In my previous post, I discussed the effect of an agricultural emissions tax. The effect of the tax would be to reduce New Zealand production of agricultural goods, and less production of agricultural goods in New Zealand means less agricultural emissions originating in New Zealand. However, as I noted in the footnotes to the post, the analysis left out the market effects of international trade. I argued that:
...the omission of trade doesn't affect the conclusions we draw from the model, that taxing agricultural emissions would increase the domestic price and decrease the quantity of dairy products traded.
Let's look at the market again in this post, but with international trade included. Before we get that far, it is worth revisiting the effect of international trade in an exporting country. This is shown in the diagram below. This is the market for an exporting country, which means that this country has a comparative advantage producing the agricultural good. That means that this country can produce the agricultural good at a lower opportunity cost than other countries, which is represented on the diagram by the domestic market equilibrium price of (PD) being below the price on the world market (PW). Because the domestic price is lower than the world price, if the country is open to trade there are opportunities for traders to buy the agricultural good 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 the agricultural good. The domestic consumers would end up having to pay the price PW for the agricultural good 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 of the agricultural good, while the domestic suppliers sell Qs0 of the agricultural good (assuming that the world market could absorb any quantity of agricultural goods that was produced). The difference (Qs0 - Qd0) is the quantity of agricultural goods that is exported. Essentially the demand curve with exports follows the red line in the diagram.
Now consider what happens if the government decides to tax production of the agricultural good. For the moment, let's assume that the tax doesn't affect the world price (we'll come back to that later). Sellers who sell to the world market receive the world price PW, but then must pay a tax (T) to the government, which leaves them with (PW - T). There is less incentive to sell the agricultural good, so less will be produced. The quantity of the agricultural good supplied decreases to Qs1. The domestic consumers must still compete with the world market, so they still face the price of PW, so the quantity of the agricultural good demanded remains Qd0. So, as we saw in my previous post, the agricultural emissions tax would reduce domestic production of the agricultural good.
But what happens if the reduction in domestic production is large enough that it reduces global supply of the good? Then, we are back to the analysis in the previous post, where the price increases in the domestic market (because the world price increases and domestic consumers must also pay the world price), and production of the agricultural good decreases.
So, in markets where New Zealand is a large producer and has an appreciable effect on the world price, an agricultural emissions tax would reduce New Zealand production. And, in markets where New Zealand is a small producer and has no effect on the world price, an agricultural emissions tax would reduce New Zealand production and New Zealand emissions. Whether the tax would reduce global emissions, though, is a much more complicated question. It depends on all of the factors I highlighted in the previous post, and we don't have a complete answer to it yet (however, as I noted, it is likely that global emissions will be somewhat lower). I'll reiterate that there is more research needed in this area.
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