Welfare Effects of Quotas under Variable Returns to Scale

Abstract

Recently, there has been a growing use of quantitative restrictions on imports by countries for protecting their import-competing industries. It is well-known that the quantitative restriction on imports set below the free trade level would result in higher domestic prices, smaller quantities of importables available to consumers and, hence, a reduction in national real income. Thus, import quotas, similar to tariffs in a small economy, reduce welfare. This result has been derived in the traditional Heckscher-Ohlin trade model with production functions subject to constant returns to scale (CRS).' While the assumption of CRS greatly simplifies the analysis, it is not easily justified in view of reality. Firms usually are exposed to various kinds of externalities which give rise to economies or diseconomies of scale.