Agricultural Trade Policy and Arrangements

1. Agricultural Trade Policy andArrangements Chapter 19

2. Discussion Topics • Trade and welfare • Why restrict trade? • Trade restrictions • Agricultural trade policy making • The importance of preferential trading agreements • Forms of economic integration 2

3. Trade and Welfare • Autarky/closed economy – A country is self-sufficient • No trade takes place between nations • Markets are in equilibrium • Arbitrage – purchasing commodities in one market at a low price and rapidly selling them in another market at a higher price. • Partial equilibrium and excess supply – goods will always move from where prices are low (excess supply) to where prices are high (excess demand). 3 Page 370

4. Trade and Welfare • Equilibrium price in U.S. market: PUS • Prices above PUS, → excess supply • PE: producers would supply QSUS3while consumers would only want QDUS4 $ US Market SUS Excess Supply (ES) PE 3 1 2 PUS DUS Q 4 QUS QDUS4 QSUS3 Page 371

5. Trade and Welfare • Equilibrium price in U.S. market: PJ • Prices below PJ, → excess demand • PE: producers would only want supply QSJ3while consumers would want QDJ4 $ Japan Market SJ PJ A Excess Demand (ED) B PE Same PE as in U.S. DJ Q 5 QDJ4 QSJ3 QJ Page 371

6. Trade and Welfare • PUS → U.S. price where ES = 0 • ES = SUS – DUS at price above PUS • PJ → Japanese price where ED = 0 • PE → World price after trade (ES = ED = QE) SJ Japan World Trade United States $ $ ES $ SUS PJ QE ED0 PE DJ QE PUS ES0 ED DUS QD QE QJ 6 Page 371

7. Trade and Welfare • Let PJ2 = PUS2 • What happens if the price in Japan decrease to PJ2? • What happens if the price in the U.S. increases to PUS2? • At PJ2 = PUS2 → ES > ED • Thru trade, both country’s markets would be equilibrium where ED = ES at PE SJ Japan World Trade United States $ $ ES $ SUS Excess Supply Excess Demand PJ ED0 PUS2 PJ2 DJ PUS ES0 ED DUS QD QJ Page 371 7

8. Trade and Welfare • If Japan price ↓ from PJ to PE • Japan consumer surplus ↑ by area (A+B) • Japan producer surplus ↓ by area A • If U.S. price ↑ from PUS to PE • U.S. consumer surplus ↓ by area 1 • U.S. producer surplus ↑ by area (1+2) SJ Japan World Trade United States $ $ ES $ SUS PJ ED0 B A B PE 2 PE 2 1 DJ PUS ES0 ED DUS 8 Page 371

9. Trade and Welfare • Both countries register a net societal gain from trade • Who wins and who loses differ across country Gains From Trade 9 Page 373

10. Why Restrict Trade? • To protect a new or infant industry • To counter unfair foreign competition • To improve the balance of payments • To protect national health, the environment or food safety 10 Page 373

11. Trade Restrictions • Tariff barriers • Nontariff barriers (NTB) • Voluntary export restraints (VERs) • Tariff rate quotas (TRQ) • Import quotas 11 Page 375

12. Importing Country Tariff Impact $/ton Domestic supply Sd Domestic market equilibrium 4,000 3,000 1,500 Free trade supply (SFT) ED Dd World price Q 80 20 50 Domestic demand At world price, ED = (80-20) = 60 Page377 12

13. Importing Country Tariff Impact $/ton Sd World price plus tariff of $1,500 SFT + Tariff 3,000 ED $t 1,500 SFT Dd Q 80 60 40 20 With tariff, ED = (60-40) = 20 Page377 13

14. Importing Country Tariff Impact $/ton Sd World price plus tariff of $1,500 G E F 3,000 SFT +Tariff $t A C D B 1,500 SFT H Dd Q World price 80 60 40 20 Page377 14

15. Welfare Effects of a Tariff • CSbefore tariff on the previous slide was equal to Area (A+B+C+D+E+F+G) • After the tariff, the CS would fall to Area (E+F+G), or a lossof Area (A+B+C+D) • PS↑ from area Hto Area (A+H)after tariff • The tariff revenue received by the gov’t is AreaC • Dead-weight loss to society is Area (B+D) Page 377

16. Tariff Rate Quota (TRQ) • TRQ: combines two trade policy tools • Quota component: Imports entering under quota portion of a TRQ are subject to a lower (sometimes zero) tariff • Imports above the quota’s threshold face a much higher (usually prohibitive) tariff Page 377

17. TRQ Impact on Small Nation Importer • Without trade: domestic • price of $300 • With free trade, Sd = 10, Qd = 50, QI = 40 • Assume TRQ is set at 5 tons $/ton Tariff1 = $50 Tariff2 = $50 Sd Autarkic price 300 200 SFT+Tariff2 SFT+Tariff1 100 SFT Dd Q (tons) 60 45 15 40 50 20 10 • With initial imports exceeding the imports both within and over quota rates apply • TRQ causes price to ↑ from $100/ton to $200/ton Page 380 17

18. TRQ Impact on Small Nation Importer • TRQ causes price to ↑ from $100/ton to $200/ton • Domestic production ↑ to 20 tons • Domestic consumption ↓ to 40 tons • Imports ↓ to 20 tons Sd Dd $/ton Tariff1 = $50 Tariff2 = $50 200 SFT+Tariff2 SFT+Tariff1 100 SFT Q (tons) 60 45 15 40 50 20 10 Page 380 18

19. TRQ Impact on Small Nation Importer • Welfare effects of TRQ • ↑ in domestic prices and ↑ in production ↑ PS to E Sd Dd $/ton Tariff1 = $50 Tariff2 = $50 200 SFT+Tariff2 C D E SFT+Tariff1 F G B A 100 SFT Q (tons) 60 45 15 25 40 50 20 10 Page 380 19

20. TRQ Impact on Small Nation Importer • Government tariff revenue generated by TRQ = Area (A + B + C) • Government Tariff Revenue • 20 tons imported after TRQ • Area A = Gov’t tariff revenue under initial tariff = $50 x 5 tons • Area (B + C) = Gov’t tariff revenue from TRQ = $100 x 15 tons Sd Dd $/ton Tariff1 = $50 Tariff2 = $50 200 SFT+Tariff2 C 150 SFT+Tariff1 B A 100 SFT Q (tons) 60 45 15 25 40 50 20 10 Page 381 20

21. TRQ Impact on Small Nation Importer • Windfall Profits • For 1st 5 tons imported, price = $150/ton ($100 price + $Tariff1) • Importer obtains foreign corn for $150 and sell domestically for $200 → Area D windfall profits • If exporters restrict corn shipments and raise price to $200/ton • Any portion of Area D captured by exporters represents a welfare loss to importing nation • Windfall profits generated by TRQ for domestic or foreign producers = Area D Sd Dd $/ton Tariff1 = $50 Tariff2 = $50 200 SFT+Tariff2 D 150 SFT+Tariff1 100 SFT Q (tons) 60 45 15 25 40 50 20 10 Page 381 21

22. Welfare Effects of aTRQ • CS would ↓ by Area (E + F + D + A + C + B + G) • PS would ↑ by Area (E + D) • Tariff revenue obtained by gov’t is Area (A + B + C) • Dead-weight loss to society is Area (F + G) Sd Dd $/ton Tariff1 = $50 Tariff2 = $50 200 SFT+Tariff2 C D E SFT+Tariff1 F G B A 100 SFT 20 10 Q (tons) 60 45 15 25 40 50 Page 380 22

23. Rationale for Export Policy • Dispose of surplus production • Limit price increases in domestic markets • Grow processing industries and employment • Limit capability of another nation • Encourage policy reforms by denying trade Page 382

24. Examples of Economic Integration • Free trade areas • 1994 North American Free Trade Agreement (NAFTA) • Canada, Mexico and U.S. • Free trade agreements with S. Korea, Panama, and Columbia • Signed by Pres. Obama in October 2011 • Unions: European Union and its common agricultural policy (CAP) • 27 member countries • Transferred some of their sovereignty or lawmaking authority Page 388

26. Reasons for U.S. Preferential Trading Agreements… • Economic or political reasons tied to U.S. strategic interest • Timely reductions in barriers to trade • Counter economic and political power of other trading agreements • Reduce illegal immigration • Foster political stability and economic prosperity Page 389

27. Impact of Trade Agreements • Lets look at trade between Mexico and the U.S. where Mexico is the small nation importer • Assume U.S. is the least cost supplier • Prior to free-trade agreement a tariff of t per unit of imports • Domestic (Mexican) production, QS1, and demand, QD1 • Quantity imported is (QD1-QS1) SM DM $ DM,SM are Mexico D & S MUS+t = supply of U.S imports w/the tariff MUS+t PM+t Quantity imported Q QS1 QD1 Page 391

28. Impact of Trade Agreements • Lets assume a free trade area is created • Removes tariff • ↑imports from the U.S. to MUS and ↓ price to PM • Domestic (Mexican) production ↓ • Domestic (Mexican) consumption ↑ • Imports from the US ↑ to (QD2 – QS2) SM DM $ PM+t MUS+t Increased imports PM MUS Q QS1 QS2 QD1 QD2 Page 391

29. Impact of Trade Agreements • Impacts of Free Trade Agreement of small nation tariff • Mexican CS ↑ by Area (A + B + C + D) • Mexican PS ↓ by Area A • Mexican gov’t loses tariff revenue by Area C • Total Mexican welfare gains is Area (B + D) SM DM $ PM+t MUS+t A C D B PM MUS Q QS2 QD2 Page 392

30. Impact of Trade Diversion • Trade Diversion • Assume one has a free-trade agreement • Lower-cost imports from a non-member nation • Replaced (diverted) by higher cost imports from a member nation • Trade diversion ↓ global welfare • Shifts production from more efficient producers outside Agreement • To less efficient producers within the Agreement • Trade Diversion may result in Agreement members gaining or losing individually Page 392

31. Impact of Trade Diversion • Trade Diversion: • Assume one has a free-trade agreement • Lower-cost imports from a non-member nation • Replaced (diverted) by higher cost imports from a member nation • Assume the following • Both the EU and the U.S. compete for the Mexican market • The EU is initially the largest supplier to the Mexican market, MEU > MUS • There is an equal tariff, t, applied to the imports from both countries Page 392

32. Impact of Trade Diversion • Trade Diversion: • With an equal tariff, the EU is the sole exporter to Mexico because PEU+t< PUS+t • With no free trade area the price in Mexico is PEU+t • Mexican consumption: QD1, Mexican production, QS1 No trade equilibrium DM SM $ Imports from the EU = QD1 – QS1 PM PUS+t MUS+t PEU+t MEU+t PUS MUS MEU PEU Q Page 392 QM QD1 QS1

33. Impact of Trade Diversion • Trade Diversion: • Free-Trade Agreement between Mexico and the U.S. • Remove tariff from U.S. but not EU imports • PUS is now the price in Mexico • Mexican consumption ↑ to QD2, Mexican production ↓ to QS2 • Imports from the EU ↓ to 0 and U.S. imports ↑ from 0 to QD2 - QS2 • →EU imports replaced by imports from the U.S. DM SM Imports from the US = QD2 – QS2 $ PUS+t MUS+t PEU+t MEU+t PUS MUS Q QD2 QD1 QS1 QS2 Page 392

34. Impact of Trade Diversion • Welfare Impacts of Trade Diversion: • Consumers gain at the expense of producers and gov’t Welfare Impacts of Price ↓ $ DM SM PUS+t MUS+t MEU+t PEU+t A C B D PUS MUS E MEU PEU QD2 Q QD1 QS1 QS2 Page 393

35. Summary • Free trade affects exporting and importing nations differently • Restrictions take the form of tariff and nontariff barriers. • PTAs can take many forms, including free trade areas and economic unions • PTAs should lead to trade creation and increased welfare of member nations. • PTAs take on political importance.

36. World Oil Trade: China and ROW • Pw is world oil price • China demands more than supplied domestically SC China DC $ PC PW The difference (QCd-QCs) is the amount imported Q QCd QCs

37. World Oil Trade: China and ROW • Pw is world oil price • Venezuela produces more than domestic demand Venezuela SV $ DV PW The difference (QVS-QVD) is the amount exported PC Q QVs QVd

38. World Oil Trade: China and ROW • China and Venezuela are two economies that obviously benefit from oil trade. • A graph of all importing nations would look similar to our one for China. • A graph of all exporting nations would look similar to our one for Venezuela. • By combining exporters and importers in systematic way, we can identify an equilibrium world price.

39. World Oil Trade: China and ROW Crude Oil Exporter Excess Supply P $ ES = Amounts Oil Exporters PNT De Se Q Q Export (Trade) Potential

40. World Oil Trade: China and ROW • Why is crude oil Excess Supply (ES) upward sloping? • At higher and higher prices, exporting nations not bound by OPEC production constraints start producing more oil • Exploration increases • Stocks (inventories) decline • Domestic consumption declines at higher prices

41. World Oil Trade: China and ROW ES $ ES PNT = Amounts ED Sm Dm Oil Importers Trade

42. World Oil Trade: China and ROW • Why is crude oil Excess Demand (ED)downward sloping? • As prices rise, importers demand less (i.e., people start driving less, purchasing hybrids) • As prices rise, suppliers in importing region increase output. (i.e., U.S. oil production rises.)

43. World Oil Trade: China and ROW World price determined where ES = ED P P P ES Pw ED Dm Sm De Se Qt Q Oil Importers Oil Exporters Trade

44. World Oil Trade: China and ROW • Let's work through some examples using the above model of trade • The emerging tiger • Former Vice-President Gore: Tax what you burn, not what you earn policy. • How could a hurricane cause gasolinesprices to rise while at the same time cause crude oil prices to fall at the same time?

45. World Oil Trade: China and ROW Impact of China’s growing economy P P P ES Q*t P*w Qt Pw ED* ED SC DC De Se QT Q*T Q China Oil Exporters Trade

46. World Oil Trade: China and ROW Impact of Global Carbon Tax Pre-Tax Equilibrium P P P D*e ES ES* Pw P*w ED DC ED* SC De Q*T QT Se D*C Q China Trade Oil Exporters

47. World Oil Trade: China and ROW Carbon Tax on World Oil Markets • Downward pressure on world oil prices • Reduce greenhouse gases • Increase demand for non-carbon energy sources: Wind, geothermal, solar, etc.

48. Katrina Impacts on World Oil Markets • Shuts down oil supply into the US • a left shift of the import demand for oil by a major importer, the U.S. • →An excess supply available to ROW’s importers • Decreases world crude oil prices • Shuts down gasoline refineries leaving U.S. consumers with less gas supply • → a left shift in the supply of gasoline to the U.S. retail market • Increased domestic retail gasoline price

49. World Oil Trade: U.S. and ROW Impact of Hurricane Katrina P P P ES P*w Pw ED ED* SC DC De Se QT Q*T Q U.S. Oil Exporters Trade

50. World Oil Trade: U.S. and ROW Impact of Katrina on U.S. Retail Gasoline Market P The supply curve shifts up due to lack of ability to access enough crude oil feedstock to produce QRG S* S P*RG PRG D Q QRG Q*RG