Partial Equilibrium Trade Model, Gains from Trade, Trade Elasticities

1
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

2

Edgeworth Box Allocation of Resources
Labor used in food production
Land used in food production
Land used in cloth production
Labor used in cloth production
3
Relationship between Gen. Equilb. Partial
Equilb. Model, deriving the supply curve
Slope of PPF is cloths opp. cost (mrt)
Wheat, bushels
Cloth, yards
Supply
Bushels/yard
Cloth, yards
4
Deriving demand curves from indifference curves
Wheat, bushels
I
-Pc/Pf
Cloth, yards
?
?
Bushels/yard
D
?
Cloth
5
From General to Partial Equilibrium
Wheat, bushels
Cloth, yards
S
Bushels/yard
D
Cloth
6
Comparative advantage under increasing
opportunity cost
Home
Foreign
Wheat, bushels
Wheat, bushels
Cloth, yards
Cloth, yards
SHome
SFor
Bushels/yard
Bushels/yard
Cloth, yards
Cloth, yards
7
Review of Producer Surplus
Producer surplus quasi rent, or excess of
gross receipts over TVC. R TR- TVC Defined as
the area above the supply curve below the price
line
price
S
PS
Q
8
Review of Consumer Surplus
Consumer utility is not observable, so
economists try to compute a money-based measure
of welfare effects. CS gives the change in what
the consumer is willing to pay over that which is
actually paid.
price
P0
P1
Demand
Q
q0
q1
9
Generating Excess Supply Excess Demand
Functions in World Market
International Market
Foreign
Home
price
S
price
price
S
ES
PT
ED
D
D
QT
Q
Q
Q
10
Gains from Trade
11
Elasticity of Import Demand -(Excess Supply)
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 dp And
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 q As
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.
12
Elasticity of Import Demand (Excess Supply)
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/.25 Which (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.
13
Lecture 10 Modeling Country Interventions
Foreign
International Market
Home
S
price
price
price
S
ES
ED
D
D
Q
Q
Q
14
Transmission of Shocks

• Country B
• Experiences a short crop-
• Shifts Sb to Sb
• which shifts Ed out to Ed
• Raising world price to Pw
• and expands trade to 08
• Note both countries adjust

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

• The imposition of a tariff t by country B
  shifts Ed to Ed
• Price in exporter A falls from Pw to Pw
  exports contract
• Price importer B rises to Pb aand imports
  contract
• B collects tariff revenue of (Pb Pw) X Q

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

• Suppose Ex A fixes producer prices at P, thus
  domestic supply becomes Sa and excess supply
  becomes Es if also fixes P to consumers excess
  supply becomes perfectly inelastic -Es.
• If P is floor price for both producers and
  consumers excess supply becomes Es below P and
  Es above P Lesson Domestic price intervention
  reduces the elasticity of Es

17
Impact on excess demand of importer fixed-price
policies

• Is mirror image from exporter case- if Im B fixes
  producer price at Pp excess demand rotates to
  Ed, fixing Pp also to consumers makews excess
  demand perfectly inelastic Ed.
• 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

18
World Market Impacts of Guaranteed Producer
Prices.

• Put together, guaranteed producer prices in both
  exporters and importers rotates Es to Es and Ed
  to Ed, world trade contracts from Q to Q and
  world price falls from Pw to Pw.
• 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

19
Distribution of the effects of supply shocks in
both countries

• 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

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Optimal Export Tariff
World Market
P
S

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

P P(1t)
PF
P
ED
MR
Q
21
Optimal Import Tariff
World Market
P
MO

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

S
P P(1t)
P
ED
Q
22
Tariff v Quota Equivalence large country
P
P
World Market
S
Home
ES
PF
ED
D


Q
Q
For quotas, welfare effects depend crucially on
how import licenses are distributed. e.g., a)
Auction quotas (Australia) b) Assign Import
rights to home firms (Japan, Indonesia Canada)
c) Give licenses to foreigners (USA).
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Import Quota Domestic Monopolist
Unlike with a tariff, Monopolist is now free to
? prices
Domestic Market
P
Imports

S
Pq
Quota rent
Quota shifts D left by amount of quota
PF
D
Dq
MRq
Q
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Tariff v Quota that leads to same level of imports
Domestic Market
P
Quota shifts D left by amount of quota
S
Pq
Unlike with a tariff, Monopolist is now free to
? prices
PF t
PF
D
MR
Dq


0
Q
Quota creates more monopoly power than tariff
Qq
Qt
QF

Imports
25
D
Source David Skully
26
World bound agricultural tariff averages, by
region
Sourcewww.ers.usda.gov/db/Wto/WTOTariff_database/
27
Sourcewww.ers.usda.gov/db/Wto/WTOTariff_database/
28
Tariff Escalation Effective Rate of Protection
S
D
Price
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
Pb 1,600
T
Pbeef 1,000 (foreign supply)
S
G
Pcorn 500 (foreign supply)
0
Qcorn,beef
Nominal rate of protection ST/OS
60 Effective rate of protection ST/GS 120
29
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