Baldwin & Wyplosz The Economics of European Integration

Baldwin & Wyplosz The Economics of European Integration
Teaching/Studying Presentation Baldwin & Wyplosz The Economics of European Integration Chapter 4: Basic Economics of Preferential Liberalisation This presentation looks at a unilateral preferential tariff reduction. “A careful presentation of the PTA Diagram “ To view this, start the slide show (‘view show’ command under the Slide Show pull-down menu) and use either the arrow keys or click the mouse to proceed

Again, for simplicity’s sake, we suppose that both are identical.
1. To consider preferential, i.e. discriminatory, liberalisation we need a diagram that allows us to consider at least two sources of imports for Home. To keep things simple, we assume two potential supplying nations, partner “P” and rest of world “RoW”, or R for short. Again, for simplicity’s sake, we suppose that both are identical. That is why R and P have identical export supply curves. Figure 4 in the book euros Home imports MD PFT RoW Exports Partner XSP XSR MS M=XP+XR XR XP

RoW Partner Home XSR XSP MS
euros euros euros XSR XSP MS An important point to keep in mind is that the price plotted on the vertical axes of the exporters diagrams (the two leftmost ones) is different from the price plotted on the vertical axes of home diagram (the rightmost diagram). That is ... PFT MD Partner Exports XR RoW Exports XP M=XP+XR Home imports

RoW Partner Home MS XSR XSP PFT
Price received by exporters Price received by exporters RoW Partner Home euros euros euros MS XSR XSP PFT On these axes, we plot the price received by exporters (measured in euros) because the export supply curves (the XS’s) tell us how much is exported at any given price received by exporters MD RoW Exports Partner Exports XR XP M=XP+XR Home imports

RoW Partner Home XSP MS XSR PFT
Price of imports in home RoW Partner Home euros euros euros XSP MS XSR PFT On this axis, we plot the price of imports inside the home country (i.e. after tariffs have been paid) because the MD curve tells us how much home will import at any given home price. To make the MS curve comparable to the MD curve, the MS curve in this diagram will show how the total imports offered to the home nation varies with the home price. MD RoW Exports Partner Exports XR XP M=XP+XR Home imports

2. The total import supply curve face home (MS) ...
euros Home imports RoW Exports Partner XSP XSR MS M’=XP’+XR’ XR’ XP’ P’ is the horizontal sum of the two export supply curves. More graphically ...

3. Click 4 times to see that the import supply facing home at price P’ (there are no trade barriers) is the sum of the amount that R and P would want to export to home at P’. euros Home imports RoW Exports Partner XSP XSR MS M’=XP’+XR’ XR’ XP’ P’

4. Likewise M” is the sum of what R and P would offer at price P”
RoW Partner Home euros euros euros XSR XSP MS P’ P” Partner Exports XR’ RoW Exports XP’ M’=XP’+XR’ Home imports XR” XP” M”=XP”+XR”

5. Finally we add in the usual home import demand curve, MD.
The free trade equilibrium import price and import quantity are PFT and M. At PFT RoW exports XR and Partner exports XP. euros Home imports RoW Exports Partner XSP XSR MS M XR XP PFT MD

6. As a first step, consider how a non-discriminatory, i. e
6. As a first step, consider how a non-discriminatory, i.e. MFN, tariff would change things. euros Home imports RoW Exports Partner XSP XSR MS M XR XP PFT MD 7. Since exporters receive the home domestic price minus the tariff, T, both R and P would supply less at any given home price. And ...

8. Graphically this shows up as a shift up of the MS curve to MS w/T
8. Graphically this shows up as a shift up of the MS curve to MS w/T. This shift is exactly equal to T. euros Home imports RoW Exports Partner XSP XSR MS M XR XP PFT MD XSP w/T MS w/T XSR w/T 9. Here is why ... P’ T M’

10. With a tariff of T, exporters see a price of P’-T when the home price is P’, so they export less. That is ... RoW Partner Home euros euros euros MS XSR XSP MS P’ T P’-T XR’ RoW Exports Partner Exports XP’ M’=XP’+XR’ Home imports XR” XP” M”=XP”+XR”

MS w/T MS XSP XSR P’ T P’-T M’=XP’+XR’ XR’ XP’ M”=XP”+XR” XP” XR”
euros Home imports RoW Exports Partner XSP XSR M’=XP’+XR’ XR’ XP’ P’-T P’ M”=XP”+XR” XP” XR” T MS w/T MS 11. With the tariff, P’-T is the price received by exporters, so they export XP” and XR” instead of XP’ and XR’. 12. Thus home sees a smaller import supply offered at any home price. Graphically, this is a leftward shift of MS to MS w/T

RoW Partner Home MS w/T MS XSR XSP T T P#-T XR=0 XP=0 M=XR + XP=0
13. Equivalently, this can be thought of as a shift up of MS by T. To see that this is true note that if the home price were P#, exporters would see a price that would make them want to export zero. RoW Partner Home euros euros euros MS w/T MS XSR XSP T P# T P#-T RoW Exports Partner Exports Home imports XR=0 XP=0 M=XR + XP=0

RoW Partner Home XSP MS XSR P’ T PFT MD XR XP M XR’ XP’ M’
14. Finally we see now that with the MFN tariff, the new equilibrium home price will be P’, and the new level of imports will be M’, with R and P exporting XR’ and XP’ . To make things clear, we label the shifted MS curve “MSMFN” RoW Partner Home euros euros euros MSMFN XSP MS XSR P’ T PFT P’-T MD XR RoW Exports XP Partner Exports M Home imports XR’ XP’ M’

Chapter 3-1: Figure 4 XSP XSR MS PFT MD P’ T Pa Pa-T M XR XP M’ XR’
Domestic price, euros Home imports RoW Exports Partner XSP XSR MS M XR XP PFT MD P’ MSMFN M’ T P’-T XR’ XP’ Border price, Pa Pa-T

Teaching/Studying Presentation Baldwin & Wyplosz The Economics of European Integration Chapter 4: Basic Economics of Preferential Liberalisation This presentation looks at a unilateral preferential tariff reduction. “A careful presentation of the positive effects of unilateral discriminatory tariff liberalisation “ To view this, start the slide show (‘view show’ command under the Slide Show pull-down menu) and use either the arrow keys or click the mouse to proceed

Positive Effects Click to advance
1. To consider preferential liberalisation, we will remove the tariff from just partner and not from RoW. Our goal is to find the price and quantity effects of this. 2. As usual, the starting point is the new domestic price but to find this we must find the MS curve, call it MSPTA (for preferential trade arrangement), when Home imposes a tariff equal to T on imports from RoW but not tariff of imports from Partner. We turn now to finding MSPTA ...

The PTA Diagram MSMFN MSPTA MSFT XSP XSR T P1 A MD T P1-T
3. Start by finding the total imports offered when the domestic price is, for example, P1. Border price, euros Domestic price, Home imports RoW Exports Partner XSP XSR MSFT MD MSMFN 3a. When the domestic price is P1 Partner and RoW exporters receive different prices (due to the preferential liberalisation). P1-T P1 T MSPTA Since both RoW and Partner exporters would offer zero exports when the domestic price is P1, we know that A is one point on the MSPTA curve. A 3b. Since Partner exporters pay no tariff, the price they receive is P1. 3b. Since RoW exporters do pay T, the price they receive is P1-T. P1 is the domestic price and the price paid to Partner exporters T

The PTA Diagram MSMFN MSPTA MSFT XSP XSR P2 B T P2-T A MD
3. Next see what imports are when the domestic price is P2. - When the domestic price is P2 Partner and RoW exporters receive different prices (due to the preferential liberalisation). - Partner exporters get P2 while RoW exporters get P2-T. Border price, euros Domestic price, Home imports RoW Exports Partner XSP XSR MSFT MD MSMFN MSPTA 3a. At these prices, Partner will offer XP2 but RoW will offer no exports. XR2=0 XP2 3b. Thus another point on MSPTA is point B. B M2=XP2+0 A

The PTA Diagram MSMFN MSPTA MSFT XSP XSR P3 C T P3-T B A MD
Border price, euros Domestic price, Home imports RoW Exports Partner XSP XSR MSFT MD MSMFN MSPTA P3-T P3 T C 3c. At point C on the MSPTA curve, both RoW and Partner offer exports. 4. The MSPTA curve is the combination of all such examples. Note that it lies between MSFT and MSMFN. B A

T P” T P’-T P” XSP XSR MD MS MFN P’ MS PTA P” M’ M” XR’ XR” XP’ XP”
Now that we have the MSPTA curve, we can easily determine the equilibrium domestic price after the preferential tariff liberalisation. - Before liberalisation the price was P’ and the level of imports was M’. 10. The impact of RoW is quite different. >Because they continues to pay T, the drop in home price from P’ to P” has the effect of lowering the price RoW exporters receive from P’-T to P”-T >RoW therefore exports less, namely XR” instead of XR’ T P” XR’ P”-T P’-T XR” 9. What happens to the price facing the exporters? Two very different things. For Partner exporters, since they pay no tariff, P” becomes the price they face. >Notice that this means that Partner exporters see a higher price, P” instead of P’-T. >Consequently, they will export more, XP” instead of XP’. T P’-T P” XP’ XP” euros Home imports RoW Exports Partner XSP XSR MD MS MFN P’ MS PTA P” M’ M” - Afterwards, it is P” since this is where import demand equals import supply. Note that the liberalisation lowers the domestic price. - The lower price for imports increases Home imports to M”

RoW Partner Home MS MFN MS PTA XSR XSP P’ P” P” P’-T MD M’ M” XR” XR’
11. To sum up the positive effects Home Partner RoW Price    Imports  n.a. n.a. Exports n.a.   RoW Partner Home euros euros euros MS MFN MS PTA XSR XSP P’ P” P” P’-T P’-T P”-T MD RoW Exports Partner Exports Home imports XR” XR’ XP’ M’ M” XP”

Figure 4-7 RoW Partner Home MS MFN MS PTA XSR XSP P’ P” P” P’-T MD M’
euros euros euros MS MFN MS PTA XSR XSP P’ P” P” P’-T P’-T P”-T MD RoW Exports Partner Exports Home imports XR” XR’ XP’ M’ M” XP”

Teaching/Studying Presentation Baldwin & Wyplosz The Economics of European Integration Chapter 4: Basic Economics of Preferential Liberalisation This presentation looks at a unilateral preferential tariff reduction. “A careful presentation of the welfare effects of preferential liberalisation “ To view this, start the slide show (‘view show’ command under the Slide Show pull-down menu) and use either the arrow keys or click the mouse to proceed

Click to Advance 1. Here we look at the welfare effects of the preferential liberalisation. 2. First we consider the impact on the exporters (since this is easy) and then we look at the impact on home. 3. We can work out the welfare effects with much less information than was presented in Figure 5, so to keep the diagram as uncluttered as possible, we drop all the unnecessary lines and quantities.

4. RoW receives a lower price for its exports and its sells less, so it definitely loses by the gray area, marked as “E”. euros Home imports RoW Exports Partner XSP XSR MD P’-T P” P’ M’ XR” P”-T E

5. Partner exporters receive a higher price and they sell more, so they gain. The size of the gain is given by the gray area, “D”. euros Home imports RoW Exports Partner XSP XSR MD P’-T P” P’ M’ XR” P”-T D E

6. The welfare impact on the home nation is more complex
6. The welfare impact on the home nation is more complex. To make this easier to see, we increase the scale of the home market diagram and get rid of the RoW and Partner diagrams for the moment ... euros Home imports RoW Exports Partner XSP XSR MD P’-T P” P’ M’ XR” P”-T D E

RoW Partner Home XSR XSP P’ P” P” P’-T P’-T P”-T P”-T MD M’ XR” XR”
euros euros euros XSR XSP P’ P” P” P’-T P’-T P”-T P”-T MD RoW Exports Partner Exports XR” XR” M’ Home imports

and the public impact (change in the tariff revenue).
7. The home welfare effect consists of the private impact (net change in consumer surplus plus producer surplus) and the public impact (change in the tariff revenue). euros Home imports MD P” P’ P’-T M’ XR” P”-T 7a. The private impact (net change in consumer surplus plus producer surplus) is equal to the gray area. That is ... The lower import price helps home consumers but hurts home producers. Yet since home is consuming more of the good than it is producing (that is why it is importing the stuff) the gain to consumers is greater than the loss to producers.

8. The level of tariff revenue also changes.
euros Home imports MD P” P’ P’-T M’ XR” P”-T 8. The level of tariff revenue also changes. 10. After removing T on imports from Partner, this is what the tariff revenue becomes. 9. This was the tariff revenue collected before the liberalisation.

Since this area is paid both before and after the liberalisation P’-T
Home euros minus 11. The change in tariff revenue is thus minus the blue stripped area plus the green stripped area. P’ P” Since this area is paid both before and after the liberalisation P’-T P”-T plus MD Home imports M’ XR”

only the triangle as the net private gain
euros Home imports MD P” P’ P’-T M’ XR” P”-T NB: this part (rectangle) of the private gain is offset by a loss in tariff revenue. Leaving ... only the triangle as the net private gain

Home euros plus 12. Putting the net private change together with the net public change, the net home welfare effect consists of 3 parts. P’ P” minus P’-T P”-T plus MD Home imports M’ XR”

euros Home imports MD P” P’ P’-T M’ XR” P”-T minus plus 13. As drawn, it looks like home loses from the preferential liberalisation. However, depending upon the slopes of the XS and MD curves, the net effect might also be positive. The result that home may gain or lose from a unilateral preferential tariff cut is known as “Viner’s ambiguity”.

euros Home imports MD P” P’ P’-T M’ XR” P”-T minus plus 14. It may be helpful to think a little bit more carefully about the 3 areas.

>It is therefore called the trade volume effect. plus
Home euros 15. The gain from the triangle is related to the increase in the volume of imports. >It is therefore called the trade volume effect. plus P’ P” P’-T P”-T MD Home imports M” M’ XR”

16. The two rectangles correspond to 2 distinct trade price effects (also called terms-of-trade effects). >The liberalisation means that home now pays more for imports from Partner. The net welfare cost of this equals the blue stripped rectangle. Home euros P’ P” minus P’-T P”-T plus MD Home imports XR” M’

Home euros 17. By contrast, home now pays less for imports from RoW and the net welfare gain from this equals the green stripped rectangle. P’ P” minus P’-T P”-T plus MD Home imports XR” M’

Figure 4-9 XSP XSR A P’ P” D C P’-T P”-T B MD M’ XR” euros E RoW
Home imports RoW Exports Partner XSP XSR MD P’-T P” P’ M’ XR” P”-T A D C E B

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