Equivalence and difference between Tariff & Quota, describe the difference. The diagram describes the domestic situation in the car market of a small car-importing nation that faces infinitely elastic export supply on the world market.
In the case of Tariff
In the absence of international trade, the domestic price is P1, while under free trade the price (world price) is P2 and ab (-cd) units are imported.
A tariff (t) raises the domestic price to P3 and imports are reduced to gh (=ef). The same effect on the domestic price and the volume of imports would be produced if the govt. imposed on import quota of gh.
The only difference is the shaded area. It represents govt. revenue in the case of a tariff and quota rents, occurring to the holders of the import licenses, in case of a quota.
If conditions were perfectly competitive in all markets if the demand and supply curves were stationary, and import licenses were auctioned to produces the same govt. revenue as under the tariff, the effects of a tariff and a quota could be identical. This is referred to as the equivalence of a tariff and a quota.
Such “equivalence” holds if three conditions are met, the import licenses are auctioned off by the govt. the demand and supply curves are stationary, and perfect competition prevails in all markets.
Suppose there is an upward shift in domestic demand to D’ under a tariff (t) the domestic price can never exceed world price P2 plus the tariff.
It, therefore, remains at P3, and the volume of imports rises from ef to ei. In other words, the increase in demand is accommodated by an increase in imports.
In the case of Quota
On the other hand, in the case of the import quota, quantity adjustments are not possible, the volume of imports is fixed at ef.
Consequently, the upward shift in demand will produce a price adjustment. Domestic price rises to P4, where the quantity imported remains unchanged at jk=ef.
The shift in Demand In case of a decrease in domestic demand or an increase in domestic supply, the domestic price would decline under a quota, with the quantity imported remaining unchanged, while the volume of imports would decline under a tariff with the price remaining unchanged.
The general conclusion is that the adjustment to any shift in demand or supply occurs in the number of imports in the case of a tariff and in the domestic price in the case of quota.
A Tariff and Quota when Domestic Demand Rises
A quota is more harmful to welfare. In this diagram, it is shown as triangles cem and nfd. Strongly from this position of equivalence, consider first a rise in domestic demand for the commodity.
This is portrayed in the diagram as a rightward shift to D’, with a tariff t, the price remains at P3, the quantity imported rises to ei = gb, and the welfare loss becomes triangles cem and dil, it remains roughly unchanged, with quota gh, the prices rises to P4, where the quantity imported remains unchanged at jk=gh.
The welfare loss from a quota is greater, for it consists of the larger triangle, Cjq, and rkl. The equivalence of a tariff and a quota is broken. A quota is more harmful to welfare.
Another possible difference between a tariff and a quota is suggested by the theory of effective protection.
Import duties on raw material are sometimes rebated when the final product is exported no such rebate occurs in the case of quotas.
Domestic Producer Momoplist
The third important difference is that in the case of quota the domestic producer becomes a monopolist while in the case of tariff it is not like that.
Tariff does not provide protection with certainty, but certainty is guaranteed in the case of a quota.
Import quotas require a cumbersome administrated apparatus. The system contains the seeds of corruption. Usually, the import permits are given to domestic importers, so they collect the rents. But if foreigners receive the licenses, then the rents may be captured by them.