Tutorial on Partial Equilibrium Modeling: Export Tax by a Large Country Exporter

1. Tutorial on Partial Equilibrium Modeling:Export Tax 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 a specific export tax Specific tax on exports • A per unit tax on exports (e.g., 30kr/kg) such that the difference between the domestic price and the world price is equal to 0, i.e., (PW)1 - (PD)1 = 0. • A tax 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 government's budgetary position (i.e., expenditures and revenue).

3. Economic effects of a specific export tax Market analysis • Analyzing the production, consumption and trade effects: the perspective of the exporting country World market Exporter's domestic market  τ0    

4. Economic effects of a specific export tax • Economic intuition and expectations • Regardless of the reason a tax is applied, the result is a reduction in the quantity exported. (Graphically, ES shifts to the left by the per unit tax rate.) It is assumed that the import-country's government does not take any policy action to counter the export tax. • The world price increases (PW) because a large seller on the international market reduces export supply, i.e., a TOT effect. • The internal price in the exporter's market decreases (PD) because there is more of the good in the domestic market. • Producers and consumers react to the change in the domestic price, from PW to [PD]1. • Producers respond to price decrease by decreasing output, QS. • In partial equilibrium analysis, a price decrease is expected to result in an increase in consumption, QD. • Government collects tax revenue which is equal to the tax rate, τ0, times the quantity exported, [QD ]1 - [QS]1.

5. Economic effects of a specific export tax Welfare analysis • Analyzing economic costs and income transfers among producers, consumers, traders and the government: the exporting country's perspective Exporter's market + (1)  τ0  - (1+2+3+4) + (3+5) - (2+4) + (3)

6. Economic effects of a specific export tax • Economic interpretation of welfare areas • Area '1' represents the value gained by consumers that is lost by producers, i.e., it is an income transfer from the consumer to the producer. • Area '2' 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 the good in which the country has a comparative disadvantage. • The increased production reflects a misallocation of resources because because prices have been distorted. • Area '3' represents the value lost by producers is gained by government; it is an income transfer making up part of the tax on the exportable good.

7. Economic effects of a specific tariff • Area '4' 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 exportable good, discouraging specialization in the good in which the country has a comparative advantage. • The decreased production reflects a misallocation of resources in production as a result of distorted prices. • Area '5' represents revenue that is collected by the government, along with area '3', from the tax; the total revenue is (3+5) which is equal to {[PW]1 – [PD]1} · [QX]1; however, area '5' is an income transfer from the importer to the government resulting from the TOT effect of the tax (i.e., the policy-induced reduction in supply by a large international seller that raised PW). • The net effect of the tax on exporting country is uncertain because the negative DWLs can be offset by the income transfer from the importing country.

8. Economic effects of a specific export tax Market analysis • Analyzing the production, consumption and trade effects: the perspective of the importing country Importer's domestic market World market [PW]1 [PW]1 [QS]1 [QD]1 [QM]1   

9. Economic effects of a specific export tax • Economic intuition and expectations • Regardless of the reason a tax is applied, the result is a reduction in the quantity supplied. (Graphically, ES shifts to the left by the per unit rate of tax.) It is assumed that the import-country government does not take any policy action to counter the tax. • The world price increases (PW) because a large seller on the international market reduces export supply. • The internal price in the importer’s market is the new world price because no policy action has been taken. • Producers and consumers react to the change in the domestic price, from PW to [PW]1. • Producers respond to price increases by increasing output, QS. • In partial equilibrium analysis, a price increase is expected to result in a decrease in consumption, QD. • Because the import-country's government took no action, there are no budgetary outlays on or revenues collected from the imported good.

10. Economic effects of a specific export tax Welfare analysis • Analyzing economic costs and income transfers among producers, consumers, traders and the government: the importing country's perspective Importer's market - (a+b+c+d) + (a) 0 - (b+c+d)

11. Economic effects of a specific export tax • Economic interpretation of welfare areas • Area 'a' represents the value lost by by consumers from the higher price and that is gained by producers; it is an income transfer from consumers to producers. • Area 'b' 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" production. • The DWL in production in the exporting country is the cost to society of producing too little of the exportable good, the good in which the country has a comparative advantage. • The decreased production reflects a misallocation of resources away from the export sector, stifling the specialization process. Area 'c' represents the value lost by consumers that is gained by the exporting-country's government; it is an income transfer from the tax on consumers in the importing country to the exporting-country's government; the transfer is a result of the TOT effect.

12. Economic effects of a specific export tax • Area 'c' represents a part of the value lost by the consumers that is gained by the exporting-country's government; it is an international income transfer that is a result of the TOT effect of the tax. • Area 'd' represents a part of the value lost by the 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 is the cost to society of consuming too much of the importable good because the world price has been distorted. • The increased expenditures on imports reflects a misallocation of resources (i.e., a sub-optimal consumption mix). • The net effect of the tax on the importing country is negative, resulting in the DWLs and an income transfer to the exporting country.

13. Economic effects of a specific export tax Net world welfare effects • Internal domestic transfers, DWLs and international transfers - (b+d) - (c) Importer's market Exporter's market - (2+4) + (5) (e) = (5) - (b+d) - (2+4)

14. Economic effects of a specific export tax Concluding comments • The export tax 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 the importing country(ies). • 2. The lower domestic price in the exporting country is a subsidy to domestic consumers/users which is paid by domestic producers. • 3. The higher world price is a tax on import-country consumers, but benefits producers in the import-competing sector. • 4. Part of the revenue collected by the exporting-country's government is an international income transfer from consumers in the importing country, i.e, a tax by the exporter on the importer. • 5. The net effect of the tax on the world economy is an international income transfer and a series of DWLs in both the importing and exporting country because prices have been distorted.