We know that a country will be able to consumer more if they trade with other countries, but how does this affect that consumers and producers at home?
In general, producers will export a good if the world price is greater than the domestic equilibrium price. Conversely, consumers will import goods if the world price is lower than the domestic equilibrium price.
When a country exports, the price is higher for that good. This means that the producers get to charge more for the products, and that the consumers must now pay more. Therefore, we see the normal effect on surplus when the price goes up. Consumers lose surplus, and producers gain surplus.
However, there is a difference here. This time, instead of some producers and consumers being forced out of the market, the producers who would have been forced out just find international buyers. The domestic consumers are the only ones that lose out.
Additionally, because there is now more trade happening, the economy actually enjoys a total surplus increase.
When a country imports, the exact opposite is true. Consumers gain surplus both domestically and in international markets, while producers lose surplus. However, the economy enjoys a total surplus increase.
So on a whole, the economy benefits from international trade. However, there is always a group that is hurt. Usually this group, if it is powerful enough, will lobby the government to restrict the international trade that is happening.
There are two ways of restricting international trade by the domestic government.
Both of these will increase the domestic price, and therefore benefit the consumers.
A tariff functions by increasing the domestic price by a certain amount. This drives demand down and supply up. It is essentially a tax on good produced abroad.
Consumers will lose surplus. The producers will gain surplus, and the government also gains tax revenue.
However, the consumers lose more than the producers and government gain. This is deadweight loss. Some of this is due to buying from domestic consumers at artificially high prices, and the other portion of this is from the reduction of consumption overall.
A quota limits the amount of imports. What this does, is shift the supply to the right.
When a nation hits the import quota, there will be an excess in demand. This demand will be equal to the previous number of imports less the import quota. The demand curve tells us how much domestic producers are willing to pay for these extra goods. This gives us a new market price.
When the price goes up, the supply goes up (this is given by the law of supply), and hence we have a market price.
Local producers benefit, as they are able to sell the extra units at a higher price. Producers lose surplus due to having to pay a higher price. However, the gains by domestic producers losses from domestic consumers don’t equal the surplus prior to the quota being implemented.
Some of this excess surplus goes to importing agents, who are able to buy good at the lower world price, and sell the domestically at the higher domestic price. This only, however, extends to the import quota units. The other surplus goes to unknown entities. It could be anyone that gains this surplus, which opens quota policy up to a lot of fraud.
Therefore, due to the effect being the same for local producers and consumers, tariffs are preferred to quotas, as it is known where the surplus goes to, and fraud is less likely when implementing policies.