On the Equivalence of Tariffs and Quotas with Incomplete Information

Abstract

This paper compares the social welfare effects of tariffs and quotas as strategic trade policy instruments in an oligopolistic industry where the domestic market demand is uncertain and the policy is chosen before the uncertainty is resolved. The uncertain demand, once realized, is assumed to be available only to the domestic firm when the output game is played between domestic and foreign firms. To highlight our assertion, a simple scenario with linear demand, additive stochastic market shock, homogeneous products, and identical constant marginal costs is considered. It is shown that a tariff is superior to a quota regardless of the degree of uncertainty. Moreover, we also show that a prohibitive quota that results in autarky is always preferred to a quota at the free-trade level.