UNIVERSITY OF SIENA
Faculty of Economics
Course on European Economic Policy
(Prof. S. Tarditi)
REMINDERS OF PRICE POLICY ANALYSIS
AND EXERCISES
Notes taken from lectures
By Tommaso Albergotti
David Sarri
Incomplete draft
To be revised
Table of contents
1
2
3
4
CONSUMER SURPLUS ............................................................................................. 4
TAX ON CONSUMPTION ......................................................................................... 7
SUBSIDY TO PRODUCTION .................................................................................... 8
TARIFF ON IMPORTS ........................................................................................... 10
4.1
4.2
Small Country ....................................................................................................................... 10
Large country ........................................................................................................................ 11
5 NON TARIFF BARRIERS........................................................................................ 12
6 EXPORT SUBSIDIES .............................................................................................. 13
7 LARGE COUNTRY: EXTERNAL EFFECTS.............................................................. 16
7.1
Trade liberalisation ................................................................................................................ 16
7.2
Border tariff ........................................................................................................................... 17
7.3
Export subsidy ....................................................................................................................... 17
8 CUSTOMS UNION ................................................................................................. 18
9 PRODUCTION SUBSIDY ........................................................................................ 21
9.1
Trade effects. ......................................................................................................................... 21
9.2
Financial effects .................................................................................................................... 22
9.3
Domestic transfers ................................................................................................................. 22
9.4
Economic effects. .................................................................................................................. 22
9.5
Intersectoral redistribution. ................................................................................................... 22
9.6
Impact on social welfare........................................................................................................ 23
10 TAX ON CONSUMPTION ....................................................................................... 25
11 DUTY ON IMPORTS (SMALL COUNTRY) ................................................................... 28
12 DUTY ON IMPORTS (LARGE COUNTRY) ................................................................... 32
13 OTHER EXERCISES .............................................................................................. 36
13.1 Export Subsidy ...................................................................................................................... 36
13.2 Consumption subsidy ............................................................................................................ 37
13.3 Tax on production ................................................................................................................. 38
13.4 Export and production subsidy ............................................................................................. 39
13.5 Import duty and production subsidy ...................................................................................... 40
13.6 Minimum guaranteed price and co-responsibility levy ......................................................... 41
13.7 Import duty and production subsidy (2) ................................................................................ 42
13.8 Price reduction and compensation ......................................................................................... 43
13.9 Export and production subsidy (2) ........................................................................................ 44
13.10 Frame 14: Import duty and production subsidy (3) ............................................................... 45
13.11 Export subsidy and tax on consumption ................................................................................ 46
106747981, page 2 of 46
List of Frames
Frame 1-1 Strategy A of water use ......................................... Error! Bookmark not defined.
Frame 1-2 Estimating demand function .................................................................................. 4
Frame 1-3 Srategy B: single price, maximum revenue .......................................................... 5
Frame 1-4 Strategy C: full price discrimination, auction ..................................................... 6
Frame 2-1 Analysis of a tax on consumption .......................................................................... 7
Frame 3-1 Analysis of a subsidy to production ....................................................................... 8
Frame 3-2 Subsidy to production, numerical example............................................................ 9
Frame 5-1 Analysis of non-tariff barriers to trade ............................................................... 12
Frame 6-1 Effects of export subsidies ................................................................................... 13
Frame 6-2 Analysis of an export subsidy .............................................................................. 14
Frame 6-3 Export subsidy quota ........................................................................................... 15
Frame 8-1 Welfare analysius of a customs union ................................................................. 18
Frame 9-1 Subsidy to production ......................................................................................... 24
Frame 10-1 Tax on consumption ........................................................................................... 27
Frame 11-1 Duty on imports (small country) ....................................................................... 31
Frame 12-1 Duty on imports (large country ......................................................................... 35
106747981, page 3 of 46
Part I Reminders of price policy analysis
1 CONSUMER SURPLUS
Frame 1-1 Strategy A for water use
Strategy A: Free access
Q
0
20
40
60
80
100
120
Frame 1-2 Estimating demand function
P
11
10
9
8
7
6
5
4
3
2
1
0
E s tim atin g th e D e m an d fu n c tio n
Q
0
10
20
30
106747981, page 4 of 46
40
50
60
70
80
90 100
Frame 1-3 Srategy B: single price, maximum revenue
P
12
S tra te g y B : M o no po ly
10
8
6
P(Q d)
4
R'
2
Pd
Q
0
- 20 - 2
50
120
-4
P ro d u c e r re v e n u e (R = Q * P )
300
R
250
200
150
100
50
0
0
20
40
60
80
100
120
Q
Q = f(P)
P = f(Q)
R = Q * f(Q) = F(Q)
R' = f(Q)
(MAX R) R' = 0
"Q"
"P" = f("Q")
106747981, page 5 of 46
Q = 100 - 10P
P = 10 - Q/10
R = Q * P = Q * (10 - Q/10) = 10Q - Q2/10
R' = 10-2Q/10
10-2Q/10 = 0
Q/5 =10
"Q"= 50
"P" = 10 - Q/10 = 10-50/10 = 10-5 = 5
Frame 1-4 Strategy C: full price discrimination, auction
Strategy C: Full price discrimination
12
P(Qd)
10
8
6
4
2
Q
0
0
20
40
60
80
100
Consumers
A: free access
B: Monopoly
C: Full price discrimination
A: Free access
B: Monopoly
C: Full price discrimination
D: Agreement on price
Rank for efficiency: A = C, D, B
Rank for equity: A, D, B, C
106747981, page 6 of 46
?
?
0
Producers
0
250
500
Society
?
?
500
Losses
0
?
0
Consumers
500
125
0
320
Producers
0
250
500
160
Society
500
375
500
480
Losses
0
125
0
20
2 TAX ON CONSUMPTION
Frame 2-1 Analysis of a tax on consumption
Pw
Q0
Ed
t
Q =K*P^E
Kd = Q0 / Pw^Ed
P = Pw + t
Q1 =Kd*P^Ed
Q0 *Pw
Q1*P
(Pw - P) * 1
(Q1Q
-Q0)*(P-Pw)/2
(P-Pw)*(Q1+Q0)/2
World market
Price
Quantity
consumed (free
trade)
Elasticity
of
Tax
on
demand
consumption
Assumed
demand
function
Demand
intercept
Domestic
Demanded
Price
Quantity expenditure (ante)
Consumer
[M+H] expenditure (post)
Consumer
[M+N] to budget (taxpayer benefit )
Transfers
[N] consumer surplus (social
Lost
Change
cost) [G]in consumer surplus
[N+ G]
30
700
-0,5
10
N
3834
40
606
21000
24249
-6062
-469
-6531
G
H
M
Q
50
P
D
P
60
Q
40
Pw
N
30
20
M
10
3 SUBSIDY TO PRODUCTION
The analysis of a traditional subsidy to producers is indicated in Figure 3-1 and Figure
3-2. As a consequence of a direct payment to producers (P'-P) the per unit revenue of
farmers increases and as a consequence domestic supply is expanded from S1 to S2. The
domestic market price does not change, however the composition of total supply (St)
changes from S1 + (D1-S1) to S2 + (D1-S2).
Frame 3-1 Analysis of a subsidy to production
Effects
Producer Subsidy per unit (PS)
Domestic market price
Quantiy produced
Quantity consumed
Net trade
Transfers: Taxpayers vs. Producers
PS
P'-P
P=PR
S2
D1
D1-S2
P c e PR
P
S
c
P'
P =PR
D
a
e
b
St
Q
O
S1
S2
D1
For some commodities (e.g. some vegetables in the EU) public subsidies are granted
to processors (sometimes for a fixed amount of production, a quota) under commitment of
paying a higher price to producers equivalent to the subsidy received.
Under such circumstances, the market price to producers is likely to increase up to P'
in Figure 5.2 and such price increase can be considered a MPS.
For example this was the case of the so-called "consumer aid" granted to olive oil
processors only for the quantity of olive oil produced in the EU, not to imports. As a
consequence such subsidy was benefiting EU producers and not EU consumers, actually in
practice it was considered as a substitute to the larger 'producer aid' granted to olive oil
producers. In order to lower the market price and benefit consumers the "consumer aid"
should have been granted to all the olive oil consumed in the Union (Pieri, et al. 1981).
106747981, page 8 of 46
Frame 3-2 Subsidy to production, numerical example
W orld market Price
Quantity produced (free trade)
Elasticity of supply
Subsidy to production
P
Q
E
s
30
400
1
10
Assumed supply function
Supply intercept
Domestic Price
Supplied Quantity
Q =K *P^E
K = Q / P ^E
P=P +s
Q =K *P^E
13.3
40
533
Producer revenue (ante)
Producer revenue (post)
Producer extra cost
Budget expenditure (net)
Change in producer surpl
Social cost
[C]
[A+B+C+F]
[F]
[A+B]
[A]
[B]
P
Q *P
Q *P
(Q -Q )*P
(P-P )*Q
(P-P )*(Q Q )/2
(Q -Q )*(P-P )/2
12000
21333
4000
5333
4667
667
S
A
B
P
C
F
Q
Q
Q
106747981, page 9 of 46
4 TARIFF ON IMPORTS
4.1
Small Country
P
World market Price
Q
Quantity consumed (free trade)
Q
Quantity produced (free trade)
E
Elasticity of supply
E
Elasticity of demand
Border Tariff
t
Q =K*P^E
Assumed functions (constant E)
K = Q / P ^E
Demand intercept
K = Q / P ^E
Supply intercept
P=P +t
Domestic Price
Q =K *P^E
Demanded Quantity
Q =K *P^E
Supplied Quantity
Consumer expenditure (ante) [C+F+L+H] Q *P
Q *P
Consumer expenditure (post) [A+B+J+C+F+L]
Lost consumer surplus (social cost) [G] (Q -Q )*(P-P )/2
Total lost consumer surplus [A+B+J+G](P-P )*(Q Q )/2
Q *P
Producer revenue (ante) [C]
Q *P
Producer revenue (post) [A+B+C+F]
(Q -Q )*P
Producer extra cost
[F]
(P-P )*(Q Q )/2
Producer surplus
[A]
(Q -Q )*(P-P )/2
Social cost at production [B]
Trade balance (post)
Budget benefit
(Q - Q )*P
(P-P )*(Q Q )/2
[L]
[J]
30
700
400
1
-0,5
10
3834
13,3
40
606
533
21000
24249
-469
-6531
12000
21333
4000
4667
667
-2187
729
D
S
P
A
B
P
C
G
L
F
Q
J
Q
H
Q
Q
Q
106747981, page 10 of 46
Q
4.2
Large country
Change in international terms of trade
Total consumer welfare loss
Net welfare loss
Transfers to the budget (taxpayers)
Transfers to producers
Deadweight losses at production
Producer surplus
Transfers from Rest of World to budget
Trade balance
Pw - Pw'
A+B+J+G
G
J
A+B
B
A
R
L
D
P
A
B
S
J
G
R
P
C
Q
106747981, page 11 of 46
L
F
Q
H
Q
Q
5 NON TARIFF BARRIERS
All other non-tariff barriers1 to trade imply a constraint on the amount of imports
generating a reduction of the total supply in the domestic market and a consequent increase
of the domestic price and of MPS. Such increase may be added to the market price support
generated by an import tariff, as indicated in Figure 4-1.
Frame 5-1 Analysis of non-tariff barriers to trade
P
S
D
c
d
P'
g
P
PR
St
h
b
a
e
f
Q
O
S1
S2
D2
S1
In this case, the average collected tariff (g h e f divided by D2-S2) should be equal to
the nominal tariff (P-PR). However, in order to estimate the total MPS the difference
between the domestic market price (P') and the reference price (PR) must be estimated.
Estimated MPS (P'-PR) cannot be lower than the nominal or collected tariff (P-PR),
conversely the extra MPS estimated by the difference between domestic and reference
prices should by justified by existing non-tariff barriers.
The benefits of NTB (area c d h g) are economic rents generated by the quantitative
constraint to trade and usually benefit middlemen.
1
NTB include quantitative restriction and technical barriers. Technical barriers are import standards or
regulations that reflect a country’s concern and valuation for safety, health, food quality, and the
environment. They include: sanitary and phytosanitary measures related to food safety, animal and plant
health; food standards of definition, measurement, and quality; and environmental or natural resource
conservation measures.
S. Tarditi, 106747981, page 12/46
6 EXPORT SUBSIDIES
Although export subsidies are banned in principle by WTO and existing agricultural
export subsidies were put under reduction commitments in the last GATT agreement in
1994, remaining export subsidies may provide further information for the assessment of
MPS. In principle export subsidies should be lower than import tariffs otherwise it would
be profitable to import and re-export the same commodities, however export subsidies are
granted under various modalities, and especially after the 1994 GATT agreement some are
granted only for a limited amount of commodity exported.
Figure 5-1 indicates the effects of an export subsidy (XS) and of an export subsidy
quota (XSq) with reference to the following figures.
Frame 6-1 Effects of export subsidies
Effects
Export Subsidy per unit (XS)
Export subsidy quota (quantity)
Export Subsidy quota (price effect)
Domestic market price
Quantiy produced
Quantity consumed
Net trade
Transfers: Consumers vs. Producers
Taxpayers vs. Producers
Taxpayers vs. Middlemen
(*) XS = Export subsidy
XSq = Export Susidy quota
XS
P-PR
XSq
P-PR
D2 - S2
P' - PR
P
P'
S2
S2
D2
D2
S2-D2
S2-D2
P c e PR P' g c' PR
cdfe
g h f' e'
c' d' h g
In order to reduce supply on the domestic market and increase the MPS, export
subsidies are granted to exporters (e.g. P-PR in Figure 7-1) in order to unable them to buy
at an higher price (P) in the domestic market and sell in the world market at a lower price
(PR). If we limit the perspective only to traders we could accept the funny name of "export
restitutions" currently used by the CAP. Actually the real aim of such policy measure is not
to repay money to traders (c d f e), but rather to create or maintain the existing transfers
from consumers to producers (P c e PR) when domestic supply has grown larger than
domestic demand.
S. Tarditi, 106747981, page 13/46
Frame 6-2 Analysis of an export subsidy
P
D
S
P
PR
d
c
e
a
b
Dt
f
Q
O
D2
D1 S1
S2
In principle information on the amount of such budgetary expenditure should be
easily available at different detail: by product, by season, month, etc. In practice such
information is not easily available at such detailed level, at least in the EU, however we are
confident that the Commission will soon improve the transparency of the public EU
expenditure.
The average collected export subsidy could be a good indicator of the lower level of
MPS.
S. Tarditi, 106747981, page 14/46
Frame 6-3 Export subsidy quota
P
D
S
c'
P
d'
i
j
g
h
Dt
P'
a
l
PR
b
e'
k
f'
S
O
D2 D1 S1
S2
Q
When export subsidies are limited to a limited amount of exports their effect on the
level of the domestic price could be much lower2, as indicated in Figure 5-3. An export
subsidy of P-PR if limited to the amount of exports S2-D2 generates only a limited MPS
equal to P'-PR. Part of the amount of budgetary expenditure (g h f ' e') is passed to domestic
producers, while the remaining part (c' d' h g) flows to middlemen in terms of economic
rents.
In this case the average budgetary expenditure per unit of exported product would
overestimate the MPS generated by such export subsidy quota.
2
The full effect of the export subsidy would be i j k l
S. Tarditi, 106747981, page 15/46
7 LARGE COUNTRY: EXTERNAL EFFECTS
7.1
Trade liberalisation
Trade liberalisation
Pa
Pb
Da
Sa
Db
Sb
Pe
Pe
Qe
0
Qe
0
Pa
Pb
Pw
Da
Sa
Db
Sb
Pe
ESb
Pw
Pw
Pw
ESa
0
Q1 Q e Q 2
0
T
S. Tarditi, 106747981, page 16/46
Pe
0
Q1 Q e Q 2
7.2
Border tariff
Border Tariff (large country)
Pa
Pb
Pw
Da
Sa
Db
Sb
Pe
ESb
Pa
Pw
Pw'
Pww
Pw
ESa
Pw'
Pe
Esa'
Q 1 Qe Q2
Q1' Q2'
0
7.3
0
T' T
Q1
0
Qe
Q2
Q1' Q2'
Export subsidy
Export subsidy (large country)
Pa
Pb
Pw
Da
Sa
Db
Sb
Pe
ESb
Esb'
Pw
Pw
Pw'
ESa
0
Q1' Q1 Qe Q2 Q2'
0
T T'
Pb
Pww
Pw'
Pe
0
S. Tarditi, 106747981, page 17/46
Q1' Q1 Qe Q2 Q2'
8 CUSTOMS UNION
Frame 8-1 Welfare analysius of a customs union
Price harmonization
Alternative policies
[1] Pc = Pb [2] Pc = Pa [3] Pa<Pc<Pb
Country A
Consumers
A+B+C+E
A'+B'+C+E'
Producers
-A
-A'
Taxpayers
-C
-C'
Overall
B+E
B'+E'
Country B
Consumers
-F-G
-F'-G'
Producers
F+G+H
F'+G'+H'
Taxpayers
-G-H-I
-G'-H'-I'
Overall
-G-I
-G'-I'
Customs Union (A+B) B+E
-G-I
B'+E'-G'-I'
Invisible transfers
from A to B
CU budget proceeds
Customs Union
[1] Pc = Pb [2] Pc = Pa
A+B+C+E
-A
-C
B+E
B+E
[3] Pa<Pc<Pb
A'+B'+C'+E'
-A'
-C = -(G+H+I) -C' -J
-C = -(G+H+I) B'+E' -J
-F-G
F+G+H
-F'-G'
F'+G'+H'
H
-G-I
H'
B'+E'-G'-I'
C = (G+H+I)
(G'+H'+I')
J - (G'+H'+I')
S. Tarditi, 106747981, page 18/46
P
P
Da
Db
Sa
Sb
P
Pa
C
A
E
B
Pc=Pw
Pw
Q
Q
0
Q1
Q3
Q4
0
Q2
Q5
Q6
P
P
Da
Db
Sa
Sb
P
Pc=Pa
F
C
G
Pw
Pw
H
I
Q
Q
0
Q1
Q3
Q4
Q2
0
S. Tarditi, 106747981, page 19/46
Q7
Q5 Q 6
Q8
P
P
Da
Db
Sa
Sb
Pa
Pc
A'
B'
E'
J
Pw
0
C'
Q1 Q3
Pw
Q4 Q 2
F'
G'
H'
I'
Q
Q
0
S. Tarditi, 106747981, page 20/46
Q Q 5 Q 6 Q8
7
Part II Quantitatve analysis, exarcises
9 PRODUCTION SUBSIDY
In country A, in free trade, at world market price €/t 100, the domestic demand of a
perishable agricultural product is 2000 t and the domestic supply is 1000 t. Elasticity of
demand is assumed to be -0.5 and elasticity of supply 0.8.
Domestic producers are granted € 20 per ton as a subsidy.
Find the likely effects3 of such policy on:
1. The most important trade variables: (a) demand price, (b) supply price, (c) demanded
quantity, (d) supplied quantity, (e) internationsally traded quantity.
2. The resulting effects on: (f) consumer expenditure, (g) producer revenue, (h) trade
balance (at border price).
3. The domestic transfers from or to: (i) consumers, (j) producers, (k) public budget.
4. The economic effects: (l) at consumption level, (m) at production level, (n) tax raising
cost (assumed to be 5%) of transfers to the public budget), (o) programme
administration cost (assumed to be 10% of transfers from the public budget), (p)
transfers (to or from) the rest of world.
5. The intersectoral redistribution: (q) consumers surplus, (r) producers surplus, (s)
taxpayers income.
6. The overall social welfare (t).
9.1
Trade effects.
a) In the domestic market, the demand price does not change.
b) The production price (producer revenue per unit) will grow by the same amount as the
producer subsidy (€20) consequently the new producer price is €/t 100 + 20 = €/t 120.
c) Impact on the demanded quantity: none.
d) The estimated effect on supplied quantity
We may follow two different approaches to quantify the likely effects on the quantity
supplied:
First approach (approximate, usually done by hart). The formula of the supply elasticity is
the ratio between the percent variation of quantity and the percent variation of price
 = Q%/P%;
knowing the percent variation of price, we can find the percent variation of quantity
Q% = *P%.
In our example P% = 20/100=20%, the percent variation of supplied quantity:
Qs% = 0.8*0.2 = 0.16 =16%. Consequently QS = 0.16*1000 = 160 t. The new supplied
quantity, will be Q2 = 1000 + 160 = 1160 t.
3
Our analysis is partial equilibrium and small country case, i.e. the effects of this sectoral policy on
macroeconomic variables and on the international terms of trade are insignificant. In order to simplify our
analysis in computing areas related to significant economic variables, we consider functions of demand and
of supply as linear, in the considered interval.
Second approach (more precise, in case the elasticity is reliably estimated). If we know the
elasticity, we can find the supply function QS=A*P^ passing through the observed
point on our diagram (whose coordinates are 1000,100). Then: 1000=A*1000.8;
A=1000/1000.8 =1000/39.81 = 25.12; the supply function will be Qs=25.12*P0.8; at a
price €/t 120, the supplied quantity will be: QS = 25.12*1200.8 =1157 t.
The estimated effect on supplied quantity is: 1157-1000 = 157 t
e) Imports grow from (-2000+1000) =-1000 t to (-2000+157)= -843 t, with a
difference of
(-847 +1000) = 157t.
9.2
Financial effects
f) We don’t have effects on consumer expenditure as consumer price and the quantity
demanded did not change.
g) Effect on the producer revenue: at first the revenue was: 100*1000 =100000. After the
subsidy is granted to producers: it becomes 120*1157 =138844.
Effect of the subsidy € 138844-100000 = € 38844.
h) Effect on trade balance (border price): at first the value of imports was € 100*1000 =
100000, after granting the subsidy it is € 100*-843 = -84297, resulting in a reduction
of outlays of foreign currency € 100000-84297 = 15703
9.3
Domestic transfers
i) There are no transfers to or from consumers.
j) Transfers from the public budget to producers are € P*Q2 = 20*1157 = 23141,
(rectangle P1-c-d-Pw in figure 1).
k) The cost for public budget is € 20 per supplied unit: -20*1157 = -23141.
9.4
Economic effects.
Until now we have considered the effects on costs and revenues for different groups
of citizens, now we analyse the effects on social welfare.
l) At consumption level we don’t notice any economic costs or benefits.
m) At production level, the worse allocation of resources produces an economic cost,
shown by the triangle a-c-d in figure 1, that is: 0.5* P*QS = 0.5 *20*157 =
€ -1570.
n) The administrative costs are assumed to be 15% of the public budget transfer: 5% for
tax raising cost and 10% for the programme administration cost: -23141 * 0.15 =
€ -3471. Such costs may be considered as a net loss of resources not only for
taxpayers but for the whole society .
o) As international terms of trade are unchanged, we have no invisible transfers of
resources from, or to the rest of the world.
9.5
Intersectoral redistribution.
p) There is no change in consumer behavious and no impacton on consumer surplus.
q) Effects on producer surplus: the net benefit for producers is indicated by the area of the
trapezium P1-c-a-Pw in figure 1: 0.5 *P*(Q1+Q2) = 0.5 *20*(1000+1157) = €
21570. We can get the same result also by subtracting the cost of new marginal
S. Tarditi, 106747981, page 22/46
production 0.5*157*20 = 1570, from the gross transfer of resources to producers (€
23141), that is: € 21570.
r) Effect on taxpayers’ income: it coincides with the budgetary cost of the subsidy
previously examined (€ -23141) plus administrative costs € -3471, assumed to be
15% of the public budget transfer. In total: -23141-3471= € -26612.
9.6
Impact on social welfare
u) The overall effect on social welfare is due to the economic costs at production level and
to the administrative costs. They result in a reduction of social welfare -[m]-[n] =
-1570-3471= € -5041. The same result is obtained by summing up the impact on
producers’ and taxpayers’ surpluses: [q]+[r] =21570-26612 = € - 5042
S. Tarditi, 106747981, page 23/46
Frame 9-1 Subsidy to production
Production Subsidy
In country A, in free trade, at world market price €/t 100, the
domestic demand of a perishable agricultural product is 2000 t and
the domestic supply is 1000 t. Elasticity of demand is assumed to be
-0.5 and elasticity of supply 0.8.
Domestic producers are granted € 20 per ton as a subsidy.
Find the likely effects on producers' revenue, trade balance, public
budget and consumers' surplus.
P
300
S
D
250
200
150
100
50
0
0
1000
2000
3000
4000
10
TAX ON CONSUMPTION
In country A, in free trade, at world market price €/t 100, the domestic demand of a
perishable agricultural product is 2000 t and the domestic supply is 1000 t. Elasticity of
demand is assumed to be -0.5 and elasticity of supply 0.8.
A € 20 per ton tax on consumption is imposed.
Find the likely effects4 of such policy on:
1. The most important trade variables: (a) demand price, (b) supply price, (c) demanded
quantity, (d) supplied quantity, (e) internationsally traded quantity.
2. The resulting effects on: (f) consumer expenditure, (g) producer revenue, (h) trade
balance (at border price).
3. The domestic transfers from or to: (i) consumers, (j) producers, (k) public budget.
4. The economic effects: (l) at consumption level, (m) at production level, (n) tax raising
cost (assumed to be 5%) of transfers to the public budget), (o) programme
administration cost (assumed to be 10%) of transfers from the public budget), (p)
transfers (to or from) the rest of world.
5. The intersectoral redistribution: (q) consumers surplus, (r) producers surplus, (s)
taxpayers income.
6. The overall social welfare (t).
* * *
Trade effects.
a) In the domestic market, the demand price will grow by the same amount as the tax on
consumption (€20), consequently the new consumer price is €/t 100 + 20 = €/t 120.
b) The production price (producer revenue per unit) does not change.
c) The estimated effect on demanded quantity
We may follow two different approaches to quantify the likely effects on the quantity
demanded:
First approach (approximate, usually done by hart). The formula of the demand elasticity is
the ratio between the percent variation of quantity and the percent variation of price
 = Q%/P%;
knowing the percent variation of price, we can find the percent variation of quantity
Q% = *P%.
In our example P% = 20/100=20%, the percent variation of supplied quantity:
Qs% = -0.5*0.2 = -0.10 =-10%. Consequently QD= -0.10*2000 = -200 t. The new
supplied quantity, will be Q4 = 2000-200= 1800 t.
Second approach (more precise, in case the elasticity is reliably estimated). If we know the
elasticity, we can find the demand function QD=A*P^ passing through the
observed point on our diagram (whose coordinates are 2000,100). Then:
2000=A*100-0.5; A=2000/100-0.5 = 20000; the demand function will be
QD=20000*P-0.5; at a price €/t 120, the demanded quantity will be: QD =
20000*120-0.5 =1826 t.
4
Our analysis is partial equilibrium and small country case, i.e. the effects of this sectoral policy on
macroeconomic variables and on the international terms of trade are insignificant. In order to semplify our
analysis in computing areas related to significant economic variables, we consider functions of demand and
of supply as linear, in the considered interval.
The estimated effect on demanded quantity is: 2000-1826 = 174 t
d) No impact on the supplied quantity.
e) Imports fall from (-2000+1000) =-1000 t to (-1826+1000)= -826 t, with a
difference of 26 +1000) = 174 t.
Financial effects
f) Effect on the consumer expenditure: at first the expenditure was: 100*2000 =200000.
After the tax is imposed to consumers: it becomes 120*826 =219089. Effect of tax €
219089-200000 = € 19089.
g) No effects on producer revenue as producer price did not change.
h) Effect on trade balance (border price): at first the value of imports was € 100*1000 =
100000, after imposing the tax it is € 100*-826= -82574, resulting in a reduction of
outlays of foreign currency € 100000-82574= 17426
Domestic transfers
i) Transfers from consumers to the public budget are € P*Q2 = 20*1826 = 36515,
(rectangle P1-e-f-Pw in figure 2).
j) There are no transfers to or from producers.
k) The revenue for public budget is € 20 per demanded unit: 20*1826 = 36515.
Economic effects.
Until now we have considered the effects on costs and revenues for different groups
of citizens, now we analyse the effects on social welfare.
l) At the consumption level, the worse allocation of resources produces an economic cost,
shown by the triangle e-b-f in figure 2, that is: 0.5* P*QD = 0.5 *20*174 = € 1743.
m) At production level we don’t notice any economic costs or benefits.
n) The administrative costs are assumed to be 15% of the public budget transfer: 5% for
tax raising cost and 10% for the programme administration cost: 36515 * 0.15= € 5477. Such costs are a net loss of resources for taxpayers and for the whole society .
o) Because the international terms of trade are unchanged, we have no invisible transfers
of resources from, or to the rest of the world.
Intersectoral redistribution.
p) Effect on the consumers surplus: the surplus of consumers decreases by the area of
trapezium P1-e-b-Pw in figure 2: 0.5 *P*(Q3+Q4) = 0.5 *20*(2000+1826) = € 38257. We can get the same result also by adding the further economic cost at
consumption level 0.5*174*20 = -1743, to the obtained transfer of resources (€ 36515), that is: € -38257.
q) The situation of producers remains unchanged therefore no effects on redistribution.
r) Effect on the income of taxpayers: the proceeds of the tax (€ 36515) minus the further
costs for public administration produced by the state intervention, € -5477 wich is
assumed to be 15% of the public budget transfer. In total: 36515-5477 = € 31038.
Overall social welfare
u) The total effect on social welfare is given by the addition of economic costs at the
consumption level and of the administrative costs. They represent a negative change
of social welfare -[m]-[n]= -1743-5477= -7220. The same result can be obtained by
adding the effects on distribution of the revenue between consumers and taxpayers:
[q]+[r] =-38257+31038 = € -7220.
If negative or positive externalities are generated by the examined policy measure, their
estimated impact on social welfare should be added to these results.
S. Tarditi, 106747981, page 26/46
Frame 10-1 Tax on consumption
Tax on consumption
In country A, in free trade, at world market price €/t 100, the domestic
demand of a perishable agricultural product is 2000 t and the domestic
supply is 1000 t. Elasticity of demand is assumed to be -0.5 and
elasticity of supply 0.8.
A € 20 per ton tax on consumption is imposed.
Find out how large would be the cost or benefit to consumers,
producers and the public budget.
P
250
D
S
200
150
100
50
Q
0
0
1000
2000
3000
4000
11 DUTY ON IMPORTS (
SMALL COUNTRY)
In country A, in free trade, at world market price €/t 100, the domestic demand of a
perishable agricultural product is 2000 t and the domestic supply is 1000 t. Elasticity of
demand is assumed to be -0.5 and elasticity of supply 0.8.
A € 20 per ton import duty is imposed.
Find the likely effects5 of such policy on:
1. The most important trade variables: (a) demand price, (b) supply price, (c) demanded
quantity, (d) supplied quantity, (e) internationsally traded quantity.
2. The resulting effects on: (f) consumer expenditure, (g) producer revenue, (h) trade
balance (at border price).
3. The domestic transfers from or to: (i) consumers, (j) producers, (k) public budget.
4. The economic effects: (l) at consumption level, (m) at production level, (n) tax raising
cost (assumed to be 5%) of transfers to the public budget), (o) programme
administration cost (assumed to be 10%) of transfers from the public budget), (p)
transfers (to or from) the rest of world.
5. The intersectoral redistribution: (q) consumers surplus, (r) producers surplus, (s)
taxpayers income.
6. The overall social welfare (t).
Trade effects.
a=b) In the domestic market, we have a rise in the demand and supply price by the same
amount as the import duty (€20) because the cost per unit of imports increases from
€100 to 120. The erliest supply and demand prices increase by the same amount as
the import duty.
c-d) We may follow two different approaches to quantify the likely effects on the
quantity demanded and supplied:
First approach (approximate, usually done by hart). The formula of the demand elasticity is
the ratio between the percent variation of quantity and the percent variation of price
 = Q%/P%;
knowing the percent variation of price, we can find the percent variation of quantity
Q% = *P%.
In our example P% = 20/100=20%, the percent variation of demanded quantity: QD%= 0.5*0.2= -10% and this means QD = -0.1*2000 =-200 t. The new demanded
quantity at price by €120, will be Qd’ = 2000-200=1800 t. In the same way, we can
find the new supplied quantity: QS%= 0.8*0.2=0.16= 16%; Consequently QS
=0.16*1000 =160 t. The new supplied quantity, will be: Qs’ =1000 +160 =1160 t .
Second approach (more precise, in case the elasticity is reliably estimated). If we know the
elasticity, we can find the demand function QD=A*P^ passing through the
observed point on our diagram (whose coordinates are 2000,100). Then:
2000=A*100-0.5; A=2000/100-0.5 = 20000; the demand function will be
QD=20000*P-0.5; at a price €/t 120, the demanded quantity will be: QD =
20000*120-0.5 =1826 t. In the same way, If we know the elasticity of supply, we can
5
Our analysis is partial equilibrium and small country case, i.e. the effects of this sectoral policy on
macroeconomic variables and on the international terms of trade are insignificant. In order to semplify our
analysis in computing areas related to significant economic variables, we consider functions of demand and
of supply as linear, in the considered interval.
find the supply function QS=A*P^ passing through the observed point on our
diagram (whose coordinates are 1000,100). Then: 1000=A*1000.8; A=1000/1000.8
=1000/39.81 = 25.12; the supply function will be Qs=25.12*P0.8; at a price €/t 120,
the supplied quantity will be: QS = 25.12*1200.8 =1157 t.
The estimated effect on demanded quantity is: 2000-1826 = 174 t and the estimated
effect on supplied quantity is: 1000-1157=157 t.
e) Imports fall from (-2000+1000) =-1000 t to (-1826+1157)= -669 t, with a
difference of (-669 +1000) = 331t.
Financial effects
f) Effect on the consumer expenditure: at first the expenditure was: 100*2000 =200000.
After the duty is imposed to consumers: it becomes 120*826 =219089. Effect of
duty € 219089-200000 = € 19089.
g) Effect on the producer revenue: at first the revenue was: 100*1000 =100000. After the
duty is imposed: it becomes 120*1157 =138844. Effect of duty € 138844-100000 =
€ 38844.
h) Effect on trade balance (border price): at first the value of imports was € 100*1000 =
100000, after imposing the duty it is € 100*-669= -66871, resulting in a reduction of
outlays of foreign currency € 100000-66871= 33129
Domestic transfers
i) The equivalente tax on consumers: we have an increase in the cost related to the new
demanded quantity and the higher price (rectangle P1-e-f-PW in figure 3): P *Qd’
= 20*1800 = € 36000.
j) The equivalent subsidy to producers: the increase in the revenue related to new supplied
quantity at the new price (rectangle P1-c-d-PW in figure 3): P*Qs’ = 20*1200 =
24000 Ecu.
k) The effect on the public budget: the previously imported quantity was 2000-1000
=1000, after the duty was imposed: 1826-1157 =669. Before we have no duty, after
the imposition of the duty the public income is € 20 per unit imported: € 20*669 =
€13374 .
Economic effects.
Until now we have considered the effects on costs and revenues for different groups
of citizens, now we analyse the effects on the social welfare.
l) At the consumption level the worse allocation of resources produces an economic cost
(“social cost”, according to the nomenclature used by Gandolfo) shown by the
triangle e-b-f in figure 3, that is: -0.5*P*QD = -0.5 *20*174 = € -1743.
m) At the production level, the worse allocation of resources produces an economic cost,
shown by the triangle a-c-d in figure 3 that is: -0.5 * P* QS = 0.5 *20*-157= € 1570.
n) The administrative costs are assumed to be 15% of the public budget transfer: 5% for
tax raising cost and 10% for the programme administration cost: 13374 * 0.15= € 2006. Also those costs represent a net loss of resources not only for taxpayers but for
the whole society .
o) Because the international terms of trade are unchanged, we have no invisible transfers of
resources from, or to the rest of the world.
Intersectoral redistribution.
p) Effect on the revenue of consumers: the consumers expenditure increases by the area of
trapezium P1-e-b-Pw in figure 3: 0.5 *P*(Q3+Q4) = -0.5 *P*(Qd+Qd’) = 0.5*20*(2000+1826) =-38257. We can split this area in to 3 parts: (i) the income
S. Tarditi, 106747981, page 29/46
transfer to producers 20*1157 = € 23141, (ii) the income transfer to taxpayers
20*669 = €13374, (iii) the net loss of welfare related to the reduction of consume0.5 *20*174 = € -1740.
q) Effect on the revenue of producers: the revenue of producers increases by the area of
trapezium P1-c-a-Pw in figure 3: 0.5*P*(Qs+Qs’) = 0.5*20*(1000+1157) = €
21570. We can get the same result also by subtracting the further cost of new
marginal production 0.5*157*20 = 1570, from the obtained transfer of resources
(€23141) from consumers, , that is € 21570.
r) Effect on the income of taxpayers: it is consists of the net revenue of duty previously
examined (€ 13374) minus the further costs for public administration produced by
the state intervention, € -2006 wich is assumed to be 15% of the public budget
transfer. Total: 13374-2006= € 11368.
Overall social welfare
u) The total effect on social welfare is given by the addition of economic costs at the
consumption level, at the production level and of the administrative costs. They
represent a negative variation of social welfare –[l]-[m]-[n]= -1743-1570-2006= 5319. The same result can be obtained by adding the effects on distribution of the
revenue between consumers and taxpayers: [p]+[q]+[r] =-38257+21570+11368= € 5319.
If negative or positive externalities are generated by the examined policy measure, their
estimated impact on social welfare should be added to these results.
S. Tarditi, 106747981, page 30/46
Frame 11-1 Duty on imports (small country)
Import duty and production subsidy (3)
In country A, in free trade, the world market price is €/t 100, the domestic demand for a
perishable, and therefore not stored, agricultural product is 1200 t and the domestic
supply is 1000 t. The elasticity of demand is assumed to be -0.5 and the elasticity of
supply 1.
An €/t 5 import duty is imposed and a €/t 15 production subsidy is granted to producers.
The world market price is expected to react with a €/t 10 change.
Find out how large would be the cost or benefit to consumers, producers and the public
budget.
P
140
D
S
120
100
80
60
40
20
Q
0
0
500
1000
1500
2000
12 DUTY ON IMPORTS (
LARGE COUNTRY)
In the example of a large country, the adopted policies, affect the international (world
market) price; in other words, the policies change the international terms of trade
with other countries. In the next table and in the figure 4 the effects of an import
duty in a big country with the same caracteristics as in the exercise 3 are described.
The import duty increases the price, so reduces consume and grows the domestic production
reducing, as a consequence the importations. The quantity demanded in the world
market fall drastically, because it concerns with a large country. Consequently, we
have a reduction in the world market price.(from PW to PW') and therefore the
effect of the duty is lower: the domestic price raises from P W’ to P (instead of from
PW to P). To solve this exercise in the case of a big country, we should therefore
know, the effect on the international terms of trade. In the table, we assume that the
imposition of the duty causes a reduction of € 5 in the world market price.
* * *
Trade effects.
In the domestic market, we have a rise in the demand and supply price by €/t 15 as the cost
per unit of imports increases from € 100 to € 115 /t. The earliest supply and demand
prices increase by the same amount as the import duty, minus the change in the
world market price.
c-d) We may follow two different approaches to quantify the likely effects on the
quantity demanded and supplied:
First approach (approximate, usually done by hart). The formula of the demand elasticity is
the ratio between the percent variation of quantity and the percent variation of price
 = Q%/P%;
knowing the percent variation of price, we can find the percent variation of quantity
Q% = *P%.
In our example P% = 15/100 =15%, the percent variation of demanded quantity: QD%=
-0.5*0.15= -0.075= -7.5% and that means  QD = -0.075*2000 =-150 t. The new
quantity demanded at price of €/t 115, will be Qd’ = 2000-150=1850 t. In the same
way, we can find the new supplied quantity: QS%= 0.8*0.15=0.12=12%; QS =
0.12*1000 = 120 t. New quantity supplied will be: Qs’ =1000 +120 =1120 t.
Second approach (more precise, in case the elasticity is reliably estimated). If we know the
elasticity, we can find the demand function QD=A*P^ passing through the
observed point on our diagram (whose coordinates are 2000,100). Then:
2000=A*100-0.5; A=2000/100-0.5 = 20000; the demand function will be
QD=20000*P-0.5; at a price €/t 120, the demanded quantity will be: QD =
20000*115-0.5 =1865 t. In the same way, If we know the elasticity of supply, we can
find the supply function QS=A*P^ passing through the observed point on our
diagram (whose coordinates are 1000,100). Then: 1000=A*1000.8; A=1000/1000.8
=1000/39.81 = 25.12; the supply function will be Qs=25.12*P0.8; at a price €/t 115,
the supplied quantity will be: QS = 25.12*1150.8 =1118 t.
The estimated effect on demanded quantity is: 2000-1826 = 135 t and the estimated
effect on supplied quantity is: 1000-1157=118 t.
e) Imports fall from (-2000+1000) =-1000 t to (-1865+1118)= -747 t, with a
difference of (-747 +1000) = 253.
Financial effects
f) Effect on the consumer expenditure: at first the expenditure was: 100*2000 =200000.
After the duty is imposed to consumers: it becomes 115*1865 =214476. Effect of
duty € 214476-200000 = € 14476.
g) Effect on the producer revenue: at first the revenue was: 100*1000 =100000. After the
duty is imposed: it becomes 115*1118 =128604. Effect of duty € 128604-100000 =
€ 28604.
h) Effect on trade balance (border price): at first the value of imports was € 100*-1000 = 100000, after imposing the duty it is € 100*-747= -70937, resulting in a reduction of
outlays of foreign currency € 100000-70937= 29063
Domestic transfers
i) The equivalente tax on consume: we have an increase in the cost related to the new
demanded quantity and the higher price (rectangle P-e-f-PW in figure 4): P *Qd’ =
15*1865 = € 27975.
j) The equivalent subsidy on production: the increase in the revenue related to new
supplied quantity at the new price (rectangle P-c-d-PW in figure 4): P*Qs’ =
15*1118 = € 16774.
k) The effect on the public budget: the previously imported quantity was 1000-2000=1000, after the duty was imposed: 1118-1865 =-747. Before we have no duty, after
the imposition of the duty the public income is € 20 per unit of imports, but the
domestic price changes only by €/t 15; therefore, the transfer from consumers to
taxpayers is only € 15 per unit imported: € 15*747 = € 11201.
Economic effects.
Until now we have considered the effects on costs and revenues for different groups
of citizens, now we analyse the effects on the social welfare.
l) At the consumption level the worse allocation of resources produces an economic cost
(“social cost”, according to the nomenclature used by Gandolfo) shown by the
triangle e-b-f in figure 4, that is: -0.5*P*QD = -0.5 *15*135= € -1012.
m) At the production level, the worse allocation of resources produces an economic cost,
shown by the triangle a-c-d in figure 4 that is: -0.5 * P* QS = 0.5 *15*118= € 887.
n) The administrative costs are assumed to be 15% of the public budget transfer: 5% for
tax raising cost and 10% for the programme administration cost: 11201 * 0.15= € 1680. Also those costs represent a net loss of resources not only for taxpayers but for
the whole society .
o) As the international terms of trade changed, we have transfers from or to the rest of the
world: imports are cheeper now (PW’ instead of PW), and as a consequence we have
lower expenditure: (Qd’-Qs’)*(PW-PW’) = 747*+(-5) = € 3734, corrisponding to an
equal reduction of revenue for producers in the rest of the world. Those transfers of
resources from, or to the rest of the world. (defined as “invisible” because they are
due to changes in price system), represent also an increase in the overall social
welfare, therefore they are included in economic effects.
S. Tarditi, 106747981, page 33/46
Intersectoral redistribution.
p) Effect on the revenue of consumers: the consumers expenditure increases by the area of
trapezium P-e-b-Pw in figure 4: -0.5 *P*(Qd+Qd’) = -0.5*15*(2000+1865) = €28988. We can split this area in to 3 parts: (i) the income transfer to producers
15*1118 = € 16774, (ii) the income transfer to taxpayers 15*747 = €11205, (iii) the
net loss of welfare related to the reduction of consume-0.5 *15*135 = € -1012.
q) Effect on the revenue of producers: the revenue of producers increases by the area of
trapezium P-c-a-Pw in figure 4: 0.5*P*(Qs+Qs’) = 0.5*15*(1000+1118) = €
15887. We can get the same result also by subtracting the further cost of new
marginal production 0.5*118*15= 887, from the obtained transfer of resources
(€16774) from consumers, , that is € 15887.
r) Effect on the income of taxpayers: it is consists of the net revenue of duty: (P-Pw’)(Qd’Qs’) = 20*747 minus the further costs for public administration produced by the
state intervention, € -1680 wich is assumed to be 15% of the public budget transfer.
Total: 14934-1680= € 13254.
Overall social welfare
u) The total effect on social welfare is given by the addition of economic costs at the
consumption level at the production level, the transfer to or from the rest of the
world and of the administrative costs. They represent a positive variation of social
welfare –[l]-[m]-[n]+[o]= -1012-887-1680+3734= 154. The same result can be
obtained by adding the effects on distribution of the revenue between consumers,
producers and taxpayers: [p]+[q]+[r] =-28988+15887+13254= € 154.
To this result it would be necessary to add the effects on social welfare of negative or
positive externalities and the effects on social welfare connected on revenues
redistribution generated at interpersonal level. Those two elements are not
considered here.
S. Tarditi, 106747981, page 34/46
Frame 12-1 Duty on imports (large country
Duty on imports (large country)
In country A, in free trade, at world market price100 €/t , domestic demand
of a perishable, and therefore not stored, agricultural product is 2000 t and
domestic supply is 1000 t. Elasticity of demand is assumed to be -0.5 and
elasticity of supply 0.8
A €/t 20 import duty is imposed. As a consequence, the estimated
variation of €/t 3 of the world market price is expected. Find the likely effects
on producers' revenue, trade balance, public budget and consumers' surplus.
P
Elasticity of Demand
Elasticity of supply
World market price
a
b
c
d
e
250
D
Ante
S
200
f
g
h
i
j
k
150
P
l
m
n
o
Pw
100
Pw'
p
q
r
s
t
u
v
50
0
0
500
1000
1500
2000
2500
3000
Figure
Post
Figure
Differen.
Figure
BASIC PARAMET ERS
-0.5
€/t
0.8
100
-0.5
Pw
0.8
95
0
Pw'
0
-5
POLICY MEASURES
Import duty
€/t
20
20
Production subsidy
Consumption tax
T RADE EFFECT S ON:
Demand price
€/t
100
115
P
15
.
Supply price
€/t
100
115
P
15
Quantity demanded
t
2000
Qd
1865
Qd'
-135
Quantity supplied
t
1000
Qs
1118
Qs'
118
Foreign trade
t
-1000
Qs-Qd
-747
Qs'-Qd'
253
FINANCIAL EFFECT S ON:
Consumer expenditure
€
200000
QdxPw 214476
Qd'xP 14476
Producer revenue
€
100000
QsxPw 128604
Qs'xP 28604
trade balance (foreign exchange) € -100000 [Qs-Qd]xPw -70937 [Qs'-Qd']xPw' 29063
DOMEST IC T RANSFERS
Consumers (equivalent tax)
€
-27975
Qd'x[P-Pw]
Producers (equivalent subsidy)
€
16774
Qs'x[P-Pw]
Public budget (from consumers to budget)
€
11201
[Qd'-Qs']x[P-Pw]
ECONOMIC EFFECT S
At consumption leves
€
-1012 [P-Pw]x[Qd'-Qd]/2
At production level
€
-887 [P-Pw]x[Qs-Qs']/2
Administrative costs
€
-1680
T ransfers to (or from) the rest of world
€
3734 [Pw-Pw']x[Qd'-Qs']
INT ERSECT ORAL REDIST RIBUT ION
Consumers' surplus
€
-28988 [P-Pw]x[Qd+Qd']/2
Producers' surplus
€
15887 [P-Pw]x[Qs'+Qs]/2
T axpayers' income
€
13254 [Qd'-Qs']x[P-Pw']-n
EXT ERNALIT IES
Positive externalities
€
Negative externalities
€
CHANGE IN SOCIAL WELFARE €
154
l+m+n+o
Check on overall social welfare
€
154
p+q+r
Parameter in demand function
20000
Parameter in supply function
25.1189
S. Tarditi, 106747981, page 35/46
13 OTHER EXERCISES
13.1 Export Subsidy
Export Subsidy
In the country A, in free trade, the world market price is €/t 100, the domestic
demand of a perishable, and therefore not stored, agricultural product is 400
t and the domestic supply is 1000 t. The elasticity of demand is assumed to
be -0.4 and the elasticity of supply 0.6.
An €/t 20 export subsbidy is granted to producers.
Find the likely impact of such policy on producer and consumer surplus,
budget and trade balance.
P
250
D
S
200
150
P'
Pw
100
50
0
0
200
400
600
800 1000 1200 1400 1600 1800
S. Tarditi, 106747981, page 36/46
13.2 Consumption subsidy
Consumption subsidy
In the country A, in free trade, the world market price is €/t 100, the
domestic demand of a perishable, and therefore not stored, agricultural
product is 2000 t and the domestic supply is 1000 t. The elasticity of
demand is assumed to be -0.4 and the elasticity of supply 0.6.
An €/t 20 subsbidy on consumption is granted to consumers.
Find out how large would be the cost or benefit to consumers,
producers and to the public budget.
P
300
D
S
250
200
150
P'd
100
50
Pw
Qs
Qd
0
0
500
1000
1500
2000
Qd'
Q
2500
S. Tarditi, 106747981, page 37/46
13.3 Tax on production
Tax on production
In the country A, in free trade, the world market price is €/t 100, the domestic
demand of a perishable, and therefore not stored, agricultural product is 400 t
and the domestic supply is 1000 t. The elasticity of demand is assumed to be 0.3 and the elasticity of supply 0.5. An €/t 10 tax on production is imposed.
Find the likely impact of such policy on producer and consumer surplus,
budget and trade balance.
P
300
D
S
250
200
150
100
50
Q's
Qd
Qs
0
0
200
400
600
800
1000 1200 1400 1600 1800
S. Tarditi, 106747981, page 38/46
13.4 Export and production subsidy
Trade liberalization (export and production subsidy)
In an imaginary country the guaranteed minimum price for a
perishable product is €/t 100, and a €/t 10 subsidy is granted to
farmers. The world market price is €/t 50, the average annual
production is 9000 tonnes and exports are 5000 t.
As a result of international negotiations production subsidies are
abolished and the government's support to market price is reduced
by 30%. The world market price is expected to register a 10% change.
Assuming a -0,6 demand elasticity and a 0,8 supply elasticity ,find
out how large would be the cost or benefit to consumers, producers
and the public budget.
P
180
D
S
160
140
120
Ps
Pd
P'
100
80
60
Pw'
40
Pw
20
Qd
Q'd
Q's
Qs
Q
0
0
5000
10000
15000
S. Tarditi, 106747981, page 39/46
13.5 Import duty and production subsidy
Impo rt duty and pro duc tio n subsidy
In the country A, in free trade the world market price is €/t 100, the
domestic demand of a perishable agricultural product is 1500 t and the
domestic supply is 800 t. The elasticity of demand is assumed to be 0.5 and the elasticity of supply 0.6.
A €/t 20 import duty is imposed and a €/t 10 subsidy is granted to
producers.
As a consequence a €/t 5 estimated variation of the world market price
is expected.
Find the likely effects on producers' revenue, trade balance, public
budget and consumers'surplus.
P
200
D
180
Pd
Pw
€
€
€
€
100
Pw'
80
€/t
€/t
t
t
t
€
€
€
Ps
120
€/t
€
€
€
S
160
140
€/t
€
€
€
60
40
€
€
€
€
20
0
0
500
1000
1500
2000
S. Tarditi, 106747981, page 40/46
13.6 Minimum guaranteed price and co-responsibility levy
Minimum guarante e d price and co-re sponsibility le vy
In an imaginary country, in free trade, the world and domestic price
for a perishable product is €/t 40, 1500 t are consumed and 2300 t are
supplied. The estimated demand elasticity is -0,5 and the supply
elasticity is 0,8. The local government is willing to guarantee a
minimum domestic price to producers at €/t 80 by enforcing variable
levies (or variable export subsidies) at the border. The world market is
expected to react by a 10% change. In order to reduce the budgetary
outlay and ease the new policy, producers are willing to pay a €/t 10
co-responsibility levy.
Find the likely impact of such policy on producer and consumer
surplus, budget and trade balance.
P
160
140
D
S
120
100
Pd
Ps
80
60
Pw
40
Pw'
20
Qd'
0
0
1000
Qd
2000
Qs
Qs'
3000
4000
5000
Q
6000
S. Tarditi, 106747981, page 41/46
13.7 Import duty and production subsidy (2)
Liberalization (import duty & production subsidy)
In an imaginary country the guaranteed minimum price for a perishable
product is €/t 100 and a €/t 10 subsidy is granted to farmers. The world
market price is €/t 50, the average annual production is 1000 tonnes and
exports are 400 t. As a result of international negotiations the production
subsidies are abolished and the government's support to market price is
reduced by 30%. The world market price is expected to register a 10%
change.
Assuming a -0,6 demand elasticity and a 0,7 supply elasticity, find out
how large would be the cost or benefit to consumers, producers and the
public budget.
P
200
D
180
S
160
140
120
Ps
Pd
P'
100
80
60
Pw'
40
Pw
20
0
0
500
1000
1500
S. Tarditi, 106747981, page 42/46
13.8 Price reduction and compensation
Cereals: Price reduction and compensation
In a large country cereals are cultivated on 13 mn ha, average anual production is 65 mn t
and net exports are 7mn t. Domestic price is supported at €/t 155 while average world market
price is €/t 80. A proposal for reforming the agricultural policy envisages a reduction of the
guaranteed minimum price at €/t 100, while compensating farmers by means of a partially
decoupled subsidy related to the cultivated area. Under this condition a low supply elasticity
0,2 is assumed, while demand elasticity could be higher, for example - 0,5 due to the likely
increase of cereal use in animal feed ratios. The world market price is expected to react by a
€/t 10 change. Compute the likely impact of this policy on producer surplus (without
compensation), on the surplus of cereals users and on the trade balance. Compute also what
percentage of the producers' loss could be compensated by the savings of the public budget.
€
€
€
€
€
€
€
P
250
D
200
€
€
€
S
€
€
€
Ps=Pd
150
P'
Pw'
100
€
€
€
€
€
Pw
50
0
Q
0
20
40
60
80
S. Tarditi, 106747981, page 43/46
€/ha
€
13.9 Export and production subsidy (2)
Trade liberalization ( Export and production subsidy)
In the country A, in free trade, the world market price is €/t 100, the
domestic demand of a perishable, and therefore not stored, agricultural
product is 400 t and the domestic supply is 1000 t. The elasticity of demand
is assumed to be -0.5 and the elasticity of supply 0.5. An €/t 5 export
subsidy and a €/t 20 production subsidy are granted to producers.
Find the likely effects on: the intersectoral redistribution: consumer surplus,
producer surplus, taxpayer income, on the trade balance and on the foreign
trade.
P
200
D
S
180
160
140
P's
120
P'd
100
Pw
80
60
40
20
Q'
Qd
Qs
Q's
Q
0
0
500
1000
1500
2000
S. Tarditi, 106747981, page 44/46
13.10Frame 14: Import duty and production subsidy (3)
Import duty and production subsidy
In the country A, in free trade, the world market price is €/t 100, the domestic
demand of a perishable, and therefore not stored, agricultural product is 1200 t
and the domestic supply is 1000 t. The elasticity of demand is assumed to be 0.5 and the elasticity of supply 1. An €/t 5 import duty is imposed and a €/t 15
production subsidy is granted to producers.
The world market price is expected to react by a €/t 10 change.
Find out how large would be the cost or benefit to consumers, producers and
the public budget.
P
140
D
S
120
100
80
60
40
20
Q
0
0
500
1000
1500
2000
S. Tarditi, 106747981, page 45/46
13.11Export subsidy and tax on consumption
Export subsidy & Tax on consume
In the country A, in free trade, the world market price is €/t 100, the domestic
demand of a perishable, and therefore not stored, agricultural product is 1500
t and the domestic supply is 2300 t. The elasticity of demand is assumed to
be -0.4 and the elasticity of supply 0.8.
An €/t 15 production subsidy is granted to producers, but in order to reduce
the budgetary outlay a €/t 8 tax on consume is imposed.
The world market price is expected to react by a 12% change.
Find out how large would be the cost or benefit to consumers, producers
and the public budget.
P
200
D
S
150
100
50
Q
0
0
1000
2000
3000
4000
S. Tarditi, 106747981, page 46/46