Sensitivity of Tariffs and Quotas: A Signaling Game

In a model with cost-based informational asymmetry and trade policy determined endogenously, we show that tariffs and import-quotas have different sensitivities to the signal sent by the private agents to the home government. Specifically, the optimal quota is shown to be more sensitive than the optimal tariff as measured in terms of the reduction in equilibrium import-volume caused by the change in the government's perception about the true cost of the domestic firm. Consequently, signaling distortion is larger in the quota regime than in the tariff regime. Non-equivalence between the two policy tools follows from this difference in their sensitivities. The model is benchmarked so that under complete information tariffs and quotas are equivalent.