Introduction to Agricultural Economics SIXTH EDITION CHAPTER 18

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Introduction to Agricultural Economics SIXTH EDITION CHAPTER 18 Agricultural Trade Policy and Preferential Trading Arrangements Introduction to Agricultural Economics, 6 e Penson | Capps | Rosson | Woodward Copyright © 2015, 2010 by Pearson Education, Inc. All Rights Reserved

Discussion Topics • • • Trade and welfare Why restrict trade? Trade restrictions Agricultural trade policy making The importance of preferential trading agreements Introduction to Agricultural Economics, 6 e Penson | Capps | Rosson | Woodward Copyright © 2015, 2010 by Pearson Education, Inc. All Rights Reserved

Discussion Topics • Forms of economic integration • Reasons for preferential trading agreements • Do preferential trading agreements create or divert trade? Introduction to Agricultural Economics, 6 e Penson | Capps | Rosson | Woodward Copyright © 2015, 2010 by Pearson Education, Inc. All Rights Reserved

Trade and Welfare • Autarky/closed economy § The nation is self-sufficient, no trade takes place between nations, and 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. Introduction to Agricultural Economics, 6 e Penson | Capps | Rosson | Woodward Copyright © 2015, 2010 by Pearson Education, Inc. All Rights Reserved

Trade and Welfare • Partial equilibrium and excess supply § Goods will always move from where prices are low (excess supply) to where prices are high (excess demand). Introduction to Agricultural Economics, 6 e Penson | Capps | Rosson | Woodward Copyright © 2015, 2010 by Pearson Education, Inc. All Rights Reserved

Figure 18– 2 In an open economy, trade is allowed to take place. Prices rise in the United States and decline in Japan. Producers in the United States and consumers in Japan benefit from trade. Consumers in the United States and producers in Japan experience losses in economic welfare. Introduction to Agricultural Economics, 6 e Penson | Capps | Rosson | Woodward Copyright © 2015, 2010 by Pearson Education, Inc. All Rights Reserved

The equilibrium price in the U. S. market is PUS. at prices above PUS, the market would exhibit excess supply conditions. Introduction to Agricultural Economics, 6 e Penson | Capps | Rosson | Woodward Copyright © 2015, 2010 by Pearson Education, Inc. All Rights Reserved

At price PE, for example, producers would supply QSUS 3 while consumers would only want QDUS 4. Introduction to Agricultural Economics, 6 e Penson | Capps | Rosson | Woodward Copyright © 2015, 2010 by Pearson Education, Inc. All Rights Reserved

The market equilibrium in Japan occurs at Pj. At prices below Pj, excess demand conditions will occur. Introduction to Agricultural Economics, 6 e Penson | Capps | Rosson | Woodward Copyright © 2015, 2010 by Pearson Education, Inc. All Rights Reserved

At PE, for example, consumers were willing to buy QDj 4 while producers only wished to supply QSj 3. Introduction to Agricultural Economics, 6 e Penson | Capps | Rosson | Woodward Copyright © 2015, 2010 by Pearson Education, Inc. All Rights Reserved

U. S. price where excess supply (ES 0) is equal to zero… Introduction to Agricultural Economics, 6 e Penson | Capps | Rosson | Woodward Copyright © 2015, 2010 by Pearson Education, Inc. All Rights Reserved

Japanese price where excess demand (ED 0) is equal to zero… Introduction to Agricultural Economics, 6 e Penson | Capps | Rosson | Woodward Copyright © 2015, 2010 by Pearson Education, Inc. All Rights Reserved

If the price is the U. S. Is PUS 2, excess supply would be ES 1 Introduction to Agricultural Economics, 6 e Penson | Capps | Rosson | Woodward Copyright © 2015, 2010 by Pearson Education, Inc. All Rights Reserved

If the price in Japan is Pj 2, excess demand would be ED 1. Introduction to Agricultural Economics, 6 e Penson | Capps | Rosson | Woodward Copyright © 2015, 2010 by Pearson Education, Inc. All Rights Reserved

Through trade, both country's markets would be in equilibrium where ED = ES at price PE. Introduction to Agricultural Economics, 6 e Penson | Capps | Rosson | Woodward Copyright © 2015, 2010 by Pearson Education, Inc. All Rights Reserved

If the price in the U. S. is PE, consumer surplus would decline by area 1+2 while producer surplus would increase by area 1+2+3. Introduction to Agricultural Economics, 6 e Penson | Capps | Rosson | Woodward Copyright © 2015, 2010 by Pearson Education, Inc. All Rights Reserved

If the price in Japan is PE, consumer surplus would increase by area a+b while producer surplus would fall by area a. Introduction to Agricultural Economics, 6 e Penson | Capps | Rosson | Woodward Copyright © 2015, 2010 by Pearson Education, Inc. All Rights Reserved

Both countries register a net societal gain in economic welfare. The winners and losers differ however… Introduction to Agricultural Economics, 6 e Penson | Capps | Rosson | Woodward Copyright © 2015, 2010 by Pearson Education, Inc. All Rights Reserved

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 Introduction to Agricultural Economics, 6 e Penson | Capps | Rosson | Woodward Copyright © 2015, 2010 by Pearson Education, Inc. All Rights Reserved

Trade Restrictions • Tariff barriers • Nontariff barriers (NTB) § Voluntary export restraints (VERs) § Tariff rate quotas (TRQ) § Import quotas Introduction to Agricultural Economics, 6 e Penson | Capps | Rosson | Woodward Copyright © 2015, 2010 by Pearson Education, Inc. All Rights Reserved

Figure 18– 3 Free trade equilibrium is denoted by the intersection of Sd+w and Dd. Imports equal 60 tons at a price of $1, 500/ton. The imposition of a tariff, t, on imports would lower imports to 20 tons (60 tons − 40 tons) and increase domestic production to 40 tons. A tariff has the overall effect of protecting domestic producers from import competition but also causes higher prices for consumers. In this small-nation case, the full burden of the $1, 500/ton tariff is passed on entirely to consumers. Consumption of domestic output declines to 60 tons. Introduction to Agricultural Economics, 6 e Penson | Capps | Rosson | Woodward Copyright © 2015, 2010 by Pearson Education, Inc. All Rights Reserved

50 Domestic market equilibrium under free market conditions shows a price of $4, 000 and quantity of 50 tons. Introduction to Agricultural Economics, 6 e Penson | Capps | Rosson | Woodward Copyright © 2015, 2010 by Pearson Education, Inc. All Rights Reserved

Quantity supplied (left) and quantity demanded (right) Introduction to Agricultural Economics, 6 e Penson | Capps | Rosson | Woodward Copyright © 2015, 2010 by Pearson Education, Inc. All Rights Reserved

Prevailing world price (left) and free trade supply (right) Introduction to Agricultural Economics, 6 e Penson | Capps | Rosson | Woodward Copyright © 2015, 2010 by Pearson Education, Inc. All Rights Reserved

Prevailing world price plus tariff (left) and supply with tariff (right) Introduction to Agricultural Economics, 6 e Penson | Capps | Rosson | Woodward Copyright © 2015, 2010 by Pearson Education, Inc. All Rights Reserved

Welfare Effects of Tariff • Consumer surplus before the tariff on the previous slide was equal to area a+b+c+d+e+f+g. • After the tariff, consumer surplus would fall to area e+f+g, or a loss of area a+b+c+d. Introduction to Agricultural Economics, 6 e Penson | Capps | Rosson | Woodward Copyright © 2015, 2010 by Pearson Education, Inc. All Rights Reserved

Welfare Effects of Tariff • Producer surplus increases from area h to area a+h after the tariff. • The tariff revenue received by the government is equal to area c. • Dead-weight loss to society is equal to area b+d. Introduction to Agricultural Economics, 6 e Penson | Capps | Rosson | Woodward Copyright © 2015, 2010 by Pearson Education, Inc. All Rights Reserved

Figure 18– 4 The tariff-rate quota combines both a tariff and a quota. Imports are allowed to enter the market at a low duty rate up to the quota, and imports over-quota are assessed a higher duty rate. The TRQ represents a compromise between consumers who desire low prices and producers who want high prices. Introduction to Agricultural Economics, 6 e Penson | Capps | Rosson | Woodward Copyright © 2015, 2010 by Pearson Education, Inc. All Rights Reserved

Producer surplus increases by area e as price to $200 Introduction to Agricultural Economics, 6 e Penson | Capps | Rosson | Woodward Copyright © 2015, 2010 by Pearson Education, Inc. All Rights Reserved

Welfare Effects of TRQ • Consumer surplus would fall as a result of the TRQ by area e+f+d+a+c+b+g. • Producer surplus increases by area e+d. • The revenue received by the government is equal to area a+b+c. • Dead-weight loss to society is equal to area f+g. Introduction to Agricultural Economics, 6 e Penson | Capps | Rosson | Woodward Copyright © 2015, 2010 by Pearson Education, Inc. All Rights Reserved

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 Introduction to Agricultural Economics, 6 e Penson | Capps | Rosson | Woodward Copyright © 2015, 2010 by Pearson Education, Inc. All Rights Reserved

Forms of Economic Integration • Free trade areas such as the North American Free Trade Agreement (NAFTA) • Customs unions such as the European Community with its common agricultural policy or CAP • Common market • Economic union Introduction to Agricultural Economics, 6 e Penson | Capps | Rosson | Woodward Copyright © 2015, 2010 by Pearson Education, Inc. All Rights Reserved

Reasons for 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 Introduction to Agricultural Economics, 6 e Penson | Capps | Rosson | Woodward Copyright © 2015, 2010 by Pearson Education, Inc. All Rights Reserved

Figure 18– 5 When tariffs imposed by a small-nation importer are removed, consumers experience welfare gains, and producers and government experience welfare and revenue losses, respectively. The nation as a whole experiences welfare gains. Introduction to Agricultural Economics, 6 e Penson | Capps | Rosson | Woodward Copyright © 2015, 2010 by Pearson Education, Inc. All Rights Reserved

Impact of removal of small nation tariffs means consumers gain A+B+C+D. The net gain to society is B+D. Introduction to Agricultural Economics, 6 e Penson | Capps | Rosson | Woodward Copyright © 2015, 2010 by Pearson Education, Inc. All Rights Reserved

Figure 18– 6 Trade diversion reduces global welfare because production is shifted from more-efficient nonmembers to less-efficient member producers. The small-nation importer gains from trade diversion only when the recovery of deadweight losses due to the tariff exceeds losses of government revenue from the tariff. Introduction to Agricultural Economics, 6 e Penson | Capps | Rosson | Woodward Copyright © 2015, 2010 by Pearson Education, Inc. All Rights Reserved

Diversion reduces global welfare. Consumers gain A+B+C+D, but the net gain to society is B+D−E. Introduction to Agricultural Economics, 6 e Penson | Capps | Rosson | Woodward Copyright © 2015, 2010 by Pearson Education, Inc. All Rights Reserved

Summary • Free trade affects exporting and importing nations differently. • Restrictions take the form of tariff and nontariff barriers. • Preferential trading agreements (PTA) legal within GATT and WTO rules. Introduction to Agricultural Economics, 6 e Penson | Capps | Rosson | Woodward Copyright © 2015, 2010 by Pearson Education, Inc. All Rights Reserved

Summary • PTAs can take many forms, including free trade areas, customs unions, common market or economic union. • PTAs should lead to trade creation and increased welfare of member nations. • PTAs take on political importance. Introduction to Agricultural Economics, 6 e Penson | Capps | Rosson | Woodward Copyright © 2015, 2010 by Pearson Education, Inc. All Rights Reserved