Tutorial on Partial Equilibrium Modeling: Export Quota by a Large Country Exporter The Microeconomics of International Trade ECN 230 Roberto J. Garcia School of Economics and Business, UMB

2 Economic effects of an export quota Export quota An export quota is a trade policy instrument that aims to limit directly the traded volume between countries, e.g., setting the quantity exported, [Q X ] 1, equal to a targeted volume traded, Q q. By limiting the quantity exported, a quota has implications for prices, which affects economic behavior and welfare. The economic effects are studied by analyzing the change in prices on: Production, consumption and trade patterns, and Producer and consumer welfare and the ability to earn quota rents by governments and/or firms. A quota requires additional administrative (e.g., customs) measures to ensure that [Q X ] 1  Q q.

3 Economic effects of an export quota Political administration of a quota An important feature of a quota is the how rents are shared between producers and governments. The administration of a quota is a key determinant for how quota rents are collected and allocated. This depends on how a government issues export licenses (on a first come, first serve basis; through a competitive auction; applying a fixed fee, etc). The objectives of a quota are numerous, but rents are an important consideration. If a government was interested in collecting rents, one should ask why an export tax is not applied instead of a quota because a tax is administratively more easily. Hence, the rents are often a means of "bribing" traders in exchange for limiting trade volume.

4 Economic effects of an export quota Market analysis Analyzing the production, consumption and trade effects: the perspective of the exporting country World marketExporter's domestic market  [Q D ] 1 [Q S ] 1 [P W ] 1 [P D ] 1 [P W ] 1   [Q X ] 1

5 Economic effects of an export quota Economic intuition and expectations Regardless of the reason for a quota being implemented, the result is a reduction in the quantity exported, such that the volume is  [Q X ] 1. (Graphically, ES 1 is kinked, becoming vertical at [Q X ] 1 and intersects ED at [P W ] 1.) The world price increases (  P W ) because a large seller on the international market reduces supply, i.e., a TOT effect. The internal price in the exporter's market decreases (  P D ) because there is a greater volume of the good on the domestic market. Producers and consumers in the exporting country react to a change in the domestic price, from P W to [P D ] 1. Producers respond to price decreases by decreasing output,  Q S. In partial equilibrium analysis, a price decrease is expected to result in an increase in consumption,  Q D. Quota rents can be collected. Who collects the rents depends on how the quota is implemented.

6 Economic effects of an export quota Welfare analysis Analyzing economic costs and income transfers among producers, consumers, traders and the government: the exporting country's perspective Welfare analysis Δ CS Δ PS Δ G Δ NSW +(a) - (a+b+c+d) - (b+d) + (e) + (c+e) Assumes the export- country's government earns the quota rents. Exporter's market

7 Economic effects of an export quota Economic interpretation of welfare areas Area 'a' represents the value gained by consumers from the lower price; it is an income transfer from producers to consumers. Area 'b' represents a part of the total value lost by the producers that is not transferred to any other economic agent in the economy; it is a "dead-weight loss" (DWL) in consumption. The DWL in consumption is the cost to society of consuming more of the exportable good at distorted prices and becoming less reliant on trade in the process. The increased expenditures on the product reflects a misallocation of resources (ie, a non-optimal consumption mix). Area 'c' represents a value lost by producers, making up part of the quota rents; if government sold export licenses at the market rate, then 'c' is paid by an exporter to the government and is an income transfer.

8 Economic effects of an export quota Area 'd' represents part of the value lost by producers that is not transferred to any other economic agent; it is a "dead-weight loss" (DWL) in production. The DWL in production is the cost to society of producing less of the good in which the country has a comparative advantage. The decreased production results in a misallocation of resources in production and trade as a result of distorted prices. Area 'e' represents quota rents that are collected along with area 'c'; the total rents are (c+e) which is equal to {[P W ] 1 – [P D ] 1 } · {[Q X ] 1 }; however, 'e' is a transfer of income from import-country consumers to the exporting country resulting from the quota's TOT effect, i.e., the policy-induced reduction in supply by a large international seller, raising world price to [P W ] 1. The net effect of the quota on the exporter is uncertain because the negative DWLs can be offset by the income transfer from the importing country. It will also depend on quota administration and rent collection.

9 Economic effects of an export quota Market analysis Analyzing the production, consumption and trade effects: the perspective of the importing country [P W ] 1 [Q S ] 1 [Q D ] 1 [Q X ] 1   [P W ] 1 [P D ] 1 World market Importer's domestic market

10 Economic effects of an export quota Economic intuition and expectations The application of a quota by an exporter results in a reduction in the quantity exported. (Graphically, the new ES is vertical at the targeted level of export, [Q X ] 1 ). It is assumed that the importing county's government has not taken any policy action to counter the quota. The world price increases (  P W ) because a large seller on the international market reduces supply. The internal price in the importer's market is the world price because no policy action has been taken. Producers and consumers react to the change in the domestic price, from P W to [P W ] 1. Producers respond to price increases by increasing output,  Q S. In partial equilibrium analysis, a price increase is expected to result in a decrease in consumption,  Q D. If there is no counteraction taken by the import- country's government, then there are no budgetary outlays or rents/taxes collected from imported goods.

11 Economic effects of an export quota Welfare analysis Analyzing economic costs and income transfers among producers, consumers, traders and the government: the importing country's perspective Welfare analysis Δ CS Δ PS Δ G Δ NSW - ( ) + (1) - (2+3+4) 0 Assumes the exporting country's government collects all quota rents Importer's market

12 Economic effects of an export quota Economic interpretation of welfare areas Area '1' represents the value gained by producers from the higher price; it is an income transfer from consumers to producers. Area '2' represents a part of the total value lost by the consumer that is not transferred to any other economic agent in the economy; it is a "dead-weight loss" (DWL) in production. The DWL in production is the cost to society of producing more of the importable good and becoming less reliant on trade to produce more of the good in which the country has a comparative disadvantage. The increased production reflects a misallocation of resources because the world price has been distorted. Area '3' represents the value lost by consumers that is gained by the export-country's government; it is an international income transfer, a result of a TOT effect.

13 Economic effects of an export quota Area '4' represents a part of the value lost by consumers that is not transferred to any other economic agent in the economy; it is the "dead-weight loss" (DWL) in consumption. The DWL in consumption in the importing country is the cost to society of consuming too little of the importable good as a result of distorted prices. The decreased expenditures reflects a misallocation of resources (ie, a non-optimal consumption mix). The net effect of the export quota, administered by the government of the exporting country, on the importing country is negative, resulting in DWLs and an income transfer to the exporting country. An export quota that is administered differently to the scenario in this example can result in a much different net welfare effect because the rents can shared by exporting firms, and the governments of both countries.

14 Economic effects of an export quota Net world welfare effects Internal domestic transfers, DWLs and international transfers Exporter's marketImporter's market Δ NSW Importer Exporter World - (2+4) - (3) - (b+d) - (2+4) - (b+d) + (e) (e) = (3)

Economic effects of an export quota Concluding comments The export quota by a large country results in a TOT effect that affects importers and exporters differently: 1. An increase in the world price benefits the exporting country(ies) at the expense of importing countries. 2. The lower domestic price in the exporting country is an income transfer to domestic consumers from domestic producers. 3. If quota rents go to the exporting country, then the higher world price is a tax on importing country consumers who cross-subsidize exporting country consumers. Rents are collected by the producer/ exporters if the government distributes export licenses to its firms for free, or are shared by government and firms if a fee is charged that is less than the per unit value of a license, i.e., [P W ] 1 - [P D ]. 4. The net effect of the quota on the world economy is an income transfer and DWLs in production and consumption in both the importing and exporting countries because prices have been distorted. This is the case regardless of which economic agent collects the quota rents and how the quota is administered. 5. Import quotas are often administered as export quotas to allow exporters to collect rents in exchange for export limits, i.e., a VER.