Although economic openness may lead to regional specialization and strengthen comparative advantage, almost every country imposes certain kind of trading policies on agriculture products considering the highly domestic political sensitivity. In principle, the trading policies that domestic government frequently adopts are tariff, quota, and TRQ.
This paper investigates the effects of government’s trading policies on social welfare under domestic capacity constraint. Firstly, the free trade regime is established as the benchmark model. In the tariff regime, we find that a binding domestic capacity constraint results in higher equilibrium domestic market price and lower social welfare comparing to the non-binding situation. For optimizing social welfare, the government will levy lower tariff when the domestic capacity constraint is binding than that of non-binding. If the tariff is relative high, tariff reduction may improve social welfare. When the domestic capacity is constrained, the effect of tariff reduction will decrease as the level of capacity increases. If the constrained domestic capacity is relieved, the optimal tariff will decrease.
In the quota regime, quota, de facto a quantity restriction, can be seen as another form of imported good’s capacity constraint. Therefore, the international supply of agriculture products is frequently restricted by dual constraints while both of the domestic capacity constraint and quota binding. We show that the social welfare will increase when the binding constrained domestic capacity is relieved as quota is non-binding, and the binding quota is further limited as domestic capacity constraint is non-binding. Consider the dual constraints case, both of the relieving domestic capacity and releasing more quota will increase social welfare. If the domestic capacity relieved, it can contribute more to social welfare than that of releasing more quota. As for the optimal quota, α/3 is the optimal quota no matter the domestic capacity constraint is non-binding or binding, just the same as free trade regime.
Further comparing with free trade regime, we conclude the following results: (1) the market price in all cases is greater than or equals to free trade regime; (2) the profit of the binding parties is less than or equals to free trade regime, while the profit of the non-binding parties is greater than or equals to free trade regime; (3) the social welfare in all cases is less than or equals to free trade regime except in the case of domestic capacity constraint is non-binding and quota is binding.
In the tariff-rate quota regime, we prove that lifting either in-quota tariff or over-quota tariff will reduce the social welfare; relieving the constrained domestic capacity will also reduce the social welfare. If the domestic capacity constraint is binding, the government can set the over-quota tariff as a “rent shift” mechanism to shift back foreign producer’s excess profit.
Different from past researches, binding domestic capacity constraint provides foreign producer opportunity to export more products and then affects domestic social welfare.
Capacity constraint just plays the distortion role to manipulate the social welfare results in their purposes.
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