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 1

2. LFLF TFTF LCLC TCTC Labor used in food production Labor used in cloth production OFOF Increasing Land used in cloth production Land used in food production F C OCOC Edgeworth Box & Allocation of Resource s 2

3. Relationship between Gen. Equilb. & Partial Equilb. Model, deriving the supply curve 3 Wheat, bushels Bushels/yard Cloth, yards Supply Slope of PPF is cloth’s opp. cost (mrt)

4. Deriving demand curves from indifference curves 4 Wheat, bushels Bushels/yard Cloth, yards D Cloth -P c /P f I   

5. From General to Partial Equilibrium 5 Wheat, bushels Bushels/yard Cloth, yards D Cloth S

6. Comparative advantage under increasing opportunity cost 6 Wheat, bushels Bushels/yard Cloth, yards Home Foreign S For Bushels/yard S Home

7. Review of Producer Surplus 7 S Q price PS 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

8. Review of Consumer Surplus 8 Demand Q price 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. P0P0 P1P1 q0q0 q1q1

9. Generating Excess Supply & Excess Demand Functions in World Market 9 D S D S price Q ForeignHome ES ED International Market Q Q price PTPT QTQT

10. Gains from Trade 10

11. 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 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) 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/.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 13 D S D S price Q Foreign Home ES ED International Market Q Q price

14. Transmission of Shocks 14 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

15. 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

16. 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

17. 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 policies 17

18. 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

19. 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

20. Optimal Export Tariff S ED P Q World Market PFPF P P*= P(1+ τ ) MR Why is MR below ED? How do we measure social return from additional exports?

21. 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 additional unit of imports? MO

22. Tariff v Quota Equivalence: large country 22 S D ES P QQ P Home World Market PFPF ED || 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).

23. Import Quota & Domestic Monopolist 23 S DqDq P Q Domestic Market PFPF PqPq MR q Unlike with a tariff, Monopolist is now free to  prices Quota rent D Quota shifts D left by amount of quota } Imports

24. Tariff v Quota that leads to same level of imports 24 S DqDq P Q Domestic Market PFPF PqPq MR Unlike with a tariff, Monopolist is now free to  prices | | D Quota shifts D left by amount of quota 0 QqQq QtQt P F + τ Quota creates more monopoly power than tariff QFQF } Imports

25. Source: David Skully 25 D

26. World bound agricultural tariff averages, by region 26 Source:www.ers.usda.gov/db/Wto/WTOTariff_database/

27. 27

28. Tariff Escalation & Effective Rate of Protection S DPrice Qcorn,beef S Nominal rate of protection = ST/OS = 60% Effective rate of protection = ST/GS = 120% G T 0 P corn = $500 (foreign supply) P beef = $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

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 US1.25 EU2.75 Japan3.75 Canada3.00 Source: Oxfam