increase oil production and combat high oil prices.

After the drop in oil demand in 2020, the oil demand was rising again, and to keep up with demand, OPEC assigned each member nation a production quota.2 In April of 2020, when COVID19 hit, oil demand dropped and OPEC slashed its oil supply, to accommodate this shift in demand.

Two years later in 2022, oil demand was rising back to its former level and prices were rising. OPEC was attempting to close the resulting supply gap by increasing the individual production quotas for each member nation month by month.2 The goal of this was to bring down oil prices or at least stop them from rising even more.

More recently still, in the Fall of 2022 OPEC+ decided to once again cut oil production as the price, in their view, had fallen too far.

An example of a production quota limiting production would look like this example.

To be a taxi driver in New York City, you must hold 1 of 13,587 medallions that are auctioned off by the city and can be bought on the open market.3 Before the city required these medallions, many different companies competed with each other, which drove prices down. By requiring a medallion, and only producing a set number, the city has limited the supply of taxis in New York City and can keep prices high.

An example of an import quota would be the government restricting the number of oranges that can be imported.

The Market for Oranges

Fig. 3 - An Import Quota on Oranges

The current world market price for a pound of oranges is $1 per pound and the demand for oranges in the US is 26,000 pounds of oranges. The US places an import quota of 15,000 pounds of oranges. This drives the domestic price up to$1.75. At this price, domestic producers can afford to increase production from 5,000 to 8,000 pounds. At \$1.75 per pound, the US demand for oranges decreases to 23,000 pounds.

An export quota prevents goods from leaving a country and reduces domestic prices.

Let's say that Country A produces wheat. They are the world's leading wheat producer and export 80% of the wheat they grow. Foreign markets pay so well for wheat that manufacturers can earn 25% more if they export their products. Naturally, they want to sell where they will bring in the most revenue. However, this is causing a shortage in Country A for a good that they themselves produce!

To help domestic consumers, Country A places an export quota on the amount of wheat that can be exported to other countries. This increases the supply of wheat on the domestic market and lowers the prices making the wheat more affordable for domestic consumers.

Let's group the disadvantages of a quota system. Quotas can seem beneficial at first but if we take a closer look, we can see that they overwhelmingly limit the development and growth of an economy.

Quotas are meant to regulate domestic prices. Import quotas keep domestic prices high to benefit the domestic producer, but these high prices come at the cost of the domestic consumer who must also pay the higher prices. These high prices also reduce the overall level of trade a country engages in because foreign consumers will reduce the number of goods they buy if prices rise, which reduces the country's exports. The gains that producers make typically do not exceed the cost to consumers of these quotas.

These import quotas also do not earn the government any money. The quota rents go to foreign producers who sell their goods on the domestic market at a higher price. The government gains nothing. A tariff would increase prices as well but would at least benefit the government so that it could increase spending in other sectors of the economy.

Export quotas have the opposite effect of import quotas, except that they also do not benefit the government. Doing the opposite of import quotas does not make them less limiting to the economy as a whole. Where they benefit consumers by lowering the price of a good, we sacrifice the potential revenue producers could have made and then reinvest into their business.

When a quota limits the production of a good, it is both the consumer and producer that suffer. The resulting increase in prices negatively impacts the consumer, while the producer loses out on potential revenue by producing under their maximum or desired output level.

## Quotas - Key takeaways

• A quota is a regulation set in place by the government that restricts the quantity of a good over a certain period.
• Three main types of quotas are import quotas, export quotas, and production quotas.
• A quota limits the overall quantity of goods in a market, whereas a tariff does not. They both increase the price of goods.
• When a government wants to reduce the amount of a good in the market, a quota is the most effective route.
• A disadvantage of quotas is that they limit an economy's development and growth.

## References

1. Eugene H. Buck, Individual Transferable Quotas in Fishery Management, September 1995, https://dlc.dlib.indiana.edu/dlc/bitstream/handle/10535/4515/fishery.pdf?sequence
2. Lutz Kilian, Michael D. Plante, and Kunal Patel, Capacity Constraints Drive the OPEC+ Supply Gap, Federal Reserve Bank of Dallas, April 2022, https://www.dallasfed.org/research/economics/2022/0419
3. Yellow Cab, Taxi & Limousine Commission, https://www1.nyc.gov/site/tlc/businesses/yellow-cab.page

A quota is a regulation set in place by the government that restricts the quantity of a good over a certain period.

Quotas are meant to keep prices from falling too low or rising too high.

Three main types of quotas are import quotas, export quotas, and production quotas.

When the goal is to reduce the number of goods in a market, a quota is a more effective route since it caps the quantity of a good available by limiting its production, imports, or exports.

Quotas affect the economy by influencing domestic prices, production levels, and by reducing imports and exports.

## Quotas Quiz - Teste dein Wissen

Question

What is a quota?

A quota is a regulation set in place by the government that restricts the quantity of a good over a certain period.

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Question

Deadweight loss is the combined loss of consumer and producer surplus due to the misallocation of resources.

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Question

What is the purpose of a quota?

Quotas are a type of protectionism meant to keep prices from falling too low or rising too high.

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Question

___________ is the additional revenue foreign producers earn as a result of the domestic price increase associated with a reduced supply.

Quota rent

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Question

True/False: Like a tariff, a quota only applies to imported goods.

False, they can apply to production and exports as well.

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Question

True/False: The benefits of a quota to producers outweigh the costs to consumers.

False. The gains that producers make typically do not exceed the cost to consumers of these quotas.

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Question

If a government wants to earn a share of import profits, should they employ a quota or a tariff?

A tariff, quotas do not earn the government any money.

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Question

What is a combination of a tariff and a quota called?

A tariff-rate quota.

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Question

If a country is experiencing a shortage of textiles because foreign prices are higher than domestic prices and producers are exporting all their goods, what can the government do?

They can set an export quota to limit the number of textiles that can be exported.

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Question

A firm is producing hundreds of thousands of cheap cars and flooding the market causing prices to fall. What can the government do to limit the number of cars this firm is producing?

They can set a production quota that limits the number of cars this firm can produce in a year.

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Question

When is a quota more effective than a tariff?

A quota is more effective when the government wants to actively limit the amount of a good in the economy.

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Question

How do import quotas increase domestic prices, and who benefits from this?

They increase domestic prices by reducing the total number of goods available in the domestic market. Producers benefit because they are able to sell their goods at a higher price since they do not have to compete with foreign producers anymore.

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Question

How do quotas cause deadweight loss?

The quota prevents the market from reaching its natural equilibrium by keeping domestic prices above the global market price, making it inefficient.

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Why might a government choose to set a quota?

To limit the amount of a good being imported, exported, produced, or harvested.

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How might quotas be used to protect natural resources?

Quotas like Individual Transferable Quotas (ITQ) can be used to limit the number of natural resources that can be harvested, like fish and catch quotas that limit the number of fish that can be caught.

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