Export Subsidy and Its Welfare Impacts
The free trade agreement between Canada and Australia allows transaction between the two nations without any restriction. Some countries are in favor of trade and support export competing industries. While others to protect their domestic industries often restricts imports either by raising price of import with import tariff or by putting an import quota (Feenstra 2015). Both the policy of an export subsidy and import quota are analyzed with their welfare impacts.
The policy of export subsidy offers exporters incentive to raise export. Following figure describes the effect an export subsidy.
The above figure represents the beef market in Australia. The domestic demand curve for beef is DD while the domestic supply curve is SS. Price of beef in the global market is PW. At this price, demand of beef in the domestic market is QD0. The domestic suppliers willing to supply QS0 amount of beef at the price. The supply of beef at the world price exceeds domestic demand. The rest, (QS0 – QD0) are exported. Now suppose, Australian government want to raise its beef export. For this, a subsidy of unit s is proposed to be given to the beef producers (Balassa 2014). The immediate effect of subsidy is to increase the price received by domestic producers. Producers now receives a price of PW1. Domestic consumers now faced with a high price reduce their demand from QD0 to QD1. Beef producers in Australia receiving a high prices are now encouraged to produce more. As a result, supply of beef in the domestic market increases from QS0 to QS1. The reduction in domestic demand combines with an increase in domestic supply raises export The quantity of beef exported after the export subsidy is (QS1 – QD1). This is how the quantity of beef exported from Australia to Canada increases when government decides to provide an export subsidy to the beef sold in the overseas market.
The effect of total surplus or welfare will be understood by comparing consumer surplus, producer surplus and total surplus before and after the subsidy. Before subsidy, consumer in Australia were getting beef at the world price of PW. At price PW, the consumer surplus received is given as (A+B+M). After the subsidy, the export of beef raises. The increased export of beef creates a supply shortage and raises price in the domestic market to PW1. With a high price, the consumers receive a surplus of M only. The loss in consumer surplus is the area (A+B). The importing country that is Canada now obtain imported beef at a lower price of PW2 (Blonigen 2016.). The area G adds to the consumer surplus to the importing country. Australian beef producers now receives a higher price. This increases the producer surplus to Australia producers. The gain in producer surplus is given as (A+B+C+D+E). The difference in price that exporter receive and importing country pays is the amount of subsidy. The Australian government has to pay the subsidy out of the total revenue. Thus, subsidy causes a loss in government revenue given by the area (B+C+D+E+F+H+I+J+K+L). Only the beef producers are benefitted from the subsidy. However, the additional benefit to producers is no enough to compensate for the loss in consumer surplus and loss in government revenue (Leigh and Blakely 2016). Therefore, total surplus or welfare reduces after subsidy. The net welfare reduced by (B+F+H+I+J+K+L).
Import Quota and Its Welfare Impacts
The import quota put a limit on the quantity of imported good.
It analyzes Canadian beef market. The domestic demand curve of beef is given by D1D1. Domestic supply of beef in Canada is given as S1S1. P* is the price prevailed in the world market. At price P*, demand of beef in Canada is Q2. The Canadian producers at this rice able to supply only Q1. The excess of domestic demand to supply is the amount of beef imported. Suppose, government in Canada intends to encourage domestic producers. For this, government places a restriction on the beef imported from Australia. Suppose, a quota is imposed to limit import of beef to only (Q3 – Q4). With restricted import, the domestic demand for beef raises. This increases price of beef in the domestic market and raises domestic supply (Rugman and Verbeke 2017). Accordingly, the domestic supply curve will shift to the right. The price in the domestic market is PW. With a higher price consumer surplus now reduces. Consumers suffer a loss in their surplus by the area (c +d +e’ +e’’+ f). The domestic producers in Canada are benefited from increased price and demand. The surplus to producers increased from g to g+c. The area e’+e’’ indicates part of the profit to Australian producers. The welfare loss to the society is (d + e + e’’+ f).
The policy of free trade is not always beneficial for all countries. Industries within the country often need protection from free trade. Several arguments have made in support of protectionist policy to free trade. The two common arguments are infant industry argument and Anti- Dumping argument.
Infant industry refers to an industry that has just started to evolve. The industry has not yet reached to the level to compete with foreign producers in the international market. Being at the initial level of production, the industries face a high operating cost and hence unable to compete with cheaper export. The argument hold particularly for countries just started their industrialization (Fine 2016). However, the infant industry argument does not completely oppose free trade. This advocates support for industries only for a period. Once the industry has developed completely it should compete freely.
Trade protection measures are often considered as anti-dumping measures. Foreign country often resort to dump commodities to capture market of the trading partners. Therefore, the domestic producers demand a high tariff to restrict dumping of foreign goods at a low price than that charged in own country (Bhagwati 2014).
Protectionist Policy Arguments
Producer surplus is the total revenue less total variable cost (Kolmar 2017).
Given that market price (P) = 40
Quantity (Q) = 2
Therefore,
Given the marginal cost total variable cost is obtained as
At the output level Q = 2,
Therefore,
Given that market price (P) = 60
Quantity (Q) = 3
Therefore,
At the output level Q = 2,
Therefore,
Given the demand function, QD = 200 – 2P
Given the supply function, QS = -10 + P
Equilibrium in the market is obtained at a point where the demand and supply curve intersects (Arrow 2015).
Equilibrium Quantity = 60kg of oranges
Equilibrium price = $70
Consumer surplus is indicated as area below demand curve and above the equilibrium price.
The maximum price that consumers willing to pay is 100.
Producer surplus is the benefit to the seller and is the area above the supply curve and below the equilibrium price .The minimum supply price is 10.
Alcopops are soft drinks that contain some proportion of alcohol. The consumption of such drinks is not good for health. Government imposes tax on activity to restrict production and consumption of harmful goods. In order to reduce teenage binge drinking the Australia government imposes a tax on Alcopops. The tax can be imposed Figure 3 analyzes effect of a tax imposed on sellers of Alcopops. The impact of taxation is evaluated using demand, supply and elasticity concept. The elasticity of demand and hence shape of the demand curve depend on the nature of commodity. Alcopops contains small proportion of alcohol. Teenagers have some sort of addiction for Alcopops. For such drinks, demand does not reduce much even when price increases (Friedman 2017). The demand is therefore relatively less elastic. The relatively inelastic demand curve is shown as DD in figure 3. The supply curve is of usual upward sloping and given as SS. Now suppose, a tax of t is imposed on the sellers of Alcopops. Because of tax, production seems less profitable to the suppliers. As a result, the supply curve shifts left by the amount of tax. Sellers now receives a lower price P2. While the buyers pay a higher price of P1. The equilibrium quantity in the market after tax is reduced to Q1 from earlier Q*. From the tax, the government receives a revenue given by the area P1ABP2.
A tax on buyers is a tax that is directly payable by the buyers. Therefore, when a tax is imposed then the immediate effect is on the demand curve. Faced with a high price because of tax, buyers reduce their demand. This is shown by a leftward shift of the demand curve by the amount of tax. As like the tax on sellers, buyers now pay a high price while sellers receive a low price. The difference in price is the tax amount (Page and Smetters 2016). The equilibrium quantity is decreased from Q* to Q2. Thee tax revenue obtained by the government is shown as the area of the rectangle PbFGPS.
Effect of Tax on Sellers of Alcopops in Australia
After the imposition of tax, there was no notable reduction in the binge drinking and alcohol related harms. Additionally, government revenue from the tax is less than predicted. The result is surprising because some reduction in the Alcopops selling should be recorded. As explained above a tax imposed on buyers or sellers reduce the equilibrium quantity to some extent. No change in quantity is possible to be recorded only when either the supply or the demand is perfectly inelastic in nature. However, in that case the tax revenue increases completely by the tax amount of tax (Varian 2014). As neither of the two goal is achieved, the policy outcome of tax is surprising.
The elasticity of demand and supply determines the burden of taxation on buyers and sellers. A high elasticity means a less burden and the tax burden is possible to bypass to other parties. For Alcopops, demand is relatively inelastic. Teenagers are not willing to reduce their consumption in response to high price. As a result they have to bear a greater tax burden.
The figure above shows the share of tax burden between buyers and sellers. The steep demand curve shows inelastic nature of demand (Tresch 2014). E is the pretax equilibrium point. After imposition of tax, the price to buyers increases from PE to PB. The price to sellers reduces from PE to PS. It is clearly seen from the figure the proportionate increase in price to buyers is greater than the price decrease to sellers. Therefore, a greater burden is borne by the Alcopops buyers.
Objective of the tax is to reduce teenage binge drinking and alcohol related harms. However, the buyers here bear a greater burden. The tax therefore yields an inefficient outcome. Answer c
The imposition of tax fails to effectively reduce Alcopops consumption because of the inelastic nature of demand. Therefore, government should resort to alternative policy measures. An alternative to tax is to restrict the quantity of Alcopops by imposing a quota on quantity sold. This will help to achieve the targeted reduction in consumption of these drinks and other related harms. In addition to this, government should take steps for generating awareness among common people especially among the teenagers. The legal system should be more stringent with a strict age limit for consumption.
References
Arrow, K., 2015. Microeconomics and operations research: Their interactions and differences. Information Systems Frontiers, 17(1), pp.3-9.
Balassa, B., 2014. Development Strategies’. International Economics and Development: Essays in Honor of Raúl Prebisch, p.159.
Bhagwati, J.N., 2014. The world trading system at risk. Princeton University Press.
Blonigen, B.A., 2016. Industrial policy and downstream export performance. The Economic Journal, 126(595), pp.1635-1659.
Feenstra, R.C., 2015. Advanced international trade: theory and evidence. Princeton university press.
Fine, B., 2016. Microeconomics. University of Chicago Press Economics Books.
Friedman, L.S., 2017. The microeconomics of public policy analysis. Princeton University Press.
Kolmar, M., 2017. Introduction. In Principles of Microeconomics (pp. 45-53). Springer, Cham.
Leigh, N.G. and Blakely, E.J., 2016. Planning local economic development: Theory and practice. Sage Publications.
Nicholson, W. and Snyder, C.M., 2014. Intermediate microeconomics and its application. Cengage Learning.
Page, B.R. and Smetters, K., 2016. Dynamic Analysis of Tax Plans: An Update. Washington DC: Urban Institute.
Rugman, A.M. and Verbeke, A., 2017. Global corporate strategy and trade policy (Vol. 12). Routledge.
Varian, H.R., 2014. Intermediate Microeconomics: A Modern Approach: Ninth International Student Edition. WW Norton & Company.
Tresch, R.W., 2014. Public finance: A normative theory. Academic Press.
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