Agricultural Economics Lecture 8: Agricultural Trade

What’s happening to world ag. trade?

Income per person, 1995 (with sub-national data for 19 countries) Source: Sachs, JD, “Tropical Underdevelopment.” NBER Working Paper Cambridge, MA: NBER. Who are the ag. exporters? Why?

Agricultural Employment as a Share of Civilian Employment and Real Farm Output as a Share of Real GDP SOURCE: U.S. Department of Commerce and the Federal Reserve Bank of St. Louis. Reprinted from K.L. Kliesen and W. Poole, "Agriculture Outcomes and Monetary Policy Actions: Kissin' Cousins?" Federal Reserve Bank of Sf. Louis Review 82 (3): 1-12.

Source: K.L. Kliesen and W. Poole, " Agriculture Outcomes and Monetary Policy Actions: Kissin' Cousins?" Federal Reserve Bank of St. Louis Review 82 (3): Food Expenditures as a Share of Total Consumer Expenditures in the US

The gains from trade are similar for both “importable” and “exportable” goods Pt Pe QdQe Supply Demand Price ($/unit) AB Qs Pt Pe QsQe A B Qd with imports, consumers gain more than producers lose: with exports, producers gain more than consumers lose:

So why don’t we see free trade? Pt Pe QdQe AB Qs Pt Pe QsQe A B Qd To understand trade policy, let’s start by describing it: For which goods do governments usually restrict trade? Effect of free trade in importable goods Effect of free trade in exportable goods

Given these effects of trade, what do governments choose to do? Free trade… for imports helps consumers but hurts producers; for exports helps producers but hurts consumers. Which constituencies do governments favor?

…So why do governments restrict imports?  the most common arguments against free trade are: foreigners are “dumping” their products and will raise their prices eventually our producers are “infant industries” and will reduce their costs eventually pollution, labor standards or other “market failures” make prices not reflect full costs/benefits if we have a large share of the world market, restricting trade could improve our prices  all these could be true, but economists find that they do not actually explain what governments do  the only plausible explanation is that governments favor some groups over others. This is a significant source of inefficiency and low incomes in all economies!

Beginning from the year 1980, Turkey changed its economic development policy from “import substituting industrialization” to “export led growth” strategy. Economy opened up to world trade, export-promoting incentives were initiated (including tax exemptions, rebates and favorable credit terms), direct import controls have been eliminated, and quantity restrictions have been dismantled. State intervention in the economy was reduced to minimum level. As a result of these efforts, Turkey has increased her share from world markets, from 0,15% in 1980 to 0,6% in the year Between 1980 and 2004 exports of Turkey has increased from 2,9 billion dollars to 63 billion dollars. Structure of exported goods has also changed much from mainly agricultural products and raw materials to higher value added industrial products. Transformation still continues with increasing exports of transportation vehicles and office equipments.

Turkey's Foreign Trade ($ Million)% Change / 2003 Exports (FOB) ,6 Imports (CIF) ,7 Volume ,8 Balance ,8 Exp./Imp.58,160,651,075,769,968,164,7-5,0

Trade and Welfare Ø Autarky/closed economy – the nation is self- sufficient, no trade takes place between nations, and markets are in equilibrium. Ø Arbitrage – purchasing commodities in one market at a low price and rapidly selling them in another market at a higher price. Ø Partial equilibrium and excess supply – goods will always move from where prices are low (excess supply) to where prices are high (excess demand).

Page 528 The equilibrium price in the U.S. market is P US. at prices above P US, the market would exhibit excess supply conditions. At price P E, for example, producers would supply QS US3 while consumers would only want QD US4. The equilibrium price in the U.S. market is P US. at prices above P US, the market would exhibit excess supply conditions. At price P E, for example, producers would supply QS US3 while consumers would only want QD US4.

Page 528 The market equilibrium in Japan occurs at P j. At prices below P j, excess demand conditions will occur. At P E, for example, consumers were willing to buy QD j4 while producers only wished to supply QS j3. The market equilibrium in Japan occurs at P j. At prices below P j, excess demand conditions will occur. At P E, for example, consumers were willing to buy QD j4 while producers only wished to supply QS j3.

Page 528 U.S. price where excess supply (ES 0 ) is equal to zero… U.S. price where excess supply (ES 0 ) is equal to zero…

Page 528 Japanese price where excess demand (ED 0 ) is equal to zero… Japanese price where excess demand (ED 0 ) is equal to zero…

Page 528 If the price in Japan is P j2, excess demand would be ED 1. If the price in Japan is P j2, excess demand would be ED 1. If the price in the U.S. is P US2, excess supply would be ES 1. If the price in the U.S. is P US2, excess supply would be ES 1.

Page 528 Thru trade, both country’s markets would be in equilibrium where ED=ES at price P E. Thru trade, both country’s markets would be in equilibrium where ED=ES at price P E.

Page 528 If the price in Japan is P E, consumer surplus would increase by area a+b while producer surplus would fall by area a. If the price in Japan is P E, consumer surplus would increase by area a+b while producer surplus would fall by area a. If the price in the U.S. is P E, consumer surplus would decline by area 1+2 while producer surplus would increase by area If the price in the U.S. is P E, consumer surplus would decline by area 1+2 while producer surplus would increase by area

Gains to Trade United StatesJapan Consumer gains-(1+2)+(a+b) Producer gains+(1+2+3)-(a) Net societal gain+3+b Both countries register a net societal gain in economic welfare. The winners and losers differ however… Both countries register a net societal gain in economic welfare. The winners and losers differ however…

Why Restrict Trade? Ø To protect a new or infant industry Ø To counter unfair foreign competition Ø To improve the balance of payments Ø To protect national health, the environment or food safety

Trade Restrictions q Tariff barriers q Nontariff barriers (NTB) ü Voluntary export restraints (VERs) ü Tariff-rate quotas (TRQ) ü Import quotas

Page 534 Domestic demand Domestic demand Domestic supply Domestic supply Domestic market equilibrium under free market conditions shows a price of $4,000 and quantity of 50 tons. Domestic market equilibrium under free market conditions shows a price of $4,000 and quantity of 50 tons. 50

Page 534 Free trade supply Free trade supply Prevailing world price Prevailing world price Quantity supplied Quantity supplied Quantity demanded Quantity demanded Excess Demand 60 = 80 – 20 Excess Demand 60 = 80 – 20

Page 534 Prevailing world price plus tariff Prevailing world price plus tariff Quantity supplied Quantity supplied Quantity demanded Quantity demanded Excess Demand 20 = 60 – 40 Excess Demand 20 = 60 – 40 Supply with tariff Supply with tariff

Welfare Effects of Tariff Consumer surplus before the tariff on the previous slide was equal to area a+b+c+d+e+f+g. After the tariff, consumer surplus would fall to area e+f+g, or a loss of area a+b+c+d. Producer surplus increases from area h to area a+h after the tariff. The tariff revenue received by the government is equal to area c. Dead-weight loss to society is equal to area b+d.

Page 539 Autarkic price Autarkic price

Page 539 Free trade supply Free trade supply

Page 539 Combines both a tariff and a quota… Combines both a tariff and a quota… Tariff rate for imports under quota Tariff rate for imports under quota Free trade supply Free trade supply

Page 539 Combines both a tariff and a quota… Combines both a tariff and a quota… Tariff rate for imports under quota Tariff rate for imports under quota Tariff rate for imports over quota Tariff rate for imports over quota Free trade supply Free trade supply

Page 539 Combines both a tariff and a quota… Combines both a tariff and a quota… Tariff rate for imports under quota Tariff rate for imports under quota Tariff rate for imports over quota Tariff rate for imports over quota Free trade supply Free trade supply Producer surplus increases by area e as price to $200 Producer surplus increases by area e as price to $200

Welfare Effects of TRQ Consumer surplus would fall as a result of the TRQ by area e+f+d+a+c+b+g. Producer surplus increases by area e+d The revenue received by the government is equal to area a+b+c. Dead-weight loss to society is equal to area f+g.