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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 “.

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Baldwin wyplosz the economics of european integration

Teaching/Studying Presentation

Baldwin & WyploszThe 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


Baldwin wyplosz the economics of european integration

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

RoW

Partner

Home

euros

euros

euros

MS

XSP

XSR

PFT

MD

Partner

Exports

RoW

Exports

Home

imports

XR

XP

M=XP+XR


Baldwin wyplosz the economics of european integration

RoW

Partner

Home

euros

euros

euros

MS

XSP

XSR

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

RoW

Exports

Home

imports

XR

XP

M=XP+XR


Baldwin wyplosz the economics of european integration

Price received by exporters

Price received by exporters

RoW

Partner

Home

euros

euros

euros

MS

XSP

XSR

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

Partner

Exports

RoW

Exports

Home

imports

XR

XP

M=XP+XR


Baldwin wyplosz the economics of european integration

Price of imports in home

RoW

Partner

Home

euros

euros

euros

MS

XSP

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

Partner

Exports

RoW

Exports

Home

imports

XR

XP

M=XP+XR


Baldwin wyplosz the economics of european integration

2. The total import supply curve face home (MS) ...

RoW

Partner

Home

euros

euros

euros

MS

XSP

XSR

P’

is the horizontal sum of the two export supply curves.

More graphically ...

Partner

Exports

RoW

Exports

Home

imports

XR’

XP’

M’=XP’+XR’


Baldwin wyplosz the economics of european integration

RoW

Partner

Home

euros

euros

euros

MS

XSP

XSR

P’

Partner

Exports

RoW

Exports

Home

imports

XR’

XP’

M’=XP’+XR’

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’.


Baldwin wyplosz the economics of european integration

4. Likewise M” is the sum of what R and P would offer at price P”

RoW

Partner

Home

euros

euros

euros

MS

XSP

XSR

P’

P”

Partner

Exports

RoW

Exports

Home

imports

XR’

XP’

M’=XP’+XR’

XR”

M”=XP”+XR”

XP”


Baldwin wyplosz the economics of european integration

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.

RoW

Partner

Home

euros

euros

euros

MS

XSP

XSR

PFT

MD

Partner

Exports

RoW

Exports

Home

imports

XR

XP

M


Baldwin wyplosz the economics of european integration

RoW

Partner

Home

euros

euros

euros

MS

XSP

XSR

PFT

MD

Partner

Exports

RoW

Exports

Home

imports

XR

XP

M

6. As a first step, consider how a non-discriminatory, i.e. MFN, tariff would change things.

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 ...


Baldwin wyplosz the economics of european integration

RoW

Partner

Home

euros

euros

euros

MS

XSP

XSR

PFT

MD

Partner

Exports

RoW

Exports

Home

imports

XR

XP

M

8. Graphically this shows up as a shift up of the MS curve to MS w/T. This shift is exactly equal to T.

MSw/T

XSP w/T

XSR w/T

9. Here is why ...

P’

T

M’


Baldwin wyplosz the economics of european integration

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

MS

XSP

XSR

P’

T

P’-T

Partner

Exports

RoW

Exports

Home

imports

XR’

XP’

M’=XP’+XR’

XR”

M”=XP”+XR”

XP”


Baldwin wyplosz the economics of european integration

RoW

Partner

Home

euros

euros

euros

11. With the tariff, P’-T is the price received by exporters, so they export XP”

and XR” instead of XP’ and XR’.

MS w/T

MS

XSP

XSR

P’

T

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

P’-T

Partner

Exports

RoW

Exports

Home

imports

XR’

XP’

M’=XP’+XR’

XR”

M”=XP”+XR”

XP”


Baldwin wyplosz the economics of european integration

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

XSP

XSR

T

P#

T

P#-T

Partner

Exports

RoW

Exports

Home

imports

XR=0

XP=0

M=XR + XP=0


Baldwin wyplosz the economics of european integration

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

MS

XSP

XSR

P’

T

PFT

P’-T

MD

XR

XP

Partner

Exports

RoW

Exports

Home

imports

M

M’

XR’

XP’


Baldwin wyplosz the economics of european integration

Chapter 3-1: Figure 4

RoW

Partner

Home

Domestic price,

euros

Border price,

euros

Border price,

euros

MSMFN

MS

XSP

XSR

P’

T

PFT

P’-T

Pa

Pa-T

MD

XR

XP

Partner

Exports

RoW

Exports

Home

imports

M

M’

XR’

XP’


Baldwin wyplosz the economics of european integration1

Teaching/Studying Presentation

Baldwin & WyploszThe 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

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

RoW

Partner

Home

Domestic price,

euros

Border price,

euros

Border price,

euros

3a. When the domestic price is P1 Partner and RoW exporters receive different prices (due to the preferential liberalisation).

MSMFN

MSPTA

MSFT

XSP

XSR

P1 is the domestic price and the price paid to Partner exporters

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.

P1

A

MD

T

P1-T

Partner

Exports

RoW

Exports

Home

imports

3. Start by finding the total imports offered when the domestic price is, for example, P1.

The PTA Diagram

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.

T


The pta diagram1

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.

RoW

Partner

Home

Domestic price,

euros

Border price,

euros

Border price,

euros

MSMFN

3a. At these prices, Partner will offer XP2 but RoW will offer no exports.

MSPTA

3b. Thus another point on MSPTA is point B.

MSFT

XSP

XSR

P2

T

P2-T

B

A

MD

Partner

Exports

M2=XP2+0

RoW

Exports

XP2

XR2=0

Home

imports

The PTA Diagram


The pta diagram2

RoW

Partner

Home

Domestic price,

euros

Border price,

euros

Border price,

euros

MSMFN

MSPTA

MSFT

XSP

XSR

3c. At point C on the MSPTA curve, both RoW and Partner offer exports.

P3

C

T

P3-T

4. The MSPTA curve is the combination of all such examples.

Note that it lies between MSFT and MSMFN.

B

A

MD

Partner

Exports

RoW

Exports

Home

imports

The PTA Diagram


Baldwin wyplosz the economics of european integration

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’

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’.

RoW

Partner

Home

euros

euros

euros

- Afterwards, it is P” since this is where import demand equals import supply.

Note that the liberalisation lowers the domestic price.

MSMFN

MSPTA

XSP

XSR

- The lower price for imports increases Home imports to M”

P’

P”

P”

P”

T

T

P’-T

P’-T

P”-T

MD

Partner

Exports

RoW

Exports

Home

imports

XR’

XP’

M’

M”

XR”

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’.


Baldwin wyplosz the economics of european integration

11. To sum up the positive effects

HomePartnerRoW

Price   

Imports  n.a. n.a.

Exportsn.a. 

RoW

Partner

Home

euros

euros

euros

MSMFN

MSPTA

XSP

XSR

P’

P”

P”

P’-T

P’-T

P”-T

MD

Partner

Exports

RoW

Exports

Home

imports

XR’

XP’

M’

M”

XR”

XP”


Baldwin wyplosz the economics of european integration

Figure 4-7

RoW

Partner

Home

euros

euros

euros

MSMFN

MSPTA

XSP

XSR

P’

P”

P”

P’-T

P’-T

P”-T

MD

Partner

Exports

RoW

Exports

Home

imports

XR’

XP’

M’

M”

XR”

XP”


Baldwin wyplosz the economics of european integration2

Teaching/Studying Presentation

Baldwin & WyploszThe 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


Baldwin wyplosz the economics of european integration

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.


Baldwin wyplosz the economics of european integration

RoW

Partner

Home

euros

euros

euros

XSP

XSR

P’

P”

P”

P’-T

P’-T

P”-T

P”-T

MD

Partner

Exports

RoW

Exports

M’

Home

imports

XR”

XR”

4. RoW receives a lower price for its exports and its sells less, so it definitely loses by the gray area, marked as “E”.

E


Baldwin wyplosz the economics of european integration

RoW

Partner

Home

euros

euros

euros

XSP

XSR

P’

P”

P”

P’-T

P’-T

P”-T

P”-T

MD

Partner

Exports

RoW

Exports

M’

Home

imports

XR”

XR”

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”.

D

E


Baldwin wyplosz the economics of european integration

RoW

Partner

Home

euros

euros

euros

XSP

XSR

P’

P”

P”

P’-T

P’-T

P”-T

P”-T

MD

Partner

Exports

RoW

Exports

M’

Home

imports

XR”

XR”

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 ...

D

E


Baldwin wyplosz the economics of european integration

RoW

Partner

Home

euros

euros

euros

XSP

XSR

P’

P”

P”

P’-T

P’-T

P”-T

P”-T

MD

Partner

Exports

RoW

Exports

M’

Home

imports

XR”

XR”


Baldwin wyplosz the economics of european integration

Home

euros

P’

P”

P’-T

P”-T

MD

Home

imports

M’

XR”

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).

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.


Baldwin wyplosz the economics of european integration

Home

euros

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.

P’

P”

P’-T

P”-T

MD

Home

imports

M’

XR”

8. The level of tariff revenue also changes.


Baldwin wyplosz the economics of european integration

Since this area is paid both before and after the liberalisation

Home

euros

minus

11. The change in tariff revenue is thus minus the blue stripped area plus the green stripped area.

P’

P”

P’-T

P”-T

plus

MD

Home

imports

M’

XR”


Baldwin wyplosz the economics of european integration

Home

euros

NB: this part (rectangle) of the private gain is offset by a loss in tariff revenue. Leaving ...

P’

P”

P’-T

only the triangle as the net private gain

P”-T

MD

Home

imports

M’

XR”


Baldwin wyplosz the economics of european integration

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”


Baldwin wyplosz the economics of european integration

Home

euros

plus

P’

P”

minus

P’-T

P”-T

plus

MD

Home

imports

M’

XR”

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”.


Baldwin wyplosz the economics of european integration

Home

euros

plus

P’

P”

minus

P’-T

P”-T

plus

MD

Home

imports

M’

XR”

14. It may be helpful to think a little bit more carefully about the 3 areas.


Baldwin wyplosz the economics of european integration

Home

euros

plus

15. The gain from the triangle is related to the increase in the volume of imports.

>It is therefore called the trade volume effect.

P’

P”

P’-T

P”-T

MD

Home

imports

M”

M’

XR”


Baldwin wyplosz the economics of european integration

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’


Baldwin wyplosz the economics of european integration

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’


Baldwin wyplosz the economics of european integration

RoW

Partner

Home

euros

euros

euros

XSP

XSR

P’

P”

P”

P’-T

P’-T

P”-T

P”-T

MD

Partner

Exports

RoW

Exports

M’

Home

imports

XR”

XR”

Figure 4-9

A

D

C

E

B


Baldwin wyplosz the economics of european integration

End


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