Case background • Consider a small country that exports steel Suppose that a ‘pro-trade’ government decides to subsidize the export of steel by paying a certain amount for each ton sold abroad.
Questions l. How does this export subsidy affect the domestic price of steel, the quantity of steel produced, the quantity of steel consumed, the quantity of steel exported? l How does it affect consumer surplus, producer surplus, government revenue, total surplus? l Is it a good policy from the standpoint of economic efficiency?
First Analysis we assume: ØA country is isolated from rest of the world and produces steel. ØThe market for steel consists of the buyers and sellers in the country. ØNo one in the country is allowed to import or export steel.
Price of steel Consumer surplus Equilibriu m price Producer surplus 0 Equilibriu m quantity Quantity of steel a) Domestic price adjusts to balance demand supply. b) The sum of consumer and producer surplus measures c) the total benefits that buyers and sellers receive.
Second we assume the country is an exporting country without subsidy: the country is a small economy. The country is a price taker. (Price taker means that the country takes the world price of steel as given. They can sell steel at this price and be exporters or buy steel at this price and be importers. )
We can analysis this question through the following graph: Price of Steel Exporting Country Domestic supply Exports A World price Price after trade B D Price before trade C Domestic demand 0 Quantity of Steel
Changes in Welfare from a Free Trade: The Case of an Exporting Country
ü It shows that the domestic equilibrium price is below the world price of steel. ü Once free trade is allowed, the domestic price will rise to equal the world price. ü The domestic quantity demanded is smaller than the domestic quantity supplied and the country becomes an exporter of steel.
The analysis of an exporting country without subsidy yields two conclusions: ① Domestic producers of the good are better off, and domestic consumers of the good are worse off. ② Trade raises the economic well-being of the nation as a whole.
Now we analysis the exporting country with subsidy An export subsidy increases the price of steel exports received by producers but not affect the world price. Let us solve this question though a figure.
Price of steel PW + s Supply A C B PW D G E F Q 1 D Q 1 S Q 2 S Demand Quantity of steel
Without Subsidy With Subsidy CHANG E Consumer Surplus A+B 0 Producer Surplus E+F+G B+C+E+F+ G +(B+C) Government Revenue 0 –(B+C+D) – (B+C+D ) A+B– D+E+F+G –D Total Surplus A+B+E+F+ G As the following table shows, consumer surplus is unaffected, producer surplus rises, government revenue declines, and total surplus declines.
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