[MUSIC] Well so far in our analysis of tariffs and quotas, we have calculated the gains to a relatively small number of European farmers from the imposition of the protective tariff and the loss to a relatively large number of European food consumers. In doing so, we thereby illustrated the well known principle and public choice theory of concentrated benefits versus diffused cost that often explains the power of numerically small interest groups in democracies. That's it. There are two more important players to consider in this protectionist game. One big winner and one big loser. So who are these players besides European farmers and European food consumers, and how would you measure their gains or losses? We shot down your answer before we move on to explore the stakes involved and answer these questions. [MUSIC] [SOUND] Okay let's start with the other big loser besides European food consumers. This is the American food industry. In this figure, we see that American farmers now export 100 fewer units and lose revenues equal to the shaded areas, CJLE and KDMF. As for the other big winner, this is the European government that has imposed the tariff on American food exports. Here, you can see that the tariff revenues are equal to the area, HIJK. From a political perspective, what is perhaps most interesting about this figure is this. Relatively small handful of people in one domestic European industry, farming has gained the considerable profit at the expense of a much larger but politically less powerful group, namely European food consumers. But also note that this protectionist tariff has also considerably harmed food producers in America. And it is this group that is unlikely to remain silent on the tariff question In fact one likely result is that pressure will build politically in America to retaliate against European food tariffs with protectionist tariffs of it's own, say on European clothing imports. There may however be a way to avert this trade war by replacing the European tariff on food with an equivalent European quota. Do you see why this maybe so? Do think about this now and try to jot down some ideas as to why a quota on American food exports in Europe would be more likely to help avert a trade war between Europe and America than a tariff. When you're ready, let's move on to what may be the surprising but intuitive answer. [MUSIC] So why is a quota likely to be more politically palatable than a tariff in our example? To see why, take a look at this figure which shows that a 100 unit quota on American food exports would get you to exactly the same level of protection for European farmers is the equivalent tariff of $2 per unit. But here's the big political difference, under a tariff the shaded area HIKJ goes to the European government in the form of tariff revenues. However under a quota, it is the foreign exporters, in this case American food producers, that will be able to capture these revenues. And in many cases, these additional revenues largely offset American losses from selling fewer exports. Thus, the result in America should well be far less political pressure from food producers for retaliatory tariffs. And that is indeed a very interesting result. Do you see it clearly? Just take a few minutes now to think this one through before moving on. [MUSIC] Now, before leaving this figure there's one more thing I want to show you. This is a very famous construct known in economics as the Deadweight Loss. It's a concept that appears primarily in microeconomics. However in this context, the Deadweight Loss is designed to capture the loss in economic efficiency that can result when a nation imposes a tariff or quota on a freely trading market. And spoiler alert here, you should know at the outset that the Deadweight Loss is exactly the same regardless of whether a tariff or quota is used. So look at this figure now very carefully as you try to answer these questions. Which shaded areas of the figure collectively represent the total Deadweight Loss in economic efficiency from the imposition of the tariff or quota? More subtly, which shaded areas or area, represent the inefficiency associated with the production side of the equation? In microeconomics, we refer to this as a loss in producer surplus. And which shaded areas or area represent the inefficiency associated with the consumption side of the equation, what we refer to in microeconomics as a loss in consumer surplus? So take a minute to study the figure very carefully as you try to answer these questions. And when you're ready, let's move on. [MUSIC] Okay, let's take this one step at a time. For starters, the shaded area, CHJ, represents the loss in producer surplus. In this case, too many European resources are being diverted into the inefficient production of food at the expense of production in other sectors. At the same time, the shaded area KID represents the loss in consumer surplus. This loss in consumer satisfaction comes not from the higher prices paid, but rather from the fact consumers are consuming less units of food. Of course, together, these two triangles, a producer and consumer surplus, measure the total Deadweight Loss. And that's a powerful argument based on economic efficiency against the use of protectionist measures like tariffs and quotas. That's not the whole story, of course. So in the next module, we will look more broadly at the pros and cons of protectionism. Take a break now if you need it. When you're ready, let's move on. [MUSIC]
