Transcript MD-MS_diagram_explained

Teaching/Studying Presentation
© R.Baldwin & C. Wyplosz
Baldwin & Wyplosz
The Economics of European
Integration
•Chapter 4: Basic Economics of Preferential Liberalisation
“A careful presentation of the Open
Economy Supply and Demand Diagram
(Figures 4-1 to 4-3 Chapter 4)”
To view this, start the slide show (‘view show’ command under the
Slide Show pull-down menu) and use either the arrow keys or
click the mouse to proceed
© R.Baldwin & C. Wyplosz
The MS-MD Diagram: The International Market
euros
p’”
p””
FT
pp”
p’
•The
import
demand
curve
volume
of imports
Home
demands
at
•The
The
import
equilibrium
supply
curve
price
shows
of shows
imports
thethe
volume
and
quantity
of imports
of imports
thatthat
will
are
be
indicated
offered
by
at any
the
anypoint
given
price.
For
example: price (called the market clearing price) is pFT. The
given
price.
“A”.
ForThe
example:
corresponding
•The
import
supply
(MS) and import
•
if
the
price
is
p’”,
then
Home
would
like
to
import
m’”.
FT
• if the
corresponding
price is p’, then
quantity
foreign
of imports
firms would
is m like
. to export m’ to Home.
•
if
the
price
is
p””,
then
Home
would
like
to
import
m””amount
demand
(MD)
price
• if the
Theprice
equilibrium
is p”, then
price
foreign
is pFTnations
becausewould
at this
like
price,
todiagram
export
the
m” has
foreign
firms wish
• The
MD
sloped
since
a higher
pricewants
makes
want
• The
toMS
sell
curve
tocurve
Home
is is
upward
isdownward
just equal
sloped
tosince
the amount
higher
prices
that
Home
make
foreign
toHome
firms
buy.
want to
to
(measured
in euros)
on the
vertical
import
sell
moreless.
to Home.
axis
•And the quantity of importsMS
on the
A axis
horizontal
Import
supply curve
MD
Imports
FT
m
m”
m’ m”’ m””
Import demand
curve
imports
© R.Baldwin & C. Wyplosz
The MS-MD Diagram: The International Market
euros
MS
pFT
Import
supply curve
MD
Import demand
curve
Imports
mFT
imports
© R.Baldwin & C. Wyplosz
Open Economy Supply & Demand Analysis: The Home Market
euros
When the price of imports is pFT as
shown here, Home firms supply a
quantity of goods equal to Z.
The price pFT
Sdom
indicates the price
This
At
pFTis, the
Home
supply
consumers
curve
ofbuy
Home
a
atimport
which
foreign
Without trade barriers, the
price
fixes the Home
firms. It is
quantity
ofupward
goods equal
sloped
to since
C. firms
FT, the
market price; because when
the import
price is pto
firms
are
willing
wish to sell more when prices are
total supply curve in the Home market is the kinked
supply imports.
high.
line shown. The first Z units of supply are made by
Home firms. The rest is imported.
Demand and supply thus meet at point B.
The level of imports
equals the difference
between Home
This is the demand curve of Home
consumption and
consumers. It is downward sloped
Home production.
since consumers wish to buy more
when prices are low.
pFT
pFT
B
Ddom
Imports
Z
C
quantity
© R.Baldwin & C. Wyplosz
Open Economy Supply & Demand Analysis: The Home Market
euros
Sdom
pFT
Ddom
Imports
Z
C
quantity
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Putting together the diagrams
euros
The level of imports can be seen
directly
in the
left-hand
For
instance
if the
world panel,
price or
The reason is that the horizontal
Here
we
put
the two panel
diagrams
indirectly
in
the
right-hand
euros
were p’, Home
wish
to
There would
are a few
features
of this
difference between Ddom and
together. This
is very useful when
as
the
horizontal
difference
import m’.
Click
5that
times
see know.
diagram
youtoshould
dom Sdom at anySworld
dom price always
dom
dom
studying
the
effects
of
changing a
D
between
D
and
S
.
that the indicated import level is
equals the level of imports
trade barrier. We first see how the
the same in both panels.
indicated by the MD curve (this
change alters the border and domestic
is how the MD curve was
prices in the left panel and then use the
constructed).
right panel to see the impact of the
price changes on the MS
Home market.
p’
pFT
pFT
m’
m’
MD
m’
m’
m’
mFT
mFT
imports
Z
C
quantity
© R.Baldwin & C. Wyplosz
Chapter 4:Figure 3
Domestic price,
euros
Border price,
euros
Ddom
Sdom
MS
pFT
pFT
MD
mFT
mFT
imports
Z
C
quantity
Teaching/Studying Presentation
© R.Baldwin & C. Wyplosz
Baldwin & Wyplosz
The Economics of European
Integration
•Chapter 4: Basic Economics of Preferential Liberalisation
“A careful presentation of the Positive
Effects of an MFN Tariff in the MS-MD
diagram”
!!! This is not in the book, but it will help
you understand the MS-MD diagram
To view this, start the slide show (‘view show’ command under the
Slide Show pull-down menu) and use either the arrow keys or
click the mouse to proceed
© R.Baldwin & C. Wyplosz
Positive Effects of an MFN Tariff
Border price,
Domestic
price,
1.We
now
use
the
diagrams
to
study
the positive
euros
euros effects) of a tariff
effects (i.e. price and quantity
Sdom
2.We start by supposing
that initially no tariff is
imposed.
MS
MD
mFT
imports
PFT
With no tariff, the
equilibrium price is PFT and
the equilibrium imports is
mFT.
Z
C
Ddom
quantity
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Positive Effects of an MFN Tariff
Border price,1. Now we impose
euros
a tariff equal to “T”
T
MS
Domestic price,
euros
2. Imposition of a tariff by
Home drives a “wedge”
between the price in the
Home market and the
price received by foreign
firms exporting to Home.
This is to say …
Sdom
PFT
MD
Ddom
mFT
imports
Z
C
quantity
© R.Baldwin & C. Wyplosz
Positive Effects of an MFN Tariff
Border price,
euros
1. Due to the
tariff wedge
Domestic
price,
T, the Home
price (also
euros
called the domestic price)
is higher than the price
foreign firms receive (also
called the ‘border’ price);
the difference is exactly T.
Sdom
T
MS
PFT
MD
Ddom
mFT
imports
Z
C
quantity
© R.Baldwin & C. Wyplosz
Positive Effects of an MFN Tariff
Border price,
euros
2. To make
this clear,
Domestic
price,we
call theeuros
domestic price P’
and the border price P’-T.
Sdom
P’
MS
PFT
P’-T
MD
Ddom
mFT
imports
Z
C
quantity
© R.Baldwin & C. Wyplosz
Positive Effects of an MFN Tariff
1. We know
Border
price,that P’ and P’-T are the Domestic price,
equilibrium prices since the market for
euros
euros
imports clears at these prices.
More precisely, at P’ Home wishes
to import m’ and at P’-T foreigners want to
sell m’ to Home.
Sdom
m’
P’
MS
PFT
P’-T
MD
Ddom
m’
mFT
imports
Z
C
quantity
© R.Baldwin & C. Wyplosz
Positive Effects of an MFN Tariff
1. The
Notice
tariff
thatraises
the the
Border price,
Domestic price,
domestic
price
and
..
border
euros
euros
price move in opposite
directions.
2.That
but is
lowers
to saythe
... border
price
Sdom
P’
MS
PFT
P’-T
MD
Ddom
m’
mFT
imports
Z
C
quantity
© R.Baldwin & C. Wyplosz
Positive Effects of an MFN Tariff
1. Now consider the impact of the
Border price,
Domestic price,
domestic price rise on Home
euros
euros
production and consumption.
P’
P’-T
Sdom
2. The rise in the Home
price from PFT to P’ causes
Home firms to expand
MS
production to Z’ and
Home consumers to
reduce consumption to C’.
PFT
MD
Ddom
m’
mFT
imports
Z
Z’
C’ C
quantity
© R.Baldwin & C. Wyplosz
Chapter 4
Border price,
euros
Domestic price,
euros
Sdom
P’
T
MS
PFT
P’-T
MD
Ddom
m’
mFT
imports
Z
Z’
C’ C
quantity
Teaching/Studying Presentation
© R.Baldwin & C. Wyplosz
Baldwin & Wyplosz
The Economics of European
Integration
•Chapter 4: Basic Economics of Preferential Liberalisation
“A careful presentation of the Welfare
Effects of an MFN Tariff in the MS-MD
diagram”
NB: This analysis does not exactly follow
the book, but it explains the results in
diagram 4-5
To view this, start the slide show (‘view show’ command under the
Slide Show pull-down menu) and use either the arrow keys or
click the mouse to proceed
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Normative Effects of an MFN Tariff
NB: Mouse click or use arrow keys to advance
1. Next we consider the “welfare” or “normative” effects of T, i.e., we see who
gains and who loses from T.
2. We start with the effects on Home.
3. Intuitively, it is easy to believe that the domestic price increase
(i) hurts consumers,
(ii) helps producers, and
(iii) raises government revenue.
4. More specifically ...
© R.Baldwin & C. Wyplosz
Normative Effects of an MFN Tariff
Border
1. The
greyprice,
area is the loss of consumerDomestic
surplus due
price,
FT
euros
to the
tariff-induced price rise from P euros
to P’.
Sdom
2. Consumers lose for 2 reasons.
3. (i) They pay a higher price for
the goods they continue to buy
P’
(this loss equals the blue rectangle
defined by the price hike times MS
consumption C’).
P’
E
F
A
G
P’-T
4. (ii) Consumers also lose
because they consume less. This
part of the loss corresponds to the
green triangle.
m’
mFT
PFT
MD
Ddom
imports
Z
Z’
C’ C
quantity
© R.Baldwin & C. Wyplosz
Normative Effects of an MFN Tariff
5. The grey area, E, is the
Border price,
gain in producer surplus
euros
due to the tariff-induced
price rise from PFT to P’.
Domestic price,
euros
Sdom
6. Home producers gain for 2
reasons. (i) they get a higher price
P’
for the quantity of goods they
used to sell (this gain equals the MS
blue rectangle defined by the
P’-T
price
hike times Z).
7. (ii) they also gain because they
sell more. This part of the gain
corresponds to the green triangle.
m’
mFT
P’
PFT
MD
Ddom
imports
Z
Z’
C’ C
quantity
© R.Baldwin & C. Wyplosz
Normative Effects of an MFN Tariff
8.Border
The grey
area is the increase in
price,
government
revenue, i.e. the tariff
euros
revenue. It equals the level of
imports C’-Z’ times the tariff T.
Domestic price,
euros
Sdom
9. The tariff revenue can be viewed as
being paid partly by Home consumers
and partly
P’ by foreigners.
P’
MS
A
10. (i) The part paid by Home
consumers
P’-T is shown by the blue
rectangle. The area equals the level of
imports consumed times the domestic
MD
price rise (PFT to P’).
11. (ii) The part paid by foreigners is the
green rectangle. It equals imports (i.e. the
level of exports) times the decrease in the
border price (PFT to P’-T).
imports
m’
FT
m
PFT
P’-T
B
Ddom
Z
Z’
C’ C
quantity
© R.Baldwin & C. Wyplosz
Normative Effects of an MFN Tariff
Border
price,
1.
Next we
look at the net gain or lossDomestic
to home, price,
i.e. we want to know if the losers lose
eurosthan the winners win.
more
euros
Sdom
2. Consumers lose
E+F+A+G, but ...
3. … part of this is offset by the
producers’
P’ gain of E, and ...
8. Note that if B-F-G is positive, it is due to
exploitation of foreigners.
That is, the amount of tariff
revenue paid by foreigners (B) exceeds the
domestic distortion loss (F+G).
P’
MS
EE
F
4. … more is offset by the part of the
P’-T gain of corresponding to A.
government’s
5. To this, we add the other part
MD
of the government’s gain, namely
B.
The net Home welfare
effect is thus +B-F-G.
This may be positive or
imports
negative.
m’
FT
m
AA
G
B
PFT
P’-T
7. We call the area “B” the ‘terms of trade’
gain, or “border price” effect. Ddom
We call the triangles F and G, the
‘domestic distortion’ loss, or the “trade
volume” effect (since they are related to
the change in import volume.
quantity
Z
Z’
C’ C
© R.Baldwin & C. Wyplosz
Normative Effects of an MFN Tariff
1. Now we look at the
Border price,
welfare effect on the
euros
foreign nation.
2. price,
The foreign nation definitely loses from the
Domestic
of a tariff since it
euros Home nation’s impositiondom
S exports less.
receives a lower price and
3. The loss consists of 2 parts.
P’
P’-T
4. (i) The loss B due to the lower
border price and …
A
B
C
MS
D
A
B
MD
P’
PFT
P’-T
5. (ii) … the loss D (green triangle) due to
the reduction in foreign sales to Home.
dom
D
Note that the area B in the left panel and in the right
m’
panel are the same since both are exports times the fall in
the border price.
The area A is the same in both panels for a
imports
quantity
similar
reason.
FT
C’ C
m
Z Z’
© R.Baldwin & C. Wyplosz
Normative Effects of an MFN Tariff
1. Here we see the net global welfare effect. Home’s change is +E-F-G
Border price,
Domestic price,
and
Foreign’s
change
is
-E-D.
Adding these leaves a loss of the three
euros
euros
triangles -(D+F+G).
Sdom
P’
P’
MS
P’-T
B
F
D
G
B
PFT
P’-T
MD
Ddom
m’
mFT
imports
Z
Z’
C’ C
quantity
© R.Baldwin & C. Wyplosz
Normative Effects of an MFN Tariff
1. The book claims that the net global welfare effect also equals C+D in the left-panel.
Here
we shall
C=F+G price,
Border
price,show that this is true, i.e.Domestic
euros
euros
2. The first thing to note is that the sum
of the bases of the triangles F
and G equals the
Sdom
base of the triangle C (since both measure the change in imports).
P’
P’
MS
C
P’-T
E
F
G
D
PFT
MD
Ddom
m’
mFT
imports
Z
Z’
C’ C
quantity
© R.Baldwin & C. Wyplosz
Normative Effects of an MFN Tariff
Border price,
euros
3. Now we move G over to C.
Domestic price,
euros
Click 5 times to do this.
Sdom
P’
P’
MS
C
P’-T
E
F
G
D
PFT
MD
Ddom
m’
mFT
imports
Z
Z’
C’ C
quantity
© R.Baldwin & C. Wyplosz
Normative Effects of an MFN Tariff
Border price,
euros
Domestic price,
euros
4. Now we move F over to C.
Sdom
Click 5 times to do this.
P’
P’
MS
C
P’-T
E
F
G
D
PFT
MD
Ddom
m’
mFT
imports
Z
Z’
C’ C
quantity
© R.Baldwin & C. Wyplosz
Normative Effects of an MFN Tariff
Border price,
euros
Domestic price,
6. So this is what we wanted to show. The net
euros
dom
global welfare change from Home’s S
MFN
tariff is the sum of the triangles C+D.
P’
P’
MS
C
P’-T
E
F
G
D
5. Finally, we have to change the shapeMD
of F to fit into C.
Remember that the area of a triangle depends only on its
height and base. Changing the shape holding these constant
does not change the area.
Click 2 times to change the shape.
m’
mFT
imports
Z
PFT
Ddom
Z’
C’ C
quantity
© R.Baldwin & C. Wyplosz
Border price,
euros
Domestic price,
euros
Sdom
P’
P’
A
P’-T
E
MS
C
E
F
A
G
D
PFT
MD
Ddom
m’
mFT
imports
Z
Z’
C’ C
quantity
© R.Baldwin & C. Wyplosz