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Master Économie et Affaires Internationales Paris Dauphine -October 2006 Dr. Ramón Mahía

International Trade with Partial Equilibrium Models and Optimization Strategies: A basic Approach. Master Économie et Affaires Internationales Paris Dauphine -October 2006 Dr. Ramón Mahía Professor of Applied Economics Department www.uam.es/ramon.mahia. STRUCTURE OF DOCUMENT AND EXPOSITION.

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Master Économie et Affaires Internationales Paris Dauphine -October 2006 Dr. Ramón Mahía

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  1. International Trade with Partial Equilibrium Models and Optimization Strategies:A basic Approach Master Économie et Affaires Internationales Paris Dauphine -October 2006 Dr. Ramón Mahía Professor of Applied Economics Department www.uam.es/ramon.mahia

  2. STRUCTURE OF DOCUMENT AND EXPOSITION International Trade with Partial Equilibrium Models and Optimization Strategies:A basic Approach Basic elements for understanding Partial Equilibrium Models Closed economy Do we need optimization? A break for introducing Excel Solver Open Economy Basic concepts Tradable / Non tradable Goods definition Impact of trade measures: example of tariffs A real example: Banana Market

  3. STARTING POINT: CLOSED ECONOMY International Trade with Partial Equilibrium Models and Optimization Strategies:A basic Approach Equilibrium with linear demand & supply curves can be mathematically derived easily

  4. STARTING POINT: CLOSED ECONOMY International Trade with Partial Equilibrium Models and Optimization Strategies:A basic Approach But it runs out to be very complex if linearity is lost

  5. EXCEL SOLVER COMPLEMENT International Trade with Partial Equilibrium Models and Optimization Strategies:A basic Approach The optimization problem should be written in an Excel worksheet as it could be solved “by hand” The basic elements of an optimization problem are: Optimization function to maximize, minimize or achieve an exact value Parameters to move to achieve optimization function objective Restrictions to be taken into account Options for changing optimization algorithm definition

  6. OPEN ECONOMY: BASIC DEFINITIONS International Trade with Partial Equilibrium Models and Optimization Strategies:A basic Approach We will use Partial Equilibrium Model with three assumptions: Single product: with no substitutive items Small country: When an economy opens, new international trade is small enough to not change international prices Perfect competition: Domestic prices automatically move to converge to international prices = financial parity prices

  7. OPEN ECONOMY: BASIC DEFINITIONS International Trade with Partial Equilibrium Models and Optimization Strategies:A basic Approach When an economy opens, an alternative market with a different price appears inducing a price competition with domestic market. For a meaningful comparison between international market price and the domestic price received by farmers, we must adjust the price of the product in the international market. International prices thus adjusted are called financial parity prices.

  8. OPEN ECONOMY: BASIC DEFINITIONS International Trade with Partial Equilibrium Models and Optimization Strategies:A basic Approach We calculate the financial export parity price by deducting from the border price (FOB in this case) all transport and marketing costs from the farm 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 farm-gate price.

  9. OPEN ECONOMY: BASIC DEFINITIONS International Trade with Partial Equilibrium Models and Optimization Strategies:A basic Approach 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 and insurance and the unloading onto the destination dock.

  10. OPEN ECONOMY: BASIC DEFINITIONS International Trade with Partial Equilibrium Models and Optimization Strategies:A basic Approach We calculate the financial import parity price by first choosing a domestic wholesale reference market, for instance the wholesale market of the capital city, where imported goods are supposed to enter into competition with locally produced equivalent goods. We then add 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 or subsidies, and the transport and marketing costs from the port to the market of reference. If we further want to obtain the import parity price at the farm-gate, we subtract the transport and marketing costs that farmers have to pay to put their produce in the market of reference

  11. OPEN ECONOMY: BASIC DEFINITIONS International Trade with Partial Equilibrium Models and Optimization Strategies:A basic Approach 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.

  12. OPEN ECONOMY: NON TRADABLE GOODS International Trade with Partial Equilibrium Models and Optimization Strategies:A basic Approach Non tradable good: (1) the domestic price (Pd) is higher than the financial export parity price (Pep), so that exporting the good is not justified

  13. OPEN ECONOMY: NON TRADABLE GOODS International Trade with Partial Equilibrium Models and Optimization Strategies:A basic Approach Non tradable good: (2) in addition the financial import parity price of the good (pip) is higher than the domestic price (Pd), and hence importing the good is not justified

  14. OPEN ECONOMY: NON TRADABLE GOODS International Trade with Partial Equilibrium Models and Optimization Strategies:A basic Approach 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)

  15. OPEN ECONOMY: EXPORTABLE GOODS International Trade with Partial Equilibrium Models and Optimization Strategies:A basic Approach 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

  16. OPEN ECONOMY: EXPORTABLE GOODS International Trade with Partial Equilibrium Models and Optimization Strategies:A basic Approach Exportable goods: The financial export parity price “Pep" is higher than the domestic price

  17. OPEN ECONOMY: EXPORTABLE GOODS International Trade with Partial Equilibrium Models and Optimization Strategies:A basic Approach 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 to domestic and export markets Producers gain more money and producers surplus grows

  18. OPEN ECONOMY: IMPORTABLE GOODS International Trade with Partial Equilibrium Models and Optimization Strategies:A basic Approach 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

  19. OPEN ECONOMY: IMPORTABLE GOODS International Trade with Partial Equilibrium Models and Optimization Strategies:A basic Approach Importable goods: The financial import parity price “Pip" is lower than the domestic price

  20. OPEN ECONOMY: IMPORTABLE GOODS International Trade with Partial Equilibrium Models and Optimization Strategies:A basic Approach Main effects before opening economy for an exportable 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

  21. OPEN ECONOMY: IMPACT OF TRADE MEASSURES International Trade with Partial Equilibrium Models and Optimization Strategies:A basic Approach Which is the effects of a tariff measure in an open economy for an importable good? We assume that the product is an importable 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 as follows

  22. OPEN ECONOMY: IMPORTABLE GOODS International Trade with Partial Equilibrium Models and Optimization Strategies:A basic Approach 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 production …… that replaces imported supply …… reducing dependency on imports …… and generating a rise in revenues of producers …... and goverment

  23. OPEN ECONOMY: OPTIMIZATION SCHEME International Trade with Partial Equilibrium Models and Optimization Strategies:A basic Approach 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

  24. OPEN ECONOMY: OPTIMIZATION SCHEME International Trade with Partial Equilibrium Models and Optimization Strategies:A basic Approach 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, ….

  25. REFERENCES International Trade with Partial Equilibrium Models and Optimization Strategies:A basic Approach (***) 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.

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