Sunday, 11 April 2021

Reduced exports due to border restrictions and the domestic market for strawberries

Last week, my ECONS102 class covered international trade, including the effects of trade restrictions on economic welfare. Usually, the examples I use involve the government interfering in the market, through the use of quotas or tariffs, and those trade policies invariably lead to a loss of economic welfare (a deadweight loss). However, sometimes other things get in the way of international trade, such as this recent example from HortNews:

Strawberry prices fell 43% in November 2020 as Covid-19 border restrictions reduced exports, Stats NZ said.

Consumer prices manager Katrina Dewbery says that fewer exports have meant there is more supply available for domestic consumption.

Prices averaged $3.45/250g punnet in November, down from $6.04 in October.

“Prices are lower than we typically see for a November month with December generally being when they are cheapest. Some people may be seeing even cheaper prices during the first half of December,” Dewbery said.

There was no government intervention here, but a lack of capacity to export strawberries due to the COVID-19 border restrictions reduced the quantity that could be exported. We could interpret that as being similar to an export quota on strawberries (where the quantity of exports was restricted to less than it would have been with open borders), so let's look at the effect on the market for strawberries.

First, consider the case without any border restrictions. This is shown in the diagram below. New Zealand is an exporting country, which means that New Zealand has a comparative advantage producing strawberries. That means that New Zealand can produce strawberries at a lower opportunity cost than other countries. On a supply-and-demand diagram like the one below, it means that the domestic market equilibrium price of strawberries (PD) would be below the price of strawberries on the world market (PW). Because the domestic price is lower than the world price, if New Zealand is open to trade there are opportunities for traders to buy strawberries in the domestic market (at the price PD), and sell it on the world market (at the price PW) and make a profit (or maybe the suppliers themselves sell directly to the world market for the price PW). In other words, there are incentives to export strawberries. The domestic consumers would end up having to pay the price PW for strawberries as well, since they would be competing with the world price (and who would sell at the lower price PD when they could sell on the world market for PW instead?). At this higher price, the domestic consumers choose to purchase Qd0 strawberries, while the domestic suppliers sell Qs0 strawberries (assuming that the world market could absorb any quantity of strawberries that was produced). The difference (Qs0 - Qd0) is the quantity of strawberries that is exported. Essentially the demand curve with exports follows the red line in the diagram.

In terms of economic welfare, if there was no international trade in strawberries, the market would operate at the domestic equilibrium, with price PD and quantity Q0. Consumer surplus (the gains to domestic strawberry consumers) would be the area AEPD, the producer surplus (the gains to domestic strawberry producers) would be the area PDEF, and total welfare (the sum of consumer surplus and producer surplus, or the gains to society overall) would be the area AEF. With trade, the consumer surplus decreases to ABPW, the producer surplus increases to PWCF, and total welfare increases to ABCF. Since total welfare is larger (by the area BCE), this represents the gains from trade.

Now consider what would happen if the quantity of strawberry exports was restricted below (Qs0 - Qd0). This is shown in the diagram below as an export quota. Let's say that the quantity of exports is reduced to the amount between B and G on the diagram (about half the amount of unrestricted exports). Now consider what happens to the demand curve (including exports). The upper part represents the domestic consumers with high willingness-to-pay for strawberries. Then there is a limited quantity of exports that can get through the border restrictions, at the world price PW. After that, there are still profit opportunities for domestic suppliers (that is, there are still some domestic consumers who are willing to pay more than what it costs the suppliers to produce strawberries). So, the demand curve (including the export quota) pivots at the point G, and follows a parallel path to the original demand curve (i.e. the demand curve including exports follows the red line in the diagram). The domestic price is the price where supply is equal to demand (P1). The domestic consumers choose to purchase Qd1 strawberries at the price P1, while the domestic suppliers sell Qs1 strawberries at that price. The difference (Qs1 - Qd1) is the quantity of exports. Notice that the price of strawberries that consumers pay has fallen, just as the article linked above noted.

Now consider the areas of economic welfare. The consumer surplus is larger than it was without the restricted exports (it is now the area AJP1), the producer surplus is smaller than it was without the restricted exports (it is now the area P1HF plus the area KLHJ. The first area (P1HF) is producer surplus as if the farmers sold all of their products to the domestic market, while the second area (KLHJ) is the extra profits the farmers get from selling the limited amount of exports that are able to get through the border restrictions. Total welfare is smaller than without the restricted exports (it is now the area AJHF+KLHJ). There is a deadweight loss (a loss of total welfare arising from the restricted exports) equal to the area [BKJ + LCH] - these areas were part of total welfare with trade and no restricted exports, but have now been lost.

The lost exports make strawberry farmers worse off, as well as society overall (in terms of economic welfare in total). However, strawberry consumers are the unwitting recipients of a gain. The interesting thing here is that the government is not responsible for the deadweight loss - this is a deadweight loss caused by a more general disruption in international trade. And it was not just strawberries that were affected - domestic consumers will have been made better off in all exported commodities that cannot be stored for long periods of time.

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