Short on time? This page is the recap. For explanations, graphs and worked examples, use the full study guide.
Recap
- Autarky: no trade. Price and quantity are set by domestic demand and domestic supply.
- Small open economy: takes the world price (Pw) as given; draw it as a horizontal line.
- Pw below autarky price → domestic price falls → imports = Qd − Qs. CS rises, PS falls, total surplus rises.
- Pw above autarky price → domestic price rises → exports = Qs − Qd. PS rises, CS falls, total surplus rises.
- Tariff: a tax on each imported unit. Domestic price = Pw + t.
- Import quota: a limit on the quantity imported. It raises the domestic price until Qd − Qs equals the quota. You explain it in words; you do not graph it.
Key relationships
| Relationship | How to use it |
|---|---|
| Imports = Qd − Qs at the domestic price | Use the price after any tariff |
| Exports = Qs − Qd at Pw | Only when Pw is above the autarky price |
| Gain from trade = ½ × (trade volume) × (gap between Pw and autarky price) | For straight-line curves |
| Tariff revenue = t × imports with the tariff | A transfer to government, not a loss |
| Deadweight loss of a tariff = ½ × t × (rise in Qs) + ½ × t × (fall in Qd) | The two triangles beside the revenue rectangle |
| Prohibitive tariff: t ≥ autarky price − Pw | Imports fall to zero |
| Policy | Domestic price | Domestic output | Imports | Gov. revenue | CS | Total surplus |
|---|---|---|---|---|---|---|
| Tariff | rises | rises | fall | yes | falls | falls |
| Quota (binding) | rises | rises | fall | none | falls | falls |
Assumptions
- The country is small: its trade does not change the world price.
- Domestic and foreign goods are identical, and transport costs are ignored.
- Total surplus with a tariff = CS + PS + tariff revenue.
Mistakes to avoid
- Calling Qd at the world price “imports”. Imports are the gap.
- Shifting the domestic supply curve for a tariff. Draw a new price line at Pw + t instead.
- Counting tariff revenue as deadweight loss.
- Saying free trade helps everyone. Name the losing group.
- Saying a quota earns the government revenue.
- Drawing a quota graph when the question asks you to explain its effect on quantity produced.
- Forgetting units: “$ million”, “thousand tonnes”.
Quick self-check
- Domestic price under autarky is $10. At a world price of $7, Qd = 500 and Qs = 200. How much is imported? (500 − 200 = 300)
- A $2 tariff cuts imports to 180. What is the revenue? (2 × 180 = 360)
- At a world price above the autarky price, Qs = 900 and Qd = 350. Who loses surplus, and how much is exported? (Consumers lose; exports = 900 − 350 = 550)
- Why does a quota raise domestic production? (The price rises, so domestic sellers move up their supply curve and fill part of the gap.)
Next: practice questions.