Tariffs Versus Quotas in the Presence of Imperfect Competition and Cross-Border Externalities

We consider trade policies intended to affect the production of a foreign monopolist that generates negative externalities. We derive the optimal tariff and optimal import quota and examine which policy measure should be used to maximize domestic welfare. We find that if the domestic government does not have full information on the foreign firm's production method and if cross-border externalities exist, import quotas are in some cases preferable to tariffs. Otherwise, however, tariffs are preferable to quotas