ceu lecture 1 2016

LECTURE 1• Why Agricultural Economics?• Principles of welfare

economics• Trade part I

Is Agricultural Economics interesting?

Agriculture is a small share of GDP in developed countries, but food is one of the largest businesses in the world, it is not only farm production, but also the food industry.

EU size: €1 tn turnover, 10% of manufacturing GVA Largest manufacturing sector in EU It relates to all aspects of live:

Live and death – food security Food Safety and Health (obesity, nutrition, etc.) Controversial (Trade, subsidies, biotechnology,

biofuels…) Very diverse …. and one gets to be invited to good food….

Why special economics? One of the most distorted,

subsidised, taxed and politically affected markets… with high environmental externalities

What we will look at…. Analysis of agricultural policies in the EU and

other OECD countries and their impacts WTO – measures of support Tariff and non tariff barriers EU rural development policy Agriculture in developing countries – what is the

story? Climate change, food security and politics What is green?

First hard theoryWelfare economics – the basis We will look at:

Partial equilibrium models and look at consumer and producer surplus

Ricardian comparative advantage Partial equilibrium analysis with trade Flaws and reasons for government

interventions: good and bad reasons

Government intervention: what for?

Infant industry argument Protect sectors of the economy Reduce income inequalities Food security Act against ‘dumping’ (or generate dumping) Food safety (phytosanitary– SPS) Environmental and public goods

Applied welfare analysisPrice

Quantity

p

q

Demand

BENEFIT

Benefit is willingness to pay

Price

Quantity

p

q

DemandCOST

SupplyWELFAR

E

What is total welfare?

Benefit (B) – costs (C) = Welfare (W)

Price

Quantity

p

q

Demand

SupplyCONSUMER SURPLUS

Consumer and producer surplus

p PRODUCERSURPLUS

Welfare (W) = Consumer surplus (CS)+ Producer surplus(PS)

Consumer surplus (CS) = Difference between willingness to pay and actual cost bought Producer surplus(PS) = Balance Sheet = Sales – costs = transfer from consumers - costs

Trade impacts: ExportingPrice

QuantityQ1

Demand

Supply

Pw

Q2

Exports

Benefit

Benefit = Willingness to pay

Trade impacts: ExportingPrice

QuantityQ1

Demand

Supply

Pw

Q2

Exports

Cost

Cost = Cost of production

Trade impacts: ExportingPrice

QuantityQ1

Demand

Supply

Pw

Q2

Exports

Foreign exchange

Trade impacts: ExportingPrice

QuantityQ1

Demand

Supply

Pw

Q2

Exports

Welfare

Welfare = Consumer surplus+ producer surplus =Benefit – Costs + Foreign exchange

Welfare gain

Trade impacts: ImportingPrice

QuantityQ1

Demand

Supply

Pw

Q2

Producer loss

Producer surplus

Welfare gain

Consumer surplus

Imports =CurrencyLoss = cost

Consumer surplus gain

No trade, government taxPrice

Quantity

Pp

Q

Demand

SupplyPt

PRODUCERSURPLUS

Consumersurplus

Tax revenue

Welfare= CS + PS + tax revenue Welfare loss = deadweight loss

Price

Quantity

Pw

qs

Demand

Supply

Pt

Pt: Price with tariffqs’ qd qd’

Does tariff revenue increase welfare? Not for an importer that remains an importer.

Tariff revenue

Price

Quantity

PwDemand

Supply

Pt

Pt: Price with tariffqs

qs’ qd qd’

Consumer surplus lost

Producer surplus win

Tariff revenue

∆Welfare=Tariff revenue + producer surplus - consumer surplus loss,Tariff only covers part of the losses = transfer of consumer to producer

Import fall

Price

Quantity

Pw

qs

Demand

Supply

Pt

Pt: Price with tariffqs’ qd qd’

∆Welfare=Tariff revenue + producer surplus - consumer surplus loss,Tariff only covers part of the losses = transfer of consumer to producer

Welfare losses

Taxing exports increases welfare? No

Price

Quantity

Pw

Demand

Supply

Pi

qs

qs’qd qd’

Taxing exports is like making producer prices lower, transfer from producer to gov – no welfare gain

Tax revenue of export

Taxing exports increases welfare? No

Price

Quantity

Pw

Demand

Supply

Pi

qs

qs’qd qd’

Taxing exports is like making producer prices lower, transfer from producer to gov – no welfare gain

Producer surplus fallsConsumer surplus up

Tax revenue is not a loss, but is only a

transfer from producer to gov.

Price

Quantity

Pw

Demand

Supply

Pi

qs

qs’qd qd’

Welfare loss

Attention: Tariffs may be welfare enhancing

Partial equilibrium only looks at the welfare impact on the product, but tax revenue may be invested in a product creating more welfare. It may reduce negative impacts on other sectors.

There are optimum tariff too for large exporters that affect world market.

The big CAP historical controversy with the world at large

The CAP was first introduced in 1968. Problem small farms, inefficient, Europe was net importer.

Instead of farm restructuring, main option was price support.

A) Intervention price Pi, minimum price to farmers B) Variable levy Plv: Tariff which adapts to

intervention price, entry price fixed C) When intervention price higher than world

price, EU subsidised the exports… which was 90% of the time the case

From underperforming to bonanzaPrice

Quantity

Pw

qd

Demand

Supply

qs

1968

Many small farms: Low farm productivity, low incomes

Why the CAP was/still is controversial

Price

Quantity

Pw

qd

Demand

Supply

qs

1970s EU Becomes surplus producerAnd dumps it. Exp. subsidies

Many small farms: Low farm incomes

Pi

Plv

qs’qd’

production

exp

This costs moneyPrice

Quantity

Pw

qd

Demand

Supply

qs

1970s EU Becomes surplus producerAnd dumps it. Exp. subsidies

Many small farms: Low farm incomes

Pi

Pvl

qs’qd’

CAP expendi

ture

FOREx revenue

But supplier faces TOTALLY ELASTIC DEMAND

Price

Quantity

Pw

qs’’

Demand

Supply

qsMany small farms: Low farm incomes

Pi

Pvl

qs’qd’

CAP expenditure

FOREx revenue

Supply’

Farm intensifica

tion

Let to 1980s EU budget crisis and UK rebate… and

90s reform

Welfare?Price

Quantity

Pw

qs’’

Demand

Supply

qsMany small farms: Low farm incomes

Pi

Pvl

qs’qd’

Supply’

CS loss

Welfare?Price

Quantity

Pw

qs’’

Demand

Supply

qsMany small farms: Low farm incomes

Pi

Pvl

qs’qd’

Supply’

PS gainLOSS

CAP expenditure loss

Why was world upsetPrice

Quantity

Pw

Deu

Seu

Price

Pw

Pi

Cut in imports + subsidised exports

Pw2

Demand from Europe falls

Sw

Dw

World supply curve shifts, more European production not responsive to Pw. Pw falls due to less Deu and more Seu

Other countries cut production at lower prices, the EC ‘dumps’ the difference

Sw’

Pth

Europe supplies subsidised exports

CAP has reformed and eliminated price support

But subsidies maintain production going World prices have however increased, the

situation has changed However, the best move is to support production

increases in other countries, not in expensive EU where we are at the production possibility frontier, each additional production requires costly inputs.