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

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Trade and offer curves in the EUref offer
curves v4
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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

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• 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

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• A countrys 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

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Derived from PPCs trade triangles
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• General equilibrium analysis. Consider
• better than partial equilibrium analysis?
• small country
• large country
• offer curves CUs

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Tariffs offer curves small country
Imports of food (F)
Exports of cloth (C)
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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)
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OH free trade OC
Imports of food (F)
H
M
O
Exports of cloth (C)
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Trade at point Q. OA are imports against exports.
Imports of food (F)
H
M
A
Q
O
Exports of cloth (C)
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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
M
A
Q
O
Exports of cloth (C)
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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
M
A
Q
Q shifts to Q, represents smaller size of
trade- contraction of trade
B
Q
O
Exports of cloth (C)
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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
M
A
Q
Q shifts to Q, represents smaller size of
trade- contraction of trade
B
Q
O
Exports of cloth (C)
c
d
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Imports of food (F)
H
H
M
A
Q
B
Q
Size of tariff
O
Exports of cloth (C)
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Large country

• Assume 2 countries
• OCH (large home country) OCF (small foreign
  country)
• Large country imposing tariff can move TOT in
  its favour
• TOT determined by intersection of 2 OCs
• Free trade equilibrium at point Q
• OQ represents relative prices of exports imports

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Large country tariff
Imports of food (F)
OC H
O
Exports of cloth (C)
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Large country tariff
Imports of food (F)
OC H
OC F
Q
O
Exports of cloth (C)
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Large country tariff
Imports of food (F)
OC H
Line OQ terms of trade
OC F
Q
O
Exports of cloth (C)
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OCH t tariff ridden offer curve. Large country
improves TOT (line OQt steeper than OQ)
Imports of food (F)
OC H
OCH t
OC F
Qt
Q
O
Exports of cloth (C)
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Size of tariff determination of optimal tariff

• If very high tariff possible trade drastically
  reduced. Thus, country can not improve its
  welfare
• Introduce trade indifference curves (TIC)

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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)
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Country is not better off after tariff, domestic
consumptionat Qt is still on TIC
Imports (F)
OC H
OCH t
OC F
Q
Qt
TIC
O
Exports (C)
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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)
OC H
OCH t1
OCH t
Qt2
OC F
Q
Qt
TIC
This optimal tariff improves welfare and TOT
O
Exports (C)
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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)
OC H
OCH t2
OCH t
Qt2
OC F
TIC1
Q
Qt
TIC
This optimal tariff improves welfare and TOT
O
Exports (C)
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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) gt loss from
  (2) by greatest margin (where TIC1 tangent to
  OCF)
• SEE HANDOUT in lecture for more information

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Conclusion

• Large countries (or the EU) can move the ToT in
  its favour
• This shouldnt be the sole reason for forming a CU