Quotas

An import quota is limit on the import of a good imported into a country or economic area. The limit is typically on the quantity of a good imported, although it could be a limit on the total value, volume, or weight. For example, a country in South East Asia restrict the quantity of imports of motor vehicles from the EU.

There are several reasons why countries or economic areas might impose a quota, including:

To protect a domestic industry from low priced imports.
To reduce imports and hence improve the current account balance.
To restrict the import of harmful demerit goods or goods which generate negative externalities.

The effects of a quota

In the diagram below, P and Q represent the domestic price and quantity of orange juice in Malaysia ^[1], assuming there is no importation of orange juice.

If Malaysia opens up to free trade, we assume that the world supply of orange juice is perfectly elastic, and that the world price (Pw) is below the domestic price.

Without protection, domestic producers share of the market would fall to Q2 and there would be imports of juice of Q1 to Q2.

This would be detrimental to domestic producers, with rising unemployment. A quota would provide some protection.

If the quota is set at quantity Q2 to Q3, imports shrink to Q2 to Q3.

However, at the world price Pw there is an excess of demand over supply, and the domestic price of juice rises to Pq. This will act as an incentive to domestic producers who respond to the higher price by producing more. The effect of this on the diagram is to create a new supply curve, S1 reflecting the increased supply of domestic producers. The excess demand is reduced until it is eventually eliminated at price Pq.

The market settles at a new equilibrium of Pq and Q4. The net result is that domestic producers have benefitted as their share of the juice market has increased considerably. Overseas suppliers now supply much less, but they do benefit from the higher price of Pq (rather than Pw).

Summary

Evaluation of quotas

Consumers in Malaysia pay a higher price for juice, and consume less, compared with the free trade situation.
Malaysian orange juice producers gain by selling more, and at a higher price.
Overseas producers lose market share, but do sell at a higher price.
There is a welfare loss of area a x y compared with the free trade situation. Consumer surplus is now the area k a Pq, and total producer surplus is composed of domestic producer surplus, and overseas producer surplus - the area Pq a y Pw.
The higher price may encourage more inefficient orange juice producers to enter the market.
Unlike tariffs, domestic governments earn no direct revenue from a quota.
Quotas are a very blunt tool to control imports, and countries have tended to rely much more on tariffs, and other non-tariff measures.