Tutorial on Partial Equilibrium Modeling:
Export Subsidy by a Large Country
Exporter
The Microeconomics of International Trade
ECN 230
Roberto J. Garcia
School of Economics and Business, UMB
Economic effects of an export subsidy
Export subsidy: case of a specific subsidy
A per unit subsidy on exports (e.g., s0 = 30kr/kg)
such that the difference between the domestic
price and the world price is equal to s0, i.e., (PD)1 (PW)1 = s0.
An export subsidy has implications for prices,
which affects economic behavior and welfare. The
economic effects are studied by analyzing the
change in prices on:
Production, consumption and trade patterns, and
Producer and consumer welfare and government's
budgetary position (i.e., expenditures and revenue).
2
Economic effects of an export subsidy
Market analysis
Analyzing the production, consumption and trade
effects: the perspective of the exporting country
World market
Exporter's domestic market
P
PW
D
S
ES
[PD]1
ES
PW
1
[PD]1
PW
[P W]1
[PW]1
ED
[QT]0 [QX]1

QT
[QD]1[QD]0

[QS]0 [QS]1 Q

3
Economic effects of an export subsidy
Economic intuition and expectations
Regardless of the reason an export subsidy is applied,
the result is an increase in the quantity exported (ES
shifts to the right by the value of the per unit subsidy).
• The world price decreases (PW) because a large seller on the
international market increases supply, i.e., a TOT effect.
• The internal price in the exporter's market increases (PD)
because more needs to be produced and there is greater scarcity
of the good in the domestic market because more is exported.
Producers and consumers react to the change in the
domestic price, from PW to [PD]1.
• Producers respond to price increases by increasing output (QS)
and the subsidy tied to export performance means QX.
• In partial equilibrium analysis, a price increase is expected to
result in a decrease in consumption, QD , allowing QX.
Government expenditures (budgetary outlays) are equal
to the subsidy, s0, times the export volume, [QS - QD]1.
4
Economic effects of an export subsidy
Welfare analysis
Analyzing economic costs and income transfers
among producers, consumers, traders and the
government: the exporting country's perspective
Exporter's market
Welfare analysis
P
D
 [PD]1
S0 PW
↓
S
b
a
d
c
e
[PW]1
Δ CS
Δ PS
ΔG
g
f
[QD]1 [QD]0
h i
[QS]0[QS]1
- (a)
+ (a+b+c)
- (2b+c+d)
- (e+f+g+h+i)
- (b+d)
Δ NSW
- (e+f+g+h+i)
Q
5
Economic effects of an export subsidy
Economic interpretation of welfare areas
Area 'a' represents the value lost by consumers that is
gained by producers, i.e., a tax on consumers; it is an
income transfer from the consumer to the producer.
Area 'b' represents a part of the total value lost by the
economy, a "dead-weight loss" (DWL) in consumption.
• The DWL in consumption is the cost to society of consuming
less of the good as a result of distorted prices.
• The decreased expenditures reflects a misallocation of
resources (i.e., a sub-optimal consumption mix).
Area 'c' represents part of the value gained by producers
that is a subsidy by the government; in it part of the
income transfer from the government to producers.
6
Economic effects of an export subsidy
Area 'd' represents an economic cost to society, a
"dead-weight loss" (DWL) in production.
• The DWL in production is the cost to society of producing
more of the exported good beyond what is commercially
viable.
• The increased production reflects a misallocation of resources
as a result of the distorted prices.
Area 'e+f+g+h+i' represents the part of the budgetary
outlay associated with the negative TOT effect. It is an
income transfer by the export-country's government to
subsidize consumers in the importing country. The
value represents the cost of a policy to the government
to sell an increased amount of exports at a commercial
loss. The total budgetary outlay is equal to {[PD]1 –
[PW]1} · [QX]1, or s0 · [QX]1.
The net effect of the export subsidy on the exporter is
negative because there are DWLs and an income
transfer from the exporting to the importing country. 7
Economic effects of an export subsidy
Market analysis
Analyzing the production, consumption and trade
effects: the perspective of the importing country
Importer's domestic market
P
S
World market
PW
ES
ES1
PW
PW
[PW]1
[PW]1
D
[QS]1[QS]0
[QD]0 [QD]1 Q
ED
[QT]0 [QT]1
QT
8
Economic effects of an export subsidy
Economic intuition and expectations
The application of an export subsidy results in an increase
in the quantity exported (ES shifts to the right). It is
assumed that the import-country's government has not
taken any policy action to counter the subsidy.
• The world price decreases (PW) because a large seller on the
international market increases the quantity supplied.
• The internal price in the importer's market is the world price
because no policy action has been taken.
Producers and consumers react to the change in the
domestic price, from PW to [PW]1.
• Producers respond to price decreases by decreasing output, QS.
• In partial equilibrium analysis, a price decrease is expected to
result in an increase in consumption, QD.
Because the government has taken no action, there are no
budgetary outlays or revenues collected on the imported
good.
9
Economic effects of an export subsidy
Welfare analysis
Analyzing economic costs and income transfers
among producers, consumers, traders and the
government: the importing country's perspective
Importer's market
P
PW
[PW]1
S
1 2
3
Welfare analysis
Δ CS
+ (1+2+3+4)
Δ PS
- (1)
ΔG
0
4
D
[QS]1 [QS]0
[QD]0 [QD]1 Q
Δ NSW
+ (2+3+4)
10
Economic effects of an export subsidy
Economic interpretation of welfare areas
Area '1' represents the value lost by producers and that
is gained by consumers from the lower price; it is an
income transfer from producers to consumers.
Area '2' represents a loss to the economy from the
reduction in production, the DWL in production.
• The DWL in production is the cost to society of reducing
production as a result of world price being distorted.
• The reduced production reflects a misallocation of resources.
Area '2+3+4' is the net welfare gain to the importer
from a subsidy financed by the exporter, an
international transfer from the export-country's
government to the consumers as a result of the TOT
effect.
11
Economic effects of an export subsidy
Area '4' represents the cost to society from the increase
in consumption, the DWL in consumption.
• The DWL in consumption in the importing country is the cost
to society of consuming too much of the importable good as a
result of distorted prices.
• The increased expenditures reflects a misallocation of
resources (i.e., a sub-optimal consumption mix).
The net effect of the export subsidy on the importing
country is positive because the income transfer from the
exporting country covers the cost of the DWLs. The
total income transfer from the exporting country equals
{[PW] - [PW]1} · [QX]1. Once the DWLs (areas '2' + '4')
are subtracted from the value of the transfer, the net
result is (area '2' + '3' + '4').
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Economic effects of an export subsidy
Net world welfare effects
Internal domestic transfers,
DWLs and international transfers
Δ NSW
Importer
Importer's market
P
Exporter's market
S
P
D
[PD]1
PW
2
[PW]1
4
1
3
[PW]1
D
[QS]1[QS]0
[QD]0 [QD]1 Q
d
c
a
e
g
f
[QD]1[QD]0
(2+3+4) =
(e+f+g+h+i) - (2+4)
S
b
PW
+ (2+3+4)
- (b+d) Exporter (e+f+g+h+i)
World
- (b+d)
- (2+4)
i
h
[Q S]0[QS]1
Q
13
Economic effects of an export subsidy
Concluding comments
The export subsidy by a large country results in a TOT
effect that affects importers and exporters differently:
1. A decrease in the world price benefits the importing country(ies)
at the expense of the exporting country(ies)
2. The higher domestic price in the exporting country is a price
support to producers which is paid by consumers and government.
3. The lower world price in the importing country is a subsidy to
consumers, but a tax on producers, hurting the import-competing
sector.
4. The international transfer, paid by the exporting country’s
government, to the importing country is large enough to cover the
costs of the DWLs from the policy, making the importing country
better off.
5. The net effect of the export subsidy on the world economy is an
international income transfer and a series of DWLs in production
and consumption in both the importing and exporting country
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because prices have been distorted.