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I'm learning about quotas from my textbook but I've found one thing that doesn't make sense to me at all and I think it may be a mistake in the book. The context: $P_w$ is the price of wheat on the world market. So far the domestic government has allowed free trade but now they set an import quota of $Q_3 - Q_1$.

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The text accompanying the graph says:

Domestic producers now supply $0Q_1$ and $Q_3Q_4$ tons of wheat at a price of $P_{quota}$. Their revenue rises from $a$ to $a+c+d+f+i+j$.

What I can't understand is why they included $f$ in the last sentence. In my opinion their revenue rises from $a$ to $a+c+d+i+j$. Domestic producers first sell $0Q_1$ quantity for price $P_w$ so they make profit of $a$ and then they sell quantity $Q_3Q4$ for price $P_{quota}$ which gives area of the rectangle: $c+i+j+d$. I have no idea what that $f$ is doing there. Can anyone explain?

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  • $\begingroup$ Welcome to Economics StackExchange. I was perplexed by the notation $0Q_1$ in your problem. I googled your book and saw that this is indeed what it writes. There are also other peculiarities, for example it says the excess demand is $Q_3 - Q_2$, but this is a negative quantity. In case you are interested in a better book I recommend "International Economics: Theory and Policy" by Krugman-Obstfeld-Melitz. $\endgroup$
    – Giskard
    Jul 17, 2015 at 7:14

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There is no mistake. The solution: it is assumed that there is only one price at the domestic wheat market. Hence domestic producers will not sell at price $P_w$ and price $P_{Quota}$ as well. This makes sense: Suppose you are a domestic producer and you are aware that the price that results from the quota system is $P_{Quota}$. Knowing this you would not sell your goods for the lower $P_w$.

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  • $\begingroup$ Thanks. I think that I misunderstood the concept a bit. I used to think about it more as a continuous process, where domestic producers "follow" the S supply curve first, THEN imports come into play selling for price $P_w$ and THEN domestic producers come again "following" the new supply curve (S + quota). Now I think about it as a more parallel process. That is, domestic producers know since the very beginning of the quota period what would the situation on the market look like and before they even start selling they know what equilibrium price would be finally reached so they ... [continued] $\endgroup$ Jul 17, 2015 at 11:25
  • $\begingroup$ [continued] ... so they start selling at the price $P_{quota}$ since the very beginning, just as importers and it all happens in parallel. Has my understanding improved? $\endgroup$ Jul 17, 2015 at 11:27
  • $\begingroup$ @RichardSmith Yes, sounds like you got the hang of it. You can read some micro books for explanations about how we reach equilibrium and why you can assume that the market players have some foresight. $\endgroup$
    – Giskard
    Jul 17, 2015 at 12:05

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