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IAI Actuarial Core Principles · Business Economics · Government intervention in a market

A government imposes a binding import quota on steel. Compared with the free-trade outcome, which combination of effects is most likely in the domestic steel market?

A binding import quota restricts supply from abroad, so the domestic price rises and domestic consumption falls, while local producers gain. Consumers lose from higher prices and lower quantity, which is why quotas are generally seen as reducing overall economic welfare.

  1. ADomestic price falls and domestic consumption rises
  2. BDomestic price rises and domestic consumption fallsCorrect
  3. CDomestic price rises and domestic consumption rises
  4. DDomestic price is unchanged and domestic output rises
  5. Domestic price falls and domestic output rises

Explanation

A binding quota limits foreign supply, shifting total supply left. The domestic price therefore rises, consumers buy less, and domestic producers expand output along their supply curve. Options showing a falling price confuse a quota with a subsidy or with freer trade.

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