The following are important economic effects of import quotas:
The Price Effect:
Import quotas, by limiting physical quantities, tend to raise the prices of commodities to which they apply. While this is generally, true also of a tariff, there is one important difference in the impact of quotas. Mostly, the rise in price caused by a tariff is limited to the amount of the duty imposed, less any decrease in price abroad. Thus, the range of the price change due to tariff can well be circumscribed.
In contrast, a quota can raise price to any extent, since it places an absolute limit upon the volume of imports and leaves price determination in the domestic market to the interaction of supply and demand force.
The price effect of quotas is, thus, related to: (i) the restrictiveness of the quota, i.e., the degree to which the supply of imported commodity is restricted; (ii) the degree of elatisticity of domestic and foreign supply of the commodity; and (iii) the nature of the demand, i.e., the intensity or elasticity of demand for the commodity in the importing country. Hence, the price change due to quotas is far less predictable.
The effect of an import quota upon the price of commodity may be illustrated diagrammatically as in.
In, DD is the domestic demand curve. Under free trade, the equilibirum price settles at PM (or OP ), the quantity traded being OM. If the importing country imports a fixed quota to the amount OM1, then the relevant import supply schedule assumes the form IQS1 Thus, the QS1 segment of the import supply curve implies that supply in excess of the quota limit is perfectly inelastic, the new equilibrium price is set at P1M1 (or OP1). Thus, it is obvious that, the extent of the price rise will be different under different conditions of demand and supply.
The Terms of Trade Effect :
As a result of the fixing of import quotas, the terms of trade of a country change. The new terms of trade may be either more or less favourable to the country importing the quota.
The terms of trade are generally improved by a quota, to the extent that the foreign offer curve is elastic. If the foreign exporters of the commodity are well-organised and the offer curve is less elastic, the terms of trade may move against the country imposing quota. But, if the foreign offer curve is more elastic, the terms of trade may move favourably to the country imposing the quota. To illustrate the point, we may follow Kindleberger, in drawing.
In, OE is the curve of England, exporting cloth. OP is the offer curve of Portugal, exporting wine. Under free trade, OA represents the terms of trade. Now, if we assume that England limits her imports of Portuguese wine to OB, the terms of trade would change. The new terms of trade between English cloth and Portuguese wine may be OA or OA or any price in between, depending upon the degree of elasticity of the offer curve of Portuguese wine. Obviously, OA is favourable to England while OA terms of trade are unfavourable to it.
The Balance of Payments Effect :
It has been argued that import quotas can also serve as a useful means for safeguarding the balance of trade. By restricting imports, quotas seek to eliminate deficit and influence the balance of payments situation favourably. Further, it is usually assumed that administrative reduction of imports, through import quotas, would be a less harmful measure for correcting disequilibrium in the balance of payments than such microeconomic measures like deflation or devaluation.
Moreover, there is a greater expansive income effect of quotas, considered important for underdeveloped countries which usually suffer from balance of payment difficulties resulting from domestic inflation. Due to import quotas, the marginal propensity to import becomes zero after the quota limit is reached, which thus, reduces leakages and increase the value of income multipliers in the country.
Other Miscellaneous Effects :
Another important effect of quotas is that they have a protective effect. By limiting imports to a fixed amount, irrespective of supply and demand conditions or prices in the domestic or foreign markets, import quotas may tend to be absolutely protective. They stimulate home production.
Further, import quotas raise domestic prices, causing reduction in overall consumption. This is the consumption effect of quotas. They tend to discourage consumption of imported goods as also domestic consumption of goods involving foreign raw materials, since the prices of these goods rise due to the artificial scarcity created by import restriction.
Another effect of quota is found to be the redistribution effect. When prices rise, there is redistribution of income from consumers to producers. The domestic producers' receipts increase when prices of goods rise and the consumers' surplus in these goods decreases. Hence, there is a redistribution effect.
All these effects, viz., protective, consumption and redistribution effects, can be depicted in a partial equilibrium diagram originated by Kindleberger.
In, OP3 is the equilibrium price, equating domestic demand (DD) and is supply (SS) in a closed economy. If, however, the country imports and we assume that OP1 is the price settled, then OM4 demand is satisfied by OM1 domestic supply and M1M4 import of goods. If we assume that the foreign supply of imports is perfectly elastic, and an import quota is fixed upto M2M3 the foreign offer price remains unaffected but the home price of the commodity would rise from OP1 to OP2 assuming it to be equal to a tariff imposition of P1P2.. This rise in price (P1P2) is the price effect of quota (same as tariff) which stimulates domestic production of the commodity to increase from OM1 to OM2. Thus, M1M2 is the protective effect. However, it reduces home consumption from OM4 to OM3 Thus, MM2 reduction is the consumption effect. Further, the domestic producers' receipts increase by the area P1 ea P2 which is derived by subtraction from consumers' surplus. Thus, P1 ea P2 is the redistribution effect.
When the domestic demand and supply curves of a commodity are not particularly inelastic, these effects of an import quota are similar to tariff effects. Hence, under such a situation, it makes no difference whether a country imposes a tariff or a quota. Thus., in the above diagram, instead of import quota M2MV if a tariff of P1P2 per unit were imposed on imports, the effects would be the same. There is, however, one significant distinction between a tariff and a quota in regard to revenue effect.
To see the revenue effect of tariff we have to multiply the quantity imported by the duty imposed per unit. Thus, in the above diagram, the area abed would be collected as governmental revenue in the importing country (for import duty (PlP2) x import quantity (M2M3) is equal to abed). This is the revenue effect. Now, instead of tariff, if a quota M2M3 is imposed, the prices of imports rise to OP2. Obviously then it is the importer who gets this high domestic price for the commodity and enjoys extra profit; the government does not get any revenue, except what may be received by way of licence fee, for issuing the import licence. However, there is one possbility; the government, by auctioning off import licences, can obtain this extra price and profit as its revenue. In such a case, quota becomes equal to tariff in revenue effect also. But usually auction of import licences is not widely used. Importers, therefore, benefit most under quota system and the government under tariffs.