The Effects of an Import Quota

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The Effects of an Import Quota

When the U.S. government imposes a quota on the import of Japanese cars, nothing happens in the market for loan able funds in panel (a) or to net capital outflow in panel (b). The only effect is a rise in net exports (exports- minus imports) for any given real exchange rate. As a result, the. demand for dollars in the market for foreign-currency exchange rises, as shown by the shift from D1 to D2 in panel (c), This increase in the demand for dollars causes the value of the dollar to appreciate from f1 to f2. This appreciation of the dollar tends to reduce net exports, offsetting the direct effect of the import quota on the trade balance.

The Effects of an Import Quota

The Effects of an Import Quota

l~e first step in. analyzing the trade policy is to determine which curve shifts, The initial impact of the  . port restriction is, not surprisingly, on imports, Because net exports equal exports minus imports, the policy also affects net exports. And because net exports are the source of demand for dollars in the market for foreign-currency exchange-the policy affects the demand curve in this market. The second step is to determine which way this demand curve shifts, Because the quota restricts the number of Japanese cars sold in the United States, it reduces imports at any given real exchange rate, Net exports, which equal exports minus imports, will therefore rise for any given real exchange rate. Because foreigners need dollars to buy U.S. net exports, there is an increased demand for dollars in the market for foreign-currency exchange. This increase in the demand for dollars is shown in panel (c) of Figure 6 as the shift from DI to·D2• . The third step is to compare the old and new’ equilibria. As we can see in panel (c), the increase in the demand for dollars causes the real’ exchange rate to appreciate from EI to E2- Because nothing has happened change in the real interest rate, there is also no change in net capital outflow, shown in panel (b). And because there is no change in net capital outflow, there can be no change in net exports, even though the import quota has reduced imports. The reason net exports can stay the same while imports fall is explained by the change in the real exchange rate: When the dollar appreciates in value in the market for foreign-currency exchange, domestic goods become more expensive relative to foreign goods. This appreciation encourages imports and discourages exports, and both of these changes work to offset the direct increase in net exports due to the import quota. In the end, an import quota reduces both imports and exports, but net exports (exports minus imports) are unchanged. We have thus come to a surprising implication: Trade policies do not affect the trade balance. That is, policies that directly influence exports or imports do not alter net exports. This conclusion seems less surprising if one recalls the accounting identity

Net exports equal net capital outflow, which equals national saving minus domestic investment. Trade policies do not alter the trade balance because they do not alter national saving or domestic investment. For given levels of national saving and domestic investment, the real exchange rate adjusts to keep the trade balance the same, regardless of the trade policies the government puts in place. Although trade policies do not affect a country’s overall trade balance, these policies do affect specific firms, industries, and countries. When the US. government imposes.an import quota on Japanese cars, General Motors has less competition from abroad and will sell more cars. At the same time, because the dollar has appreciated in value, Boeing, the US. aircraft maker, will find it harder to compete with Airbus, the European aircraft maker. U.S. exports of aircraft will fall, and U.S. imports of aircraft will rise. In this case, the import quota on Japanese cars will increase net exports of cars and decrease net exports of planes. In addition, it will increase net exports from the United States to Japan and decrease net exports from the United States to Europe. The overall trade balance of the U.S. economy, however, stays the same. ‘the effects of trade policies are, therefore, more micro economic than macroeconomic. Although advocates of trade policies sometimes claim (incorrectly) that these policies can alter a country’s trade balance, they are usually more motivated by concerns about particular firms or industries. One should not be surprised, for instance, to hear an executive from General Motors advocating import quotas for Japanese cars. Economists almost always oppose such trade policies. Free trade allows economies to specialize in doing what they do best, making residents of all countries better off. Trade restrictions interfere with these gains from trade and, thus, reduce overall economic well-being.

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The Effects of an Import Quota