Trade policies like tariffs, subsidies, and quotas shift supply and demand curves, impacting market equilibrium. These interventions affect prices, quantities, and welfare for producers, consumers, and governments. Understanding these shifts is crucial for analyzing the economic impacts of trade policies.

Supply and demand analysis reveals the distributional effects and overall welfare consequences of trade policies. Tariffs and quotas typically benefit producers at the expense of consumers, while subsidies can benefit both but at a cost to the government. The net welfare effect depends on policy specifics and market conditions.

Trade Policy Analysis Using Supply and Demand

Supply and demand in trade policies

• Trade policies shift supply or demand curves in the market
  • Tariffs and quotas reduce supply by shifting the supply curve to the left (import restrictions)
  • Subsidies increase supply by shifting the supply curve to the right (domestic production incentives)
• New market equilibrium determined by the intersection of the new supply and demand curves
  • Results in a new equilibrium price and quantity
• Magnitude of the shift in supply or demand depends on the size of the trade policy intervention
  • Higher tariffs or more restrictive quotas lead to larger shifts in the supply curve (greater import reduction)
  • Higher subsidies lead to larger shifts in the supply curve (greater domestic production increase)

Effects of tariffs, subsidies, and quotas

• Tariffs
  • Increase domestic price of the imported good (price hike for consumers)
  • Decrease quantity of imports demanded (reduced foreign competition)
  • Increase quantity of domestic production (import substitution)
  • Reduce consumer welfare and increase producer welfare (redistribution effect)
• Subsidies
  • Decrease domestic price of the subsidized good (price reduction for consumers)
  • Increase quantity of domestic production (production incentive)
  • Increase quantity of exports if applicable (export promotion)
  • Increase consumer welfare and producer welfare at a cost to the government (budget burden)
• Quotas
  • Increase domestic price of the imported good (price hike for consumers)
  • Decrease quantity of imports to the quota limit (import restriction)
  • Increase quantity of domestic production (import substitution)
  • Reduce consumer welfare and increase producer welfare (redistribution effect)
  • Generate quota rents for license holders (windfall gains)

Distributional impacts of trade policies

• Producers
  • Benefit from higher prices and increased domestic production under tariffs and quotas (protection from foreign competition)
  • Benefit from subsidies that lower production costs and increase domestic production (production incentives)
• Consumers
  • Face higher prices and reduced consumption under tariffs and quotas (welfare loss)
  • Benefit from lower prices and increased consumption under subsidies (welfare gain)
• Government revenue
  • Tariffs generate revenue for the government (tax revenue)
  • Subsidies require government expenditure (budget outlay)
  • Quotas do not directly generate revenue for the government but quota licenses can be auctioned off (revenue potential)

Welfare analysis of trade policies

• Consumer surplus
  • Decreases under tariffs and quotas due to higher prices and reduced consumption (welfare loss)
  • Increases under subsidies due to lower prices and increased consumption (welfare gain)
• Producer surplus
  • Increases under tariffs and quotas due to higher prices and increased domestic production (welfare gain)
  • Increases under subsidies due to lower production costs and increased domestic production (welfare gain)
• Deadweight loss
  • Tariffs and quotas create deadweight loss by distorting market outcomes away from the efficient equilibrium (efficiency loss)
  • Subsidies create deadweight loss by encouraging overproduction and overconsumption relative to the efficient equilibrium (efficiency loss)
• Net welfare effect
  • Tariffs and quotas reduce total welfare (consumer surplus + producer surplus) due to the deadweight loss (net welfare loss)
  • Subsidies can increase or decrease total welfare depending on the size of the subsidy and the elasticities of supply and demand (ambiguous welfare effect)