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.