Master

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International Trade with Partial Equilibrium
Models and Optimization StrategiesA basic
Approach

• Master Économie et Affaires Internationales
• Paris Dauphine September 2010
• Dr. Ramón Mahía
• Professor of Applied Economics Department
• www.uam.es/ramon.mahia

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International Trade with Partial Equilibrium
Models and Optimization StrategiesA basic
Approach
STRUCTURE OF DOCUMENT AND EXPOSITION

• Basic elements for understanding Partial
  Equilibrium Models
• Closed economy
• Do we need optimization?
• Open Economy
• Basic concepts
• Tradable / Non tradable Goods definition
• Optimization example Impact of trade measures

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International Trade with Partial Equilibrium
Models and Optimization StrategiesA basic
Approach
STARTING POINT CLOSED ECONOMY

• Equilibrium with linear demand supply curves
  can be mathematically derived easily

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International Trade with Partial Equilibrium
Models and Optimization StrategiesA basic
Approach
STARTING POINT CLOSED ECONOMY

• But it turns complex if only linearity is lost

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International Trade with Partial Equilibrium
Models and Optimization StrategiesA basic
Approach
OPEN ECONOMY BASIC DEFINITIONS

• We will use Partial Equilibrium Model with three
  assumptions
• Single product with no substitutive items
• Small country When our economy opens, the new
  international trade is NOT big enough to change
  international prices
• Perfect competition Domestic prices
  automatically move to converge to international
  prices (financial parity prices)

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International Trade with Partial Equilibrium
Models and Optimization StrategiesA basic
Approach
FINANCIAL PARITY PRICES

• When an economy opens, an alternative market
  with a different price appears inducing a price
  competition with domestic market.
• The idea is to compare domestic prices (DP) with
  export (ExP) and import international prices
  (ImP).
• If
• ImP gt DP and ExP lt DP Non tradable good
• ImP lt DP Importable good
• ExP gt DP Exportable good

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International Trade with Partial Equilibrium
Models and Optimization StrategiesA basic
Approach
FINANCIAL PARITY PRICES

• For a meaningful comparison between
  international market price and the domestic price
  received by producers, we must adjust
• 1.- Choose a domestic wholesale reference market,
  where imported goods are supposed to enter into
  competition with locally produced equivalent
  goods) ().
• 2.- Put the price of the product in the
  international market at the same basis of the
  domestic prices using what it is usually called
  financial parity prices.
• () If we further want to obtain the import
  parity price at the factory-gate, we subtract the
  transport and marketing costs that producers have
  to pay to put their product in the market of
  reference

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International Trade with Partial Equilibrium
Models and Optimization StrategiesA basic
Approach
FINANCIAL PARITY PRICES FExPP

• We calculate the financial export parity price
  by deducting from the border price (FOB) all
  transport and marketing costs from the factory to
  the port, any export taxes or subsidies, and all
  local port charges including taxes, storage,
  loading agents' fees, etc., so as to be left with
  the factory-gate price.
• FExPP FOB Price FOB Export costs
• FOB stands for FREE ON BOARD. It is the cost of
  an export good at the exit point in the exporting
  country loaded in the ship (or other means of
  transport) in which it will be carried to the
  importing country. It is equal to the CIF price
  at the port of destination minus the cost of
  international freight, insurance and the
  unloading onto the destination dock.

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International Trade with Partial Equilibrium
Models and Optimization StrategiesA basic
Approach
FINANCIAL PARITY PRICES FExPP

• We calculate the financial import parity price
  adding to the border price (CIF in this case) all
  port charges after the import touches the dock,
  any domestic tariffs and other taxes or fees,
  duties, and the transport and marketing costs
  from the port to the market of reference.
• FImPP CIF Price Inwards costs
• CIF stands for COST, INSURANCE AND FREIGHT. It is
  the landed cost of an import good on the dock or
  other entry point in the receiving country. It
  includes the cost of international freight and
  insurance and usually also the cost of unloading
  onto the dock. It excludes any charge after the
  import touches the dock such as port charges,
  handling and storage and agents' fees. It also
  excludes any domestic tariffs and other taxes or
  fees, duties or subsidies.

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International Trade with Partial Equilibrium
Models and Optimization StrategiesA basic
Approach
OPEN ECONOMY NON TRADABLE GOODS

• Non tradable good. (1) Exporting the good is not
  justified the domestic price (Pd) is higher than
  the financial export parity price (Pep)

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International Trade with Partial Equilibrium
Models and Optimization StrategiesA basic
Approach
OPEN ECONOMY NON TRADABLE GOODS

• Non tradable good. (2) Importing the good is not
  justified Financial import parity price of the
  good (pip) is higher than the domestic price (Pd)

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International Trade with Partial Equilibrium
Models and Optimization StrategiesA basic
Approach
OPEN ECONOMY NON TRADABLE GOODS

• Non tradable good (1) the domestic price (Pd)
  is higher than the financial export parity price
  (Pep) and lower than financial export parity
  price (Pip)

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International Trade with Partial Equilibrium
Models and Optimization StrategiesA basic
Approach
OPEN ECONOMY EXPORTABLE GOODS

• Exportable goods The financial export parity
  price "pep" is higher than the domestic price in
  the absence of trade, and hence there is an
  incentive for the good to be exported

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International Trade with Partial Equilibrium
Models and Optimization StrategiesA basic
Approach
OPEN ECONOMY EXPORTABLE GOODS

• Exportable goods The financial export parity
  price Pep" is higher than the domestic price

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International Trade with Partial Equilibrium
Models and Optimization StrategiesA basic
Approach
OPEN ECONOMY EXPORTABLE GOODS

• Main effects before opening economy for an
  exportable good
• Domestic demand price tends to rise up to Pep so
  domestic demand is lower at this new price and
  consumer surplus reduces
• Supply is higher at this prices
• .going now both to domestic and export markets
• Producers gain more money and producers surplus
  grows

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International Trade with Partial Equilibrium
Models and Optimization StrategiesA basic
Approach
OPEN ECONOMY IMPORTABLE GOODS

• Importable goods The financial import parity
  price of the good IS LOWER than the domestic
  price, so there is an incentive to import the good

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International Trade with Partial Equilibrium
Models and Optimization StrategiesA basic
Approach
OPEN ECONOMY IMPORTABLE GOODS

• Importable goods The financial import parity
  price Pip" is lower than the domestic price

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International Trade with Partial Equilibrium
Models and Optimization StrategiesA basic
Approach
OPEN ECONOMY IMPORTABLE GOODS

• Main effects before opening economy for an
  importable good
• Consumers have an incentive to import at this new
  price
• ..so domestic supply price tend to fall down to
  "Pip
• Demand is higher at this new and lower prices
• Coming from domestic producers but also from
  abroad
• Domestic supply is lower at this new price
• Producers lose some money
• ..but public revenues are collected from imports

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International Trade with Partial Equilibrium
Models and Optimization StrategiesA basic
Approach
OPEN ECONOMY IMPACT OF TRADE MEASSURES

• Which is the effects of a tariff measure in an
  open economy for an importable good?
• We assume that the product is an importable good
  and we start from the previous situation of
  equilibrium with trade and no protection. The
  domestic price will be equal to the international
  price Pw. Then a tariff t is introduced as a
  percentage of the import value (ad-valorem
  tariff).
• The tariff will generate a series of reactions
  over time from producers, consumers and traders
  until a new equilibrium is reached in the
  domestic market. Comparing the initial and final
  situations the effects of the tariff are the next

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International Trade with Partial Equilibrium
Models and Optimization StrategiesA basic
Approach
OPEN ECONOMY IMPORTABLE GOODS

• Main effects of a tariff in an open economy
• Domestic Prices Increases
• ...and therefore, consumers expenditures reduces
• .. and consumption reduces in volume
• Higher prices encourages producers to increase
  their supply
• that replaces imported supply
• reducing dependency on imports
• and generating a rise in revenues of producers
• ... and goverment

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International Trade with Partial Equilibrium
Models and Optimization StrategiesA basic
Approach
OPEN ECONOMY OPTIMIZATION SCHEME

• Now, I porpoise an optimization problem
• Are we able to rise the tariff to restore the
  initial situation of a closed economy?
• Objective function reduce to 0 dependency on
  imports
• Parameters to move tariff level
• Restrictions none (apart from logical
  mathematical restrictions such as non negativity
  )

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International Trade with Partial Equilibrium
Models and Optimization StrategiesA basic
Approach
OPEN ECONOMY OPTIMIZATION SCHEME

• Further complexity
• Non linearity for every relation in the scheme
• Non small country assumption
• Non perfect competition
• Importable and exportable good at the same time
• Different trade measures for import and export
  and even non measurable measures
• Matrixes different countries, different CIF and
  Fob prices, different transport costs,etc
• Market distortions market power, dumping
  strategies, .

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International Trade with Partial Equilibrium
Models and Optimization StrategiesA basic
Approach
REFERENCES

• () José María Caballero. Geraldo Calegar and
  Carlo Cappi. 2000. Instruments of Protection and
  their economic Impact. Multilateral trade
  negotiations on agriculture a resource manual.
  FAO
• de Janvry, A. Sadoulet, E. 1995. Quantitative
  Development Policy Analysis. Baltimore and
  London, The John Hopkins University Press
• FAO. 1998. The Implications of Uruguay Round
  Agreement on agriculture for Developing countries
  - a Training Manual. Training Materials for
  Agricultural Planning, No. 41. Rome.
• Gittinger, P J. 1982. Economic Analysis of
  Agricultural Projects. Second Edition. Baltimore
  and London, John Hopkins University Press.
• Josling, T. E., Tangermann, S. Warley, T. K.
  1996. Agriculture in the GATT. London, Macmillan
  Press.
• Just, R., Hueth, D.L. Schmitz, A. 1982. Applied
  Welfare Economics and Public Policy.
  Prentice-Hall, N.J.
• Tsakok, I. 1990. Agricultural Price Policy a
  Practitioner's Guide to Partial Equilibrium
  Analysis. Ithaca, New York, Cornell University
  Press.