CFA Level I Exam · International Trade

Trade Restrictions: Tariffs, Quotas and Subsidies Explained

Updated 7 October 2026 · Fact-checked

Trade restrictions are tools such as tariffs, quotas, export subsidies and voluntary export restraints that limit imports or promote exports. Each raises the domestic price, helps domestic producers, hurts consumers and creates deadweight loss. To solve questions, compare the new price with the free-trade price, then track who gains, who loses and who gets the revenue.

Understand Trade Restrictions: Tariffs, Quotas and Subsidies

A country that trades freely buys imports at the world price. If the world price is below the domestic no-trade price, the country imports the good. Consumers gain because they pay less and buy more. Domestic producers lose because they sell at a lower price.

Trade restrictions push the domestic price back up. The main tools are:

Tariff: a tax on imports. The government collects the tax.
Import quota: a limit on the quantity imported. Whoever holds the import licence earns the price gap.
Voluntary export restraint (VER): the exporting country agrees to limit its own exports. It works like a quota, but the exporter keeps the gap.
Export subsidy: a payment to domestic firms for each unit exported.
Other tools: minimum domestic content rules, and other non-tariff barriers.

With a tariff or quota on imports, the domestic price rises above the world price. Domestic producers gain surplus and sell more. Consumers lose surplus and buy less. Imports fall. The loss to consumers is bigger than the gain to producers plus any government revenue. The leftover is deadweight loss. It has two triangles: one from over-production at higher cost by domestic firms, and one from consumption that is lost.

A tariff and a quota can give the same price and import quantity. The difference is who gets the rectangle (tariff × imports after the tariff). With a tariff, the government gets it as revenue. With a quota, the licence holders get it as quota rents. If the government auctions licences at full value, the result matches a tariff. Under a VER, foreign exporters keep it, so the importing country's national welfare falls more.

An export subsidy works in the other direction. Producers receive a higher price, so they sell more abroad. The domestic price rises, so domestic consumers lose. Producers gain. The government pays the subsidy, so taxpayers lose. For a small country, net welfare falls in every case. For a large exporter, the extra supply on world markets also lowers the world price, which helps foreign consumers and hurts foreign producers, and the terms-of-trade deterioration makes the exporter's net loss worse.

Key formulas to remember

Domestic price after tariff: P(tariff) = P(world) + tariff; For a small country that takes the world price as given. A per-unit tariff is added directly.
Tariff revenue: Revenue = tariff × imports after the tariff; Use imports with the tariff in place, not free-trade imports. Imports = domestic quantity demanded − domestic quantity supplied at the new price.
Deadweight loss of a tariff: DWL = ½ × (price rise) × (increase in Qs) + ½ × (price rise) × (decrease in Qd); Two triangles. Each has base equal to the quantity change on its side and height equal to the domestic price rise. For a non-prohibitive tariff of a small country, the price rise equals the tariff. If the tariff is prohibitive, the price rise is only up to the no-trade price. Linear curves only.
Change in national welfare, small country tariff: Δ welfare = Δ consumer surplus + Δ producer surplus + tariff revenue = −DWL; For a small country that cannot move the world price. A large importing country can gain through a terms-of-trade effect, which can offset the DWL.
Quota rent: Quota rent = (domestic price − world price) × quota quantity; Goes to licence holders, to the government if licences are auctioned, or to foreign exporters under a VER.
Export subsidy welfare effect: Δ welfare = Δ CS + Δ PS − subsidy cost; Consumers lose, producers gain, taxpayers pay. Net national welfare falls for a small country.

How to solve Trade Restrictions: Tariffs, Quotas and Subsidies questions

Use this method for any tariff, quota, VER or subsidy question. Draw a quick supply and demand sketch if numbers are given.

1Identify the tool and whether the country is an importer or an exporter.
2Find the free-trade (world) price and the quantities supplied, demanded and imported at that price.
3Find the new domestic price: world price plus tariff, or the price that gives the quota quantity, or world price plus subsidy for an exporter.
4Find the new quantities supplied, demanded and imported (or exported) at the new price.
5Work out who gains and loses: consumers lose with import restrictions, producers gain, and the government or licence holders collect the rectangle.
6Calculate the triangles for deadweight loss: ½ × price change × quantity change, on each side.
7Check the answer: net welfare change should equal the sum of the gains and losses, and it should be negative for a small country.

Quickest way: Winners, losers and the rectangle

When to use it: Use for conceptual three-option questions on who gains, who loses or who gets the revenue.

Import restriction: domestic price up, consumers lose, producers gain, imports down.
Tariff: government gets the rectangle. Quota: licence holders get it. VER: foreign exporters get it.
Export subsidy: producers gain, consumers and taxpayers lose, exports up.
Small country: net welfare falls in every case; a large country can gain from a terms-of-trade effect with an import tariff.
For a numerical question, compute only the two triangles and ignore the rectangle for deadweight loss.

Common mistakes in Trade Restrictions: Tariffs, Quotas and Subsidies

Using free-trade imports to compute tariff revenue.
The free-trade quantity is the first import number you calculate, so it gets reused.
Fix: Recalculate imports at the new higher price. Revenue = tariff × imports after the tariff.
Counting tariff revenue as part of deadweight loss.
The rectangle looks like a loss because consumers pay it.
Fix: Revenue is a transfer to the government. Only the two triangles are deadweight loss.
Saying a quota and a tariff always have the same welfare effect.
They give the same price and quantity, so students stop there.
Fix: Ask who gets the rectangle. Quota rents may go to foreign firms or licence holders, so national welfare can be lower than with a tariff.
Thinking an export subsidy helps the exporting country's consumers.
Subsidies sound like help for everyone.
Fix: The subsidy lifts the domestic price, so consumers pay more. Taxpayers fund the subsidy. Net welfare falls.
Confusing a VER with a quota imposed by the importer.
Both limit quantity.
Fix: A VER is set by the exporting country, so the exporter captures the price gap. An import quota is set by the importing country.
Using the full tariff as the height of the triangle without checking the quantity change.
The formula looks like ½ × tariff × imports.
Fix: Each triangle uses the quantity change on its own side, not total imports.

Worked examples

Example 1

A small country imports a good at the world price of $20. Domestic demand is Qd = 100 − 2P and domestic supply is Qs = 3P − 20. The country imposes a $2 tariff. Calculate the deadweight loss. Options: A) $5, B) $10, C) $20.

Show the solution

Free trade at P = 20: Qd = 100 − 40 = 60. Qs = 60 − 20 = 40. Imports = 20.
No-trade price: 100 − 2P = 3P − 20 gives 5P = 120, so P = 24. The tariff price of 22 is below 24, so imports continue and the tariff is not prohibitive.
With tariff P = 22: Qd = 100 − 44 = 56. Qs = 66 − 20 = 46. Imports = 10. Tariff revenue = 2 × 10 = $20.
Increase in Qs = 46 − 40 = 6. Decrease in Qd = 60 − 56 = 4.
DWL = ½ × 2 × 6 + ½ × 2 × 4 = 6 + 4 = $10.

Answer: B) $10. The deadweight loss is the two triangles only; the $20 tariff revenue is a transfer and is not part of it.

Example 2

A small country imports a good at the world price of $10. Domestic demand is Qd = 80 − 2P and supply is Qs = 4P − 20. The country imposes a $2 tariff. What is the tariff revenue? Options: A) $32, B) $56, C) $80.

Show the solution

Free trade at P = 10: Qd = 80 − 20 = 60. Qs = 40 − 20 = 20. Imports = 40.
No-trade price: 80 − 2P = 4P − 20 gives 6P = 100, so P = 16.67. The tariff price of 12 is below this, so imports continue.
With tariff P = 12: Qd = 80 − 24 = 56. Qs = 48 − 20 = 28.
Imports after tariff = 56 − 28 = 28.
Tariff revenue = $2 × 28 = $56. Using free-trade imports of 40 would wrongly give $80.

Answer: B) $56. Use imports after the tariff (28 units), not free-trade imports.

Exam tips

Expect three-option questions asking who gains, who loses or who collects the rectangle. Learn the table: tariff to government, quota to licence holders, VER to foreign exporters.
Always check whether the tariff is prohibitive by comparing the tariffed price with the no-trade price.
For numbers, compute quantities at both prices before anything else. Most errors come from skipping this.
Remember that for a small country every restriction reduces net welfare. A large country may gain from a better terms of trade, but this is rarely tested numerically.
Eliminate options that say consumers benefit from import restrictions or that producers lose.

Practice questions from International Trade

Trade Restrictions: Tariffs, Quotas and Subsidies in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

CA FoundationNon-Tariff Barriers: Quotas and Subsidies

Trade Restrictions: Tariffs, Quotas and Subsidies: frequently asked questions

What is the difference between a tariff and an import quota?

A tariff is a tax on imports and the government collects the revenue. A quota limits the quantity imported and the price gap goes to licence holders. Both raise the domestic price and cut imports.

How do you calculate the deadweight loss of a tariff?

Find the change in domestic quantity supplied and the change in quantity demanded caused by the tariff. Then compute ½ × price rise × each quantity change and add the two triangles. For a non-prohibitive tariff of a small country, the price rise equals the tariff. Tariff revenue is not part of the deadweight loss.

What is a voluntary export restraint?

A VER is an agreement by an exporting country to limit its exports, often under pressure from the importer. It acts like a quota, but the exporters capture the price gap. The importing country therefore loses more welfare than under a tariff.

How does an export subsidy affect consumer and producer surplus?

An export subsidy raises the domestic price, so consumer surplus falls and producer surplus rises. The government pays the subsidy, so taxpayers lose. Net national welfare falls.