Download Trade and offer curves in the EU ref: offer curves v4

Trade and offer curves in the EU
ref: offer curves v4
Introduction
• Previously, we saw there are other reasons for
forming a CU, beyond static effects (TC/TD)
– Dynamic effects
– Public goods argument
Cooper & Massell (1965)
• Terms of Trade (ToT) effect – focus on this
•
•
•
•
ToT important for a large CU
Improvement in ToT increases welfare
ToT - secondary objective
Any ToT gain transferred from rest of world not wealth creating effect
• A country’s offer curve (OC) shows the
quantity that the country is willing to offer
(export) in exchange for a given quantity of
imports
• Derived from PPCs & trade triangles – see
below
Derived from PPCs & trade triangles
• General equilibrium analysis. Consider:
– better than partial equilibrium analysis?
– small country
– large country
– offer curves & CUs
Tariffs & offer curves: small country
Imports of food (F)
Exports of cloth (C)
Tariffs & offer curves: small country
Imports of food (F)
M
OM = terms of trade (TOT).
Unaffected by small country
imposing tariffs
O
Exports of cloth (C)
OH = free trade OC
Imports of food (F)
O
H
M
Exports of cloth (C)
Trade at point Q. OA are imports against exports.
Imports of food (F)
A
O
H
M
Q
Exports of cloth (C)
OH* = tariff ridden OC which raises price of imports. Thus,
demand shifts away from imports from OA to OB
Imports of food (F)
A
O
H*
H
M
Q
Exports of cloth (C)
OH* = tariff ridden OC which raises price of imports. Thus,
demand shifts away from imports from OA to OB
Imports of food (F)
H*
A
H
M
Q
Q shifts to Q*, represents
smaller size of tradecontraction of trade
B
O
Q*
Exports of cloth (C)
OH* = tariff ridden OC which raises price of imports. Thus,
demand shifts away from imports from OA to OB
Imports of food (F)
H*
H
A
M
Q
Q shifts to Q*, represents
smaller size of tradecontraction of trade
B
O
Q*
d
c
Exports of cloth (C)
Imports of food (F)
H*
A
B
H
M
Q
Q*
Size of tariff
O
Exports of cloth (C)
Large country
• Assume 2 countries
– OCH (large home country) & OCF (small foreign
country)
• Large country imposing tariff can move TOT in
it’s favour
• TOT determined by intersection of 2 OCs
• Free trade equilibrium at point Q
• OQ represents relative prices of exports &
imports
Large country: tariff
Imports of food (F)
O
OC H
Exports of cloth (C)
Large country: tariff
Imports of food (F)
OC H
OC F
Q
O
Exports of cloth (C)
Large country: tariff
Imports of food (F)
OC H
Line OQ=
terms of trade
OC F
Q
O
Exports of cloth (C)
OCH t = tariff ridden offer curve. Large country improves TOT
(line OQt steeper than OQ)
Imports of food (F)
OCH t
OC H
OC F
Qt
O
Q
Exports of cloth (C)
Size of tariff: determination of optimal tariff
• If very high tariff; possible trade drastically
reduced. Thus, country can not improve it’s
welfare
• Introduce trade indifference curves (TIC)
Country is not better off after tariff, domestic consumption still
at Qt is still on TIC
Imports (F)
OC H
OCH t
OC F
Q
Qt
O
Exports (C)
Country is not better off after tariff, domestic consumptionat Qt
is; still on TIC
Imports (F)
OC H
OCH t
OC F
Q
TIC
O
Qt
Exports (C)
Optimal tariff lies between Q & Qt, represented by OCH t1. Intersects
OCF at Qt2 & TIC2 is tangent to foreign country offer curve (OCF) at point
Qt2
Imports (F)
OCH t1
OC H
OCH t
Qt2
OC F
Q
TIC
Qt
This optimal tariff
improves welfare
and TOT
O
Exports (C)
Optimal tariff lies between Q & Qt, represented by OCH t1. Intersects
OCF at Qt2 & TIC2 is tangent to foreign country offer curve (OCF) at point
Qt2
Imports (F)
OCH t2
OC H
OCH t
Qt2
TIC1
OC F
Q
TIC
Qt
This optimal tariff
improves welfare
and TOT
O
Exports (C)
Optimal tariff formula
•
•
•
•
•
T =__1____
e-1
– (2) lower vol imports (loss)
Where; e = RoW PED for imports
2 forces at work
– (1) TOT (benefit)
Optimum tariff where gain from (1) > loss from (2)
by greatest margin; (where TIC1 tangent to OCF)
SEE HANDOUT in lecture for more information
Conclusion
• Large countries (or the EU) can move the ToT
in its favour
• This shouldn’t be the sole reason for forming a
CU