Panel (b) of Exhibit 8 shows the distribution and efflciency eifects of the quota'As a result of.the quota' U.5. consumer surplus declines by the combined biue and pink areas. Area a becomes producer surplus and thus invoives no loss of U.S' welfare' Area c shows the increased economic profit to those permitted by the-q,ro,u ,o sell Americins 3o miliion pounds for $o'r5 pu, pouna, or $o.o5 above the world price' If foreign "*por,"r, rather than U.S. importers reap this profit' area c reflects a net loss in U'S' welfare' Areab shows a welfare loss to the U'S' economy' because sugar could have been purchased abroad for io.ro p"t iorrnd, and the U'S' resources employed to increase sugar production could have been used more efficientt-y proaucing other goods' Area d is also a welfare loss because it reflects a reduction in consumer surplus with no offsetting gain to anyone' Thus, areas b and d in panei (b) of Exhibit 8 measure the minimum U.S' welfare loss from the quota' If the frofit from quota dghts (area c) accrues-to foreign prodrr.err, this increases the U'S' welfare loss' Quotas *m Practsee The United States has granted quotas to specific countries. These countries, in turn' distribute these q"o," tignO to their exporters tfrro.uSh a variety of i-,u"r,t. iy rew ar ding domestic and foreign producers with higher prices, the quota system creotes two -groups inlent oi rrriring and'perpetuating these quotas' Lobbyists for foreign producers work the halls of Congress' seeking tf,e rlghl to export to the United States' This strong r"pp"t, from pioducers, coupled with a lack ofoppo- sition from consumers (who remain rationally igno- rant for the most part), has resulted in quotas that have lasted decades. For example, sugar quotas have been around more than 50 years' In January zoog' the world price of sugar was about $o'rz a pound' but U.S. businesses that need sugar to make products' su.h u, candy, paid more than $o'zo a pound' costing consumers an extra $z billion annualiy' Sugar grow- "rr, *ho account for only r percent of-U,S' farm sales' have accounted for r7 percent of political contribu- tions from agriculture since r99o'1 Some economists have argued that if quotas are to be used, the United States should auction them off to foreign producers, thereby capturing at }east some of the dlfference between the world price and the U'S' pri.". A.t.tioning off quotas would not only increase federai revenue Uut would reduce the profitability of qrro,"r, which would reduce pressure on V/ashington i'.'fvfoLurf Schroeder, "Sugar Growers Hold Up Push for Free Trade"' Wall Street Journal 3 February 2004' 266 PART 4 Ilrl"rr'ariurlrr \l.) :oL cr't0 rt'cs T .{: # E ')*, 91 r; .f i:: to perpetuate them' Anencar "li:;n:eis are li:: ,f-t" o"iy victims of sugar quolas' lbousands oi ?::: farmeri around the world miss oui on an oppor:'-- nity to earn a living growing sugarcane for export.

1. Panel (b) of Exhibit 8 shows the distribution and
efflciency eifects of the quota'As a result of.the
quota'
U.5. consumer surplus declines by the combined
biue
and pink areas. Area a becomes producer surplus
and
thus invoives no loss of U.S' welfare' Area c shows
the
increased economic profit to those permitted by the-q,ro,u
,o sell Americins 3o miliion pounds for $o'r5
pu, pouna, or $o.o5 above the world price' If foreign
"*por,"r,
rather than U.S. importers reap this profit'
area c reflects a net loss in U'S' welfare'
Areab shows a welfare loss to the U'S' economy'
because sugar could have been purchased abroad
for
io.ro p"t iorrnd, and the U'S' resources employed
to increase sugar production could have been used

2. more efficientt-y proaucing other goods' Area d is
also a welfare loss because it reflects a reduction in
consumer surplus with no offsetting gain to anyone'
Thus, areas b and d in panei (b) of Exhibit 8 measure
the minimum U.S' welfare loss from the quota' If the
frofit from quota dghts (area c) accrues-to
foreign
prodrr.err, this increases the U'S' welfare loss'
Quotas *m Practsee
The United States has granted quotas to specific
countries. These countries, in turn' distribute these
q"o," tignO to their exporters tfrro.uSh a variety of
i-,u"r,t. iy rew ar ding domestic and foreign producers with
higher prices, the quota system creotes two -groups
inlent
oi rrriring and'perpetuating these quotas' Lobbyists for
foreign producers work the halls of Congress'
seeking
tf,e rlghl to export to the United States' This strong
r"pp"t, from pioducers, coupled with a lack ofoppo-
sition from consumers (who remain rationally

3. igno-
rant for the most part), has resulted in quotas that
have lasted decades. For example, sugar
quotas have
been around more than 50 years' In January
zoog' the
world price of sugar was about $o'rz a pound' but
U.S. businesses that need sugar to make
products'
su.h u, candy, paid more than $o'zo a pound' costing
consumers an extra $z billion annualiy' Sugar grow-
"rr,
*ho account for only r percent of-U,S' farm sales'
have accounted for r7 percent of political contribu-
tions from agriculture since r99o'1
Some economists have argued that if quotas are
to be used, the United States should auction
them off
to foreign producers, thereby capturing at
}east some
of the dlfference between the world price
and the U'S'

4. pri.". A.t.tioning off quotas would not only increase
federai revenue Uut would reduce the
profitability of
qrro,"r, which would reduce pressure on
V/ashington
i'.'fvfoLurf Schroeder, "Sugar Growers Hold Up
Push for Free Trade"'
Wall Street Journal 3 February 2004'
266 PART 4 Ilrl"rr'ariurlrr l.) :oL cr't0 rt'cs
T
.{:
#
E
')*,
91
r;
.f
i::
to perpetuate them' Anencar "li:;n:eis
are li::
,f-t" o"iy victims of sugar quolas' lbousands oi ?:::
farmeri around the world miss oui on an oppor:'--
nity to earn a living growing sugarcane for export

5. to
America.
TarFffs end Quotas ewmPared
Consider the similarities and differences between
a
tariff and a quota. Because both have identical effects
on the price in our exampie, they both lead to the
,"*" .h"r,ge in quantity demanded' In both cases'
U.S. consumers suffer the same loss of consumer
surplus, and U'S. producers reap the same gain of
proit."t surplus. rhe primary difference is that the
,"o"rrrru from the tariff goes to the U'S' government'
whereas the revenue from the quota goes to whom-
ever secures the right to seil foreign goods in the
U.S. market. IJ quota-rights accrue to foreigners' then
the
domestic ,rono*y is worse off with a quota than with
a
tariff. But even if quota rights go to domestic import-
urr,'qrro,ut, like iariffs, still increase the domestic
price, restrict quantity, and thereby reduce consumer

6. irtptu, and ectnomic welfare' Quotas and tariffs can
"tro
,"ir" production costs' For example' U'S' candy
manufacturers face higher production costs because
of ,rrg", quotas, making them less competitive on
-orti-"itets. Finaliy, and most importantiy'
quo-
tas and tariffs encourage foteign governme-nls to
retali-
ie witn quito, and tartffs of their orun' thus shrinking
U.S. expoit markets, so the loss is greater than
shown in
Exhibits 7 and8.
Sttrer Trade Restrieticms
Besides tariffs and quotas, a variety of other measures
limit free trade. A country may provide export
subsidies
to encourage exports and low-interestloans to
foreign
brryurr. S o rie c ountrie s irnp o s e dome strc co-ntent r e
quir e -
ments specifying that a certain portion of a final
good

7. must bL ptoalri"a domestically' other requirements
.on.eming health, safety' or technical standards
often discriminate against foreign goods' For
exampie'
European countries once prohibited beef from
hor-
mone-fed cattle, a measure aimed at U'S' beef'
Purity
laws in Germany bar many non-German beers'
Until
the European Community adopted-uniform
standards'
Jiff"ti"i technical requirements- forced manufactur-
ers to offer as many "i '"u"tt
different versions of the
same TV for that market' Sometimes exporters
will
voluntariiy limit exporls, as when Japanese automak-
ers agreed to cutexports to the United States'The
point
is thit tarifs and quotas are only two of many devices used
to restrict foreign trade.

8. g
F
g
!
Recent research on the cost of protectionism
indicates that international trade barriers slow the
introduction of new goods and better technologies.
So, rather than simply raising domestic prices, trade
restrictions slow economic progress.
il*4 R*du*ti*n mf
TYad* ffias rf*rs
In recent decades, countries have worked to
reduce trade barriers and increase the flow
of international trade. Let's examine multilaterai
agreements, the World Tlade Organization, and com-
mon markets more closely.
Freer Trede hy
F* u EtE $ atctre € &g neerment
Mindfui of how high tariffs cut world trade during
the Great Depression, the United States, after World
War II, invited its trading partners to negotiate lower
tariffs and other trade barriers. The result was the
Gen*::al Agr€emerlt ,:n Tariffs and 'frade (GAT'|),
an international trade treaty adopted in ry47 by z3
countries, including the United States. Each GATT
member agreed to (r) reduce tariffs through multi-
national negotiations, (z) reduce import quotas, and

9. (3) treat all members equally with respect to trade.
Ttade barriers have been reduced through trade
negotiations among many countries, or "trade
rounds," under the auspices of GATT. Trade rounCs
offer a package approach rather than an issue-b,v-
issue approach to trade negotiations. Concessio::s
that are necessary but otherwise difficult to defenci
in domestic poiitical terms can be made more accep:-
able in the context of a package that also contains
politically and economically attractive benefits. Most
early GATT trade rounds were aimed at reducing tar-
iffs. The Kennedy Round in the mid-r96os inclucled
new provisions against dumping, which is selilng a
commodity abroad for less than is charged in the
home market or }ess than the cost of produclion-
The Tokyo Round of the r97os was a more sweeping
attempt to extend and improve the system'
The most recently completed round was iauncheci
in Uruguay in September r986 and ratifred by 723par-
ticipating countries in r994. The number of signing
countries now exceeds t4o. This so-called tjru-guay'
R*und, the most comprehensive of the eight postwar
multilateral trade negotiations, included 550 pages
of tariff reductions on 85 percent of world tratie'
The Uruguay Round also created the World Trade
Organization (VVTO) to succeed GATT.
Yhe Worfid Trade
#rganiaetion
The Warlci Tracie Organiza-
tion iV/TC) now Provides
the legal and institutional
foundation for world trade.

10. au(,
=
F
U
o
(J
6
o
o
Fo
I
L
q
:f
3
E
3
B
!
o
O
Y
zo
l
6
o
l{c Llr-ir::pir:gi
The Bush Administration was often ac-
cused of being soft on China regarding

11. trade, but on December 1 9, 2008, the
United States filed a broad petition with
the WTO alleging that China was using
subsidies and cheap loans to provide
Chrnese exporters an unfair advantage.
China has irequently been accused of
dumping by American manufacturets,
pafticularly steel makers. Between
April 2008 and the end of the year,
China's monthly steel exports to
the United States nearlY triPled,
while U.S. steel mills had reduced
production Io 43o/o ol capacity. China currently produces about
4070 of global steel, though only six years
before, it barely produced any. And while controversial, in
many cases it is yet to be seen whether China's
policies have actually been illegal.
S0URCE; Pete Engardio, "Chjna: An Early Test for Obama,"
Eusrness Week, 12 January 2008. pp.1 9-20.
Gen*ral Agreer::e ;:;

12. r:n T'ariffs at-icl -liac.-
{sArr}
an ifi terft atiofl el tariif '
rer!uetion treaiy ed*p1'
ed irr 194? that fe$irtt*d
in a *esies ei neg*ti-
atesl "rcunds" ain:*ri *t
lreer traele; tl:a Uiufiuav
FountJ ereat€d GATT'€
suecesscr. th* fdoliti
Trade 0rga*iz*iien
iwr$)
riumping
seliini; a pr*duct ahroed
fr:r iess ih** +ir*rged
in th* home market *r
fcr less than :he e**t *i
producticn
Urr,rguey itc'.tncl
the {inal mui:il*--
erel trade fi eg*ti3i;.)t1
under GATT; rhis '!984
agrFemeni cut tafiss.
lormed the lVarld 1r*de
Grganizatiun 1#TOi,
end wifl eve*t;":ally
eliminate quat*s
Wcrlel'Ilade
L,rSctir4GLr!rl i ti r!
the lcg*l arid i?tst.iti''
tianal ioil*d*ltii:1';i

13. th e n: lilti i*t* iai 9:+*il:-6
sy ster;1 th tl *i;e.******
CAi-i ir: i96*
!re
,&
r',*.
tt|
'i|..,,
r..fi
$5i
CHAI'?ER i8 '.
is 99 percent Muslim, a religion that forbids alcohol
consumption. Thus, Algeria exports wine.
8fi3 T?aCe Restrieti*ns
&nd Wetfare 3.mss
Despite the benefits of exchange, nearly all
countries at one time or another erect trade
barriers, which benefit some domestic produc-
ers but harm other domestic producers and all
domestie consumers. In this section, we consider
the effects of trade barriers and the reasons they are
imposed.
eonsrxmer SurpEus amd
Produeen Surplaxs f,rom
fularEcet frxehange

14. Before we explore the net effects of world trade on
social welfare, let's develop a framework showing
the benefits that consumers and producers get from
market exchange. Consider a hypothetical market for
chicken, shown in Exhibit 5. As discussed way back
in Chapter 4, the height of the demand curve shows
what consumers are willing and able to pay for each
additional pound of chicken. In effect, the height of
the demand curve shows tlnemarginal benef t consum-
ers e4pect from that^pound of chicken. For exanlPle,
the demand curve indicates that some consum-
ers in this market are willing to pay $r.5o or more
per pound for the first few pounds of chicken. But
i..i: i:iii;i i, i.:
Consumer Surplus and Producer Surplus
!
c
o
' 1.00OJ
o_
6
o
E
o
Consumer
surplus
every consumer gets to buy chicken at the l:-'il::'
clearing price, which here is $o.5o per pouni i'r:"
consumers thus get a bonus, or a surplus, fror:- ::-":"
ket exchange.

15. The blue -shaded trian gle below the demani ; -"' =
and above the market price reflects the consums" ' --
plus in this market, which is the difference ber;;i::::
the most that consumers wouid pay for 6o pour::= :
chicken per day and the actual amount they do :a ':
We a1l enjoy a consumer surplus from most prod-: ''
we buy.
Producers usually derive a similar surplus. Tht
height of the supply curve shows what producers ai:
willing and able to accepl for each additional pou'-:
of chicken. That is, the height of the supply cun";
shows the expected marginal cost from producin=
each additional pound of chicken. For example, th:
supply curve indicates that some producers face a
marginal cost of $o.25 or less per pound for supplying
the first few pounds of chicken. But every producer
gets to sell chicken for the market-clearing price ol
$o.5o per pound. The gold-shaded triangle above the
supply curve and below the market price reflects the
producer surplus, which is the difference between the
actual amount that producers receive for 6o pounds
of chicken and what they would accept to supply
that amount.
The point is that market exchange usuaiiy gener-
ates a surplus, or a bonus, for both consumers and
producers.In the balance of this chapter, we will con-
Ltime r-tr rbr-rd'ur'.tbe^ ganirs rftnrr rinErrrattnrarr .t*.nrlr
and how trade restriclions affect consumer and pro-
ducer surplus.

16. Tariffs
AtariJf, a term first introduced in Chapter 3, is a tax
on imports. (Tariffs can apply to exports, too, but "'e
wili focus on import tariffs.) A tariff can be either
specifc, such as a tariff of $5 per barrel of oil, or ad
valorem, such as ro percent on the import price of
jeans. Consider the effects of a specific tariff on a
particular good. In Exhibit 7 on the next page' D is the
U.S. demand for sugar and S is the supply of sugar
from U.S. growers (there were about ro,ooo U'S. sug-
arcane growers in zooT). Suppose that the world price
of sugar is $o. ro per pound, as it was in June zoo7. The
world price is determined
by the world suPPlY and
demand for a product. it is
the price at which any sup-
plier can sell output on the
worid market and at which
any demander can purchase
output on the world market.
world price
the pr;ce ai which
=
g*od is tr*rieci o:t tle
wcrld mari<*t; geier"
mi*ed by tl,e w+:'irj C*-
mand a*d v.rcrlc sr.gPiit
frr the gosd
CHAPT'ER rB jtttt:t:ii-,ti'.:i,'a

17. With free trade, anyU.S. consumers could
buy any amount desired at the world price of
$o.ro per pound, so the quantity demanded
is 7o million pounds per month' of which
U.S. producers supply zo million pounds
and importers supply 5o miilion pounds'
Because U.S. buyers can purchase sugar at
the world price, U.S. producers can't charge
more than that. Now suppose that a specific
tariff of $o.os is imposed on each pound of
imported sugar, raising its price from $o'ro
to $o. r5 per pound. U.S. producers can there-
fore raise their own price to $o.i5 per pound
as well without losing business to imports'
At the higher price, the quantity supplied
by U.S. producers increases to 3o million
pounds, but the quantity demanded by U'S'
consumers deciines to 6o million pounds'
Because quantity demanded has declined
and quantity supplied by U.S. producers has
increased, U.S. imports fal} from 5o million
tixi:ii;lt ;:
Effect of a Tariff
$0.1 5
0.10

18. f
o
c)
'-
o-
70 Sugar
(millions of
pounds per month)
to 3o million Pounds Per month.
Because the U.S' price is higher after the tariff,
U.S. consumers are worse off. Their loss in consumer
surplus is identified in Exhibit 7 by the combination
oftire blue- and pink-shaded areas. Because both the
U.S. price and the quantity suppiied by U'S produc-
ur. h".r" increased, their total revenue increases by
the areas a plus b plus f. But only area a represents
an increase in producer surplus. Revenue repre-
sented by the areas b plusf merely offsets the higher
marginal cost U.S. producers face in expanding
,rrg"i ortprrt from zo million to 3o million pounds
per month. Area b represents part of the net welfare
ioss to the domestic economy because those ro mi1-

19. iion pounds could have been imported for $o'ro per
po.rrna rather than produced domestically at a higher
marginal cost.
Government revenue from the tariff is identified
by area c, which equals the tariff of $o'o5 per pound
multiplied by the 3o miliion pounds imported, for
tariff revenue of $l.5 million per month' Tariff rev-
enue is a loss to consumers' but because the tariff
goes to the government' it can be used to lower taxes
)
-
U
U
N
a
Eu
t-uL
o
*
'i*
264 PART 4 lntet
or to increase public sewices' so
it's not a loss to the
;.t.
";;;"*y.^Area

20. a shows a loss in corrsumer sur-
plus because less sugar is consumed -1:^t:"
higher
iri.u. rho ioss is not iedistributed
to anyone else' so
5t"la't"n*ts part of the net welfare loss of
the tar-
inlir,".uror", ","ut
b and d show the domestic econ-
;;;;-;;t*elfare loss of the tariff; the two triansles
measureo loss in consumer surplus
that is not offsetby a
gain to anyane in the domestic economy'
In summary:Of the total loss in U'S'
consumer sur-
p1";i;;";; ; ,u' ',
andd) resulting from the tariff' area
I'g""t ," u.s produce", u'"u c becomes government
revenue, but areas b and d are net
josses in domestic
social welfare.
Frwpor* ffiustes

21. r=l
t;l
ri
iti.:t
q.
.Lx,
ll
'?
i;
.:,,
i
t::
.1tf
?i
::t:
T
+.i:
t?g
:!
:ii!
Animport quoia is a legal limit on the
amount of a com-
;;t,u that can be imported' Quotas usually
target

22. ;;;;;it it""t certain countries' For example'
a quota
ilt timit iurniture from china or shoes from
Brazil'
To have an impact on the domestic
market' a quota
r""tiU" set beiow what would be imported
with free
trade. Consider a quota on the
U'S' market for sugar'
i" p"""il"l of s*ltiUit 8, D is the U'S' demand
curve
;;; i is the supply curve of u's' sugar producers'
i"oo"J "g"i"
i"itlte world price of sugar is $o'ro
p"ii,"""i. *rth free trade, that price would
prevaii
in the U.S. market as well' and a total
of 7o miliion
;;;;;t ;."1d be demanded per month'
u's' produc-
irs would suppiy zo million pounds and
importers'

23. so *iflior-t pounis. with "
q"o1" of 5o million pounds
or more per month, the U'S'
price would remain the
i,xlrii.:ii i:l
Effect of a 0uota
b)
$o.t s
0.10
SameaStheworldpriceof$o.loperpound,andquan-
.d;il;e 7o million pounds per month' tn-th:Tl
" 6""o
of at least so million poundswould
not rarse
the U.S. price above ttt" *otfi price because 5o
mii-
lion pounds were lmported without
a quota' A more
stringent quota, r'o*!'"u'' *::ld tY:^t*po*t'
which'
",
*in see, wouid raise the U'S' Pnce'
Suppose U'S' trade officials

24. impose an import
quo"tJ?3o miilion pounds per month'
As long as
the U.S. price is ut oi"bot'" tire world
price of $o'ro
o"l n""tiu, foreign producers
wiii supply 3o million
P o,r'' a r. t : "
t
f ':'.: :: : f il: ?: 1::f"Tti ?::i t'i;total suPPIY ot suga:
ozlrlino rn million pounds of imported sugar
to the
qqsrlrb J-
amount supplied by U'S' producers' !tS-
ana foreign
;;;;; would ''e"er
s"tt in the u's' market for
less than $o'ro per pound because
they can always
;";t;;;^;;;" o'' tr'"'*"rld market'
rhus' the supplv
curve that sums Gomestic production
and imports
is horizontal ai 1:he ;;rld price of $o'ro.per

25. pound
and remains so until the quantity
supplied reaches
5o million Pounds''" ;;;i;, io, prices above $o'ro per pound'
the new
,"o;i;'.;;",'s', "dd'
horizontilly the 3o-miliion-
;il; quota to s, the suppiy cuwe
of u's,
lroducers'
ii" u.s' price is found *tt"i" this new supply
curve'
S'. intersects the domestic demand
curve' which in
i;J*t";; "iiJut8
occurs atpointe' Bv limitins
i^r"rrt, tn" quota raises the domestic price
of sugar above
';;:;;;;;;ri;,
and reduces quantitv betow.th,e free
trade
leuel. (Note that to to-pui" more easily
the effects

26. of tariffs
"rrd
q"otu', thi' q"ota is designed to yield
the same equilibrium price'and
quantity as the tanff
examined earlier')
b)
!q
o_
L
q)
g
c
oo
0)a
c)
,9
o-
$0.1 5
0.10
20 50 70 Sugar
(millions of Pounds Per month)
30 60 -0 S-g:-
(millions of Poreds s€r '=:!i:r

27. L
o-
20
as5