PARTIAL EQUILIBRIUM TRADE MODEL, GAINS FROM TRADE, TRADE ELASTICITIES & IMPACTS OF COUNTRY INTERVENTIONS

Lectures 9 & 10 AHEED Course “International Agricultural Trade and Policy”

Taught by Alex F. McCalla, Professor Emeritus, UC Davis.

April 2 & 5 , 2010, University of Tirana, Albania

1

LF

TF

LC

TC

Labor used in food production

Labor used in cloth production

OF

Increasing

Increasing

Incre

asin

gIncre

asin

g

Lan

d u

sed

in

clo

th p

rod

ucti

on

Lan

d u

sed

in fo

od

pro

du

ctio

n

F

C

OC

Edgeworth Box & Allocation of Resources

2

Relationship between Gen. Equilb. & Partial Equilb. Model, deriving the supply curve

3

Wheat,

bush

els

B

ush

els

/yard

Cloth, yards

Cloth, yards

Supply

Slope of PPF is cloth’s opp. cost (mrt)

Deriving demand curves from indifference curves

4

Whe

at, b

ushe

ls

Bus

hels

/yar

d

Cloth, yards

D

Cloth

-Pc/Pf

I

From General to Partial Equilibrium5

Whe

at, b

ushe

ls

Bus

hels

/yar

d

Cloth, yards

D

Cloth

S

Comparative advantage under increasing opportunity cost

6

Wheat,

bush

els

Wheat,

bush

els

Bush

els

/yard

Cloth, yards Cloth,

yards

Cloth, yards

Cloth, yards

Home Foreign

SFor

Bush

els

/yard

SHom

e

Review of Producer Surplus

7

S

Q

pri

ce

PS

Producer surplus = quasi rent, or excess of gross receipts over TVC. R= TR- TVCDefined as the area above the supply curve& below the price line

Review of Consumer Surplus

8

Demand

Q

pri

ce

Consumer utility is not observable, so economists try to compute a money-based measure of welfare effects.CS gives the change in what the consumeris willing to pay over that which is actually paid.

P0

P1

q0

q1

Generating Excess Supply & Excess Demand Functions in World Market

9

D

S

D

S

pri

ce

Q

ForeignHome

ES

ED

International Market

QQ

pri

ce

pri

ce

PT

QT

Gains from Trade10

Elasticity of Import Demand -(Excess Supply)

11

Elasticity of excess supply (ES) & excess demand (ED) functions are derived from domestic supply Sd and domestic demand Dd functions. ED = Dh – Sh; and ES = Sf – Df Thus the slopes of ED & ES are derived from Dh, Sh & Sf ,Df dED = dDh – dSh dES = dSf - dDf dp dp dp dp dp dpAnd Therefore so are the elasticities of ED & ES derived from elasticities of the domestic functions. Let E =elasticity

Recall elasticity of Dh = Ehd = dq * p dp qAs shown in McCalla and Josling pp41 & 42

EED = E Dh * Home Con/Imports – E Sh* Home Sup/Imports

E ES = E Sf * For Sup/Exports – E Df * For Con/ Exports.

Elasticity of Import Demand (Excess Supply)

12

Let us give a numerical example; Suppose a country imports 25 % of its wheat consumption Let S = share of imports in domestic demand IM/Dh; and 1-s is share of consumption supplied domestically

So Home con/imports = 1/s; Home sup/ imports = 1-s & if EDh = -.2 and E Sh = .2

The elasticity of Excess Demand EED = (1/.25 *-.2) - .2 * .75/.25Which =(4 X -.2) = -.8 + - .6 (.2 X 3) = -1.4

What is obvious is that even though both domestic supply and demand are highly inelastic, import demand is elastic.

In general can say Import Demand is more elastic;a. the more elastic domestic demand;b. the more elastic domestic supply;c. the smaller the market share of imports.

Lecture 10: Modeling Country Interventions13

D

S

D

S

pri

ce

Q

ForeignHome

ES

ED

International Market

QQ

pri

ce

pri

ce

Transmission of Shocks14

Country B

Experiences a short crop-

Shifts Sb to Sb’

which shifts Ed out to Ed’

Raising world price to P’w

and expands trade to 08

Note both countries adjust

The imposition of a tariff t by country B shifts Ed to E’d;Price in exporter A falls from Pw to P’w & exports contract;Price importer B rises to P’b aand imports contract;B collects tariff revenue of (P’b –P’w) X Q’

Imposition of a unit tariff –same impact as introducing a transport cost.15

Suppose Ex A fixes producer prices at P, thus domestic supply becomes S’a and excess supply becomes E’s; if also fixes P to consumers excess supply becomes perfectly inelastic -E”s.

If P is floor price for both producers and consumers excess supply becomes E”s below P and Es above P Lesson – Domestic price intervention reduces the elasticity of Es

Impact on excess supply of exporter fixed-price policies.16

Is mirror image from exporter case- if Im B fixes producer price at Pp excess demand rotates to E’d, fixing Pp also to consumers makews excess demand perfectly inelastic E”d.The lesson for world markets is the more rigid domestic intervention the inelastic world S & D functions will be = more price instability in world markets

Impact on excess demand of importer fixed-price policies17

Put together, guaranteed producer prices in both exporters and importers rotates Es to E’s and Ed to E’d, world trade contracts from Q to Q’ and world price falls from Pw to P’w.

Note that because intervention decreased the elasticities of both excess functions, the change in price is greater than the change in quantity, i.e. domestic intervention increases price instability in World Markets

World Market Impacts of Guaranteed Producer Prices.18

In (a) the short harvest in Im. B reduces supply in Im.B by AB , the adjustment in the world market can be decomposed: -BC is reduced import demand due to price increase and AC is increased export supply in response to the price increase

Distribution of the effects of supply shocks in both countries

19

Optimal Export TariffS

ED

P

Q

World Market

PF

P

P*= P(1+τ)

MR

• Why is MR below ED?• How do we measure socialreturn from additional exports?

Optimal Import Tariff

S

ED

P

Q

World Market

P*

P= P*(1+τ)

• Why is Marginal Outlay above S?• What is the true cost of an additionalunit of imports?

MO

Tariff v Quota Equivalence: large country

22

S

D

ES

P

Q Q

PHome World

Market

PF

ED

| |

For quotas, welfare effects depend crucially on how import licenses are distributed. e.g., a) Auction quotas (Australia); b) Assign Import rights tohome firms (Japan, Indonesia; Canada) c) Give licenses to foreigners (USA).

Import Quota & Domestic Monopolist

23

S

Dq

P

Q

Domestic Market

PF

Pq

MRq

Unlike with a tariff, Monopolist is now free to prices

Qu

ota

rent

D

Quota shifts D left by amount of quota

}Imports

Tariff v Quota that leads to same level of imports

24

S

Dq

P

Q

Domestic Market

PF

Pq

MR

Unlike with a tariff, Monopolist is now free to prices

| |

D

Quota shifts D left by amount of quota

0 Qq Qt

PF + τ

Quota creates more monopoly powerthan tariff

QF}Imports

Source: David Skully

25

D

World bound agricultural tariff averages, by region

26

Source:www.ers.usda.gov/db/Wto/WTOTariff_database/

Source:www.ers.usda.gov/db/Wto/WTOTariff_database/

27

Tariff Escalation & Effective Rate of Protection

SDPrice

Qcorn,beef

S

Nominal rate of protection = ST/OS = 60%

Effective rate of protection = ST/GS = 120%

G

T

0

Pcorn = $500 (foreign supply)

Pbeef = $1,000 (foreign supply)

P*b = $1,600

Value added = Final value of good - value of imported inputs. v = p - p, where is share of imported inputs in final value.

ERP = (v’ -v)/v

Tariff Escalation

Higher import duties on semi-processed & finished products than on raw materials.

e.g., Cocoa enters US duty free but there is a relatively high tariff on the processed product chocolate.

Instant coffee v coffee beans is another example.

Average tariff on processed products as multiple of raw product

US 1.25

EU 2.75

Japan 3.75

Canada 3.00

Source: Oxfam