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Chapter 5 - Trade & Macro. 5.1 Macroeconomic Factors exchange rates interest rates government fiscal balance 5.2 International Agricultural Trade Trade agreements 5.3 Trade Theory Gains from trade Distortions (tariffs & subsidies) Farm programs. 1) Exchange Rates

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Chapter 5 trade macro

Chapter 5 - Trade & Macro

5.1 Macroeconomic Factors

exchange rates

interest rates

government fiscal balance

5.2 International Agricultural Trade

Trade agreements

5.3 Trade Theory

Gains from trade

Distortions (tariffs & subsidies)

Farm programs


1) Exchange Rates

Affects the competitiveness of agr. Products

Early 1970’s – floating exchange rates

Policy – over or under value exchange rate

What is the impact of a ER distortion?

Example 1:

Argentina: Overvalued Exchange Rate (exporter)

Shift of excess demand function

Lower producer price

Lower quantity exported

Loss of producer surplus




  • Interest Rates:

  • Why interest rates are important:

    1) Value of currency – prices received and paid

    Most commodities are US$ denominated

  • 2) Cost of borrowing:

    • Agriculture is capital intensive (borrowing)

    • Inputs: seed, fertilizer, machinery

      1980’s - high interest rates – low grain prices

      - debt crisis

      Cost of borrowing: How is it determined ?

      Role of central bank (Bank of Canada)

      Role of the market

      Government intervention (interest subsidies)


100 Basis points = 1%

Src. Globe & Mail - March 8, 2008


Government Fiscal Balance

Consequences for Agricultural Policy

1 – interest rate

- more borrowing = higher rates

"crowding out effect"

- higher cost for farm borrowing

2001 Average capital/farm = $800,000

Total farm capital = $ 200 Billion

1% change in interest rates => $ 2 Billion

(1971 - 2002) - Net market income

- 1.8 $B (2002) 3.3 $B (1975)

2 – capacity to fund interventions

- deficits = limited marge de manouvre

- reduced scope for intervention


5 2 international trade
5.2 International TRADE

Gains from trade:

> increase in output due to specialization

  • based on comparative advantage

  • each country

    • concentrates on producing goods and that it produces relatively efficiently

    • trading to obtain goods that it does not

      Trade Distortions

  • many forms of distortion (welfare reducing)

  • tariffs, taxes, subsidies, quantitative measures

  • non-tariff barriers (health, safety reg’s)

    Trade Agreements

  • institutional arrangement – restraint on behaviour

  • multi-lateral (regional), bilateral

  • Levels of cooperation

    • Range of goods (agr vs industrial)

    • Scope of instruments included

    • Customs union – full economic integration (EU)


Reasons for protection
Reasons for Protection

  • new industry (infant industry argument)

  • national health + phyto-sanitary

  • unfair foreign trade policy

  • Defend domestic programs

  • improve balance of payments

  • improve “Terms of Trade”

  • generate revenue

  • slow down painful economic adjustment

  • Political economy

    benefits of additional trade are spread thinly among

    many individuals but the cost is high for only a few

    firms or groups


Trade theory
Trade Theory

  • Why do nations trade?

  • What are the benefits?

  • Implications of trade distortions

    Theory

  • comparative advantage (Ricardo)

  • absolute advantage

  • Ohlin (1933)

  • comparative advantage

    • due to resource endowments

    • Canada land rich, capital poor

    • => export agr & import manufactures

      Gains from trade

  • Trade allows for specialization – increased welfare


Gains from trade
Gains from Trade

P1

W1

W2

Agr.

P2

.

Manufactures


Es ed framework
ES/ED Framework

  • Excess Demand (ED)

  • Excess Supply (ES)

    Gains from trade (versus no trade)

  • depend on the impact of a country on world prices

  • Small country – no price impact

  • Large country – prices adjust, impacts smaller

    2 Country Model – 1 good

  • e.g. US/Canada cattle market

  • Assume: Canada - low cost producer

  • How are consumers and farmers affected by trade between the two countries?

  • Winners and losers – distribution effects

    • US – consumers gains, farmers lose

    • CA – consumers lose, farmers gain


US

Canada

Trade Sector

ES

PUS

WUS

PW

WCA

PCA

ED

Trade

Gains from Trade

.


Analysis trade distortions
Analysis: Trade Distortions

1 ) Import Tariff

  • Fixed-tariff rate vs ad valorem

  • Small country (fixed tariff)

    • domestic price increases

    • Supply increases, demand decreases

    • imports reduced

    • Net dead weight loss

  • Large country

    • domestic price increases

    • world price decreases

    • Imports decrease; domestic output increases

    • Consumers lose; producers gain

    • Government gains tariff revenue

    • Net welfare gain

    • Potential to compensate consumers


Import quota
Import Quota

  • Binding quota

    • if it restricts imports below free trade imports

  • Similar price effects to a tariff

    • Imports lower

    • Domestic price higher

    • World price lower

    • Rents to importers

  • Quota value: right to import

    • Based on difference between new world price and domestic price


Large country import quota
Large Country – Import Quota

.

Domestic Market

World Market

S

D

ES

ED0

PQ

Pw

PWQ

Q

IQ


Large country tariff
Large Country - Tariff

.

Domestic Market

World Market

S

D

ES

ED0

Pw

TR

ED1


Import tariff small country
Import tariff – Small Country

S

PT

G income

b

a

Pw

D

Government income – few transactions


Export subsidy
Export Subsidy

  • Used extensively

    • Purpose: support domestic income (price) support

    • Subsidy to export the excess supply

    • US (EEP) starting in 1985

    • EU (ERP) – export restitutions – 1970’s

    • not unique to agriculture – e.g. Bombardier

  • price support program – increases ES

  • Subsidy Impacts

    • world price falls (large country)

    • Domestic price falls

    • Exports expand

    • Government payments = (Ps-PWs)*exports

  • value of exports increase relative to free trade

  • Deadweight loss

    • Consumers gain

    • Producers gain

    • Foreign importers gain

    • Taxpayer loses


Export Subsidy – Large Country

S

Ps

DWL

Pw

Pws

DT

Dd

Exports Before

Exports After

Dd – domestic demand

DT – total demand – including world demand


Export tax
Export Tax

  • Tax exporters

  • Exporting government gain revenue from export taxes

  • Producers in exporting country lose


Export cartel
Export Cartel

Assumptions:

  • 2 countries

  • Cartel: importer + domestic supplier

  • Suppliers maximize joint profits

  • Price according to joint supply function

  • MR = MC (joint MC)

    Results:

  • Domestic price increases

  • Imports and domestic production decrease

  • Foreign surplus increases

  • Deadweight loss


Export Cartel

.

Exporter

Importer

Sd

S

ST

PC

a

c

Pw

b

D

MR

Q

QE

Qd

Sd – domestic supply

ST – domestic + foreign supply

Exporter gain = (a-b)

Deadweight loss = c


Decoupled subsidies
Decoupled Subsidies

  • Programs that do not distort trade

    • within the green box category under GATT

  • policies that lead to a per-unit payment to producers are not decoupled

  • trade distorting => affects trade and prices

  • Is any farm program completely decoupled ?


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