Download Exercise: Tariff Reform

Practice Exercise –Armington Elasticity and Fixed
World Prices
Keywords: Elasticity, import substitution, Armington, import tariff, model closure,
fixed world price
In this practice exercise, you will learn (1) how to change an import demand elasticity at
the second level of the consumer decision and (2) how to change the model closure.
After completing this exercise, you will be able to change an Armington elasticity and
demonstrate that higher elasticity values usually lead to larger changes in traded quantity
for a given percentage change in the import price. You also will be able to change the
model closure, to describe a small country in world markets that faces fixed world prices.
The GTAP CGE model describes a 3-stage decision for consumer demand. At the top
level, consumers decide on the commodity composition of their basket of goods. That is,
they decide how to allocate their spending among food, clothing, travel, etc. At the
second level, consumers decide on the sourcing of each commodity from imported or
domestic sources, such as purchasing a domestic or an imported model of car. At the
third level, consumers decide on the sourcing of each import from competing import
suppliers. For example, consumers decide whether to import their car from Germany,
Japan, Korea, or other global auto suppliers.
Import demand elasticities describe the flexibility of consumers to shift between domestic
and imported goods as their relative prices change, and among suppliers in response to
changes in relative import prices from each supplier. The import demand elasticities at
both the second and third levels of the decision are referred to as Armington elasticities,
after the economist Paul Armington, who conceptualized this type of sourcing decision.
Note that when you change an elasticity in your model, nothing happens! That is because
changing an elasticity does not in itself generate model results; it changes the way that
agents in the model are assumed to substitute among goods in response to a shock
introduced in an experiment. Increasing the values of Armington elasticities causes
consumers to be more sensitive to a shock to relative prices; lowering elasticity values
cause consumers to be less sensitive to price changes.
In this practice exercise, your experiment in the US3x3 model is a 5-percent increase in
the world price of manufactures imported by the U.S. To implement this shock, you will
change the model closure to define world prices as exogenous. In effect, you are
imposing the assumption that the U.S. is small in world markets, and faces fixed world
prices for all of its imports and exports. This experiment is clearly unrealistic for many
of the commodities that the U.S. trades in global markets, but it serves as a useful
exercise.
INSTRUCTIONS
1. Change the Model Closure
>Open Run GTAP
> Check that the version is the US3x3 model
>Select the Closure tab
>Add the following text (fixing all prices in ROW):
swap walraslack = pfactwld;
swap incomeslack("ROW") = y("ROW");
swap profitslack(PROD_COMM,"ROW") = qo(PROD_COMM,"ROW");
swap endwslack(ENDW_COMM,"ROW") = pm(ENDW_COMM,"ROW");
swap tradslack(TRAD_COMM,"ROW") = pm(TRAD_COMM,"ROW");
swap cgdslack("ROW") = pm(CGDS_COMM,"ROW");
2. Define a Model Experiment
>Select the Shocks tab
>Clear Shocks List
>Variable to Shock: pm (import tariff by source)
>Elements to Shocks: Manufacturing, ROW
>Shock Value: 5
>Add to Shock List
>Select the Solve Tab
>Solution Method: Gragg
> Parameter file: Default
>Save Experiment, naming it: 5MFGROW
>Solve – OK -- OK
1. Report Model Results with Base Elasticity
>Select the Results tab
>Report results in the table below for two variables:
Imports: qiw (aggregate imports of good i into region r, CIF weights)
Demand for domestic food: qds (demand for domestically produced good)
>Calculate the percent change in the import/domestic variety (qiw-qds)
2. Change the Top-level Armington Import Demand Elasticity for MFG
>Select “View” on the menu bar
>Click on “Parameters” from the dropdown menu
>Double click on ESUBD row.
>Right click on the data entry for ESUBD for manufacturing
>Enter a new ESUBD value: 0.8
>Click on the green check mark to save the new elasticity parameter value on this
sheet. (Note that this does not save a new parameter file—see the next
step) (You may get an error message that “You modified the file but need
a GEMPACK license.” You may safely ignore the warning for this
exercise.)
3. Save Your New Parameter File
>Select “File” (in the ESUBD window).
>Close
>Yes (answers the prompt, Save Changes?)
>In the box, provide a new file name with a .prm suffix, such as
“LowESUBD.prm”
>Click on “Save.” (This step saves your new parameters in a file in your model
version folder in the RunGTAP5 directory)
>OK
4. Re-solve the model with a new elasticity
>Select “Solve” page tab.
>Check that the experiment description box describes “5MFGROW,” which
means that your experiment is loaded and ready to run
>If a different experiment is described, select “Load Experiment” and click on
“15TM” and then click on OK to load the experiment
>Click on “Change” next to “Parameter file:Default” in the upper right corner of
the page
>Select the name of your new parameter file: LowESUBD
>OK (Your experiment file will now always use your new parameter file until
you change this selection.)
>Click on “Save Experiment”
>OK
>Solve
5. Report Results in the Table
6. Repeat steps 3-6, this time increasing ESUBD to 4 and saving as
HiESUBD.prm
Effects of a 5-percent increase in the world price of US manufacturing
imports on import demand, with alternative import demand elasticities
Results (% change from base)
Low ESUBD
elasticity
Default
ESUBD
elasticity
Low
ESUBD
elasticity
Imports of i (qiw)
Domestically produced
manufactures (qds)
Import/domestic quantity ratio
(qiw-qds)
Check your understanding:
1. Describe the import demand decision and the role of ESUBD.
2. What is the default value of ESUBD for manufacturing in the US3x3 model?
3. Describe the “small country” assumption of fixed world prices, and when it might
be appropriately used in a CGE model.
4. Compare the import demand response to the world price shock when using
different import demand elasticities.
You may check your answers against table 4.6 in the textbook. (However, note an
error in the column headings of that table – the center column should read “default”
rather than 1.2).