Name Due: Wednesday, Nov 28. PROBLEM SET #4 AGEC 652 Fall 2018

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1 Name Due: Wednesday, Nov 28 PROBLEM SET #4 AGEC 652 Fall 2018 Read each question carefully and clearly state any assumptions that you make. Be sure to label each graph, use arrows to show change, and use letters or numbers to designate appropriate areas on each graph. This problem set is worth 50 points (10 pts) I. Exchange Rates and Welfare Analysis When China acceded to GATT in 2001, it agreed to eliminate most of its strict quantitative controls (quotas) on imports. So China has been slowly opening its markets to trade. Some economists, however, contend that the Chinese Yuan (Renminbi) has been undervalued over the last decade by as much as 40%. The current estimate is that the Yuan is about 5% overvalued. In answering the questions below, assume that China is a large cotton importing country and that the Rest-of-the-World (ROW) is the large cotton exporting region. 1. On the graph below, show the cotton market effects and welfare effects of the undervaluation of the Chinese Yuan. 2. In the table below, summarize the income redistribution (welfare) effects of the undervaluation of the Chinese Yuan using the corresponding letters or numbers for the areas on your graph above. CHINA World ROW Change in Consumer Surplus Change in Producer Surplus Change in Gov't Cost/Revenues Net Welfare Effects

2 (10 pts) II. Trade Liberalization The WTO agreement required the U.S. to eliminate its sugar import quota. U.S. sugar producers and policymakers, however, have been concerned about the welfare implications of removing the sugar quota. In answering the following questions, assume only two countries - the U.S. as the importing country and the Rest-of-the-World (ROW) as the exporting country. 1. On the graph below, illustrate the sugar market effects and income redistribution (welfare) effects of eliminating the U.S. sugar import quota in both countries and globally. 2. In the table below, summarize the income redistribution (welfare) effects of the removal of the U.S. sugar import quota using the corresponding letters or numbers for the areas on your graph above. Change in Consumer Surplus Change in Producer Surplus Change in Gov't Cost/Revenues Net Welfare Effects U.S. World ROW 3. Discuss (1) whether or not it would be possible for the U.S. to suffer a net welfare loss from removing the sugar import quota and (2) under what conditions.

3 (15 pts) III. Trade and Domestic Policy Choices Without the import quota, U.S. sugar producers are pressuring policymakers to implement a new policy to support the price of sugar at the price they received under the quota (Ps). The policy alternatives are: (1) mandatory supply reduction, (2) a government surplus purchase program, and (3) direct payments (price loss coverage (PLC) program). (A mandatory farm program requires participation under threat of penalties. There is no monetary incentive to participate.) 1. In the graph below, compare the sugar market effects of the 3 policy alternatives compared to the current import quota. (Yes, you really need to illustrate all 4 policies on just one graph!) Use the letters for "Import Quota in the table below for prices and quantities under the quota. ("US" means United States, "X" means exporting country, and "W" means world market). Use arrows to show direction of change from the current levels under the quota and label your graph well. You might want to use different colored pencils or ink to make the differences in the policies more apparent. 2. Summarize the market effects of the 3 alternative policies compared to the current import quota as shown in your graph in the following table using for "increase," for "decrease," 0 for "no change," and? for "cannot determine." For government revenues/costs, refer to the appropriate areas on your graph using letters or numbers. Effect on: Import Quota (1) Supply Reduction (2) Government Surplus Purchase (3) Direct Payments S X OD D X OC P X P x S US OY D US OZ P US P s X=M=Q M OQ q X Govt. Revenue 0 US Govt. Revenue areas h+f X Govt. Cost 0 US Govt. Cost 0

4 3. In the blanks provided, indicate which of the alternative domestic sugar policies (1, 2, or 3) you would recommend to the U.S. government to replace the quota in each of the following circumstances. List ALL that apply. Provide a supporting explanation for your choice(s). a. The U.S. government does not want its price support policy to Policy choice(s): stimulate production in exporting or other importing countries b. The U.S. government wants to avoid an accumulation of sugar Policy choice(s): stocks AND minimize the cost of price support. c. The U.S. government does not want its price support policy to Policy choice(s): raise the prices consumers pay for foods that use sugar as an ingredient. d. The U.S. is a small sugar importing country. Policy choice(s): e. The U.S. government wants to minimize the cost of price support Policy choice(s): without reducing U.S. sugar production and faces a highly price inelastic excess supply of sugar. f. The U.S. government wants to minimize the cost of price support Policy choice(s): without reducing U.S. sugar production and faces a highly price elastic excess supply of sugar.

5 (15 pts) IV. International Market Power In all of the following questions, assume you are a government analyst trained in international trade theory and analysis in a country that is a large exporter of some agricultural product (Q). 1. You are asked to calculate the effects of an importing country s import tariff (Tm) on your country s exports of Q. What data do you need to calculate the effects? 2. Now you are asked to calculate the optimal ad valorem export tax rate for exports of Q. What data do you need to calculate the optimal tax rate? 3. Assume that the government applies the optimal export tax you calculated to its exports of the commodity. After a few months, you are accused of making a mistake and calculating too high of an export tax rate because your country s exports, export price, and export tax revenue are all much lower than expected. a. If you have NOT made a mistake, world import demand for Q has not declined, and importing countries do not restrict their imports in any way, what might be the problem? b. What policy action would you recommend to your government and why? 4. Again, assume your calculated optimal export tax is applied to the exports of Q. But this time, your country s producers complain to the Minister that the export tax is having a negative effect on their industry. They request that the Minister authorize a producer marketing board and eliminate the export tax. The Minister asks you to analyze the effects of replacing the export tax with a producer marketing board. a. What would be your major conclusions in your report to the Minister regarding the benefits to producers and the effects on national welfare from making the policy change? b. What cautions might you include in your report about implementing a marketing board? 5. Now assume ONLY that the government instead applies an export subsidy in an effort to support the domestic price and increase the exports of Q. However, after a few months the data show that your exports have not increased and the world price of your country s exports has dropped sharply. Your research indicates that other exporting countries have NOT been implementing even larger export subsidies, import demand has NOT dropped, and the price in importing countries has not changed. a. The Minister asks you to explain what the problem is. What would you tell the Minister? b. What policy action would you recommend to the Minister and why?