The threat of import competition forces the monopolist to behave like a perfectly competitive firm.
The tariff allows the monopolist to raise its price, but the price is still limited by threat of imports.
Now suppose that instead of the tariff, a quota is applied. We choose the quota so that it equals the imports under the tariff, which are M2.
Since imports are fixed at that level, then the effective demand curve facing the Home monopolist is the demand curve D minus the amount M2. We label this effective demand curve as D – M2 in Figure below.
Unlike the situation under the tariff, the monopolist now retains the ability to influence its price:
Under free trade the Home monopolist produces at point A, and charges the world price of PW. With a tariff of t the monopolist produces instead at point B, and charges the price of PW+t. Imports under the tariff are M2 = D2 – S2.
Under a quota of M2, the demand curve is shifted to the left by that amount, resulting in the demand D–M2.
The marginal revenue curve is MR, and the Home monopolist produces at point C, where MR equals MC. The price charged at point C is P3 > PW+t, so the quota leads to a higher Home price than the tariff.
VER of Japanese Auto industry in the 1980’s
A recession led to less spending on durable goods (such as automobiles), and as a result, unemployment in the auto industry rose sharply.
In 1980, the United Automobile Workers and Ford Motor Company applied to the International Trade Commission (ITC) for protection under Article XIX of GATT and Section 201 of U.S. trade laws. The ITC determined that the U.S. recession was a more important cause of injury to the auto industry than increased imports. It did not recommend that the auto industry receive protection.
In response, several congressmen with auto plants in their states pursued other means. A bill was introduced in the U.S. Senate to restrict imports.
Aware its potential consequences, the Japanese government announced it would “voluntarily” limit Japan’s export of autos to the U.S.
By 1988, Japanese exports were below the VER because Japanese firms were producing their cars in the U.S. =>the average price of U.S. cars rose 43% from 1979 to 1981 due to the exercise of market power by the U.S. producers, who were sheltered by the quota.=> very costly to U.S. consumers.