FAO - GOVERNMENT OF ITALY COOPERATIVE PROGRAMME PROJECT GCP/SYR/006/ITA – Phase II “Assistance...

FAO - GOVERNMENT OF ITALY COOPERATIVE PROGRAMME

PROJECT GCP/SYR/006/ITA – Phase II

“Assistance for Capacity Building through

Enhancing Operation of the National Agricultural Policy Center”

course in

Partial equilibrium analysis of policy impacts

Part II, September 21 – October 3, 2002

Piero Conforti

- The National Institute of Agricultural Economics, Roma, Italy

Aim of this part of the course

Allow the trainees to familiarise with partial equilibrium analysis of agricultural policies, within• the single market static frameworks

• (hints on) multi market, dynamic PE frameworks, and on GE frameworks

Special emphasis on: – price policy analysis

– welfare analysis

– technical change analysis

Special emphasis on the applications: mostly exercises in Excel

Content

1. Equilibrium within a single market partial equilibrium computable model

– isolated markets and regional integration in a closed economy with transport costs

– the partial equilibrium computable model of an open economy: the effect of trade on supply demand and welfare

– price policy analysis: impacts on supply, demand and welfare

– technical change analysis with MODEXC

Content

2. Beyond the single market model – relating interdependent markets: hints on multi-

market analysis in a partial equilibrium framework

– hints on dynamic partial equilibrium frameworks

– hints on the GE approach: basic structure, computation, calibration and estimation, applicability and limitations

Single market PE: introduction

Partial equilibrium: only some parts of the economy (some markets) are taken into account. What happens in one sector in terms of demand, supply and price does not significantly affect what happens in other sectors

it can be applied: to a single market (e.g. wheat) or to a set of markets (e.g. a set of agricultural products) within a so-called multi-market framework.

In the second case it will take into account the interactions between e.g the wheat and the barley markets, but it will not take into account the effects of a change in the cereal market on fertilizers

Single market PE: isolated markets

Three isolated regional markets with no trade; region 1:

C D

Y

consumption center

production centerproduction center

Consumptìon Center Y Production Centers C & D

Demand function Supply functions

(1) Dy = Dyo+ Ay * CPy (2) Sc = Sco + Ac*(CPy - Tcy)

(3) Sd = Sdo + Ad*(CPy -Tdy)

with: Dyo = 3000

Ay = -4

with: Sco = -500

Ac = 6

Tcy = 19

Sdo = -500

Ad = 4

Tdy = 25

We want ot represent this in a demand-supply graph

inverted demand & supply

1. Demand derived from (1):

1a. CPy(D) = -Dyo/Ay + Dy/Ay

2. Supply of C derived from (2) (with and without transport)

2a. CPy = -Sco/Ac + Sc/Ac (without transport)

2b. Cpy = (Tcy*Ac - Sco)/Ac + Sc/Ac (with transport)

3. Supply of C and D (with transport)

CPy = [(Tcy*Ac+Tdy*Ad) -(Sco+Sdo)] / (Ac+Ad) +

(Sc+Sd)/(Ac+Ad)

isolated market, graph

We want to calculate the equilibrium point

0

100

200

300

400

500

600

700

800

0 500 1000 1500 2000 2500 3000 3500

Q

CP

y

Dy

Sc

Sc+T

(Sc+Sd)+T

equilibrium quantity and price

production center C only Demand = Supply of C

-Dyo/Ay + Dy/Ay = (Tcy*Ac-Sco)/Ac + Sc/Ac

since Dy = Sc = q

q = [(Tcy*Ac-Sco)/Ac) + (Dyo/Ay)] / (1/Ay - l/Ac)

q= 1554 p = 361

production centers C & D Demand = Supply of C and D Dy = (Sc+Sd) = q

q = {Dyo/Ay +

+ [(Tcy*Ac+Tdy*Ad) - (Sco+Sdo)] / (Ac+Ad)} / [(1/Ay) – l/ (Ac+Ad)]

q = 1796 p =301 (from 2a); qc = 1192 qd = 604

deducting transport costs pc = 282 pd = 276

equilibrium quantity and price

Isn’t there a simpler way to calculate the equilibrium point?

Yeeees!!Take the price first, instead of the quantity; consider the direct functions and solve directly for the price to get

Cpy = (Dyo-Sco-Sdo+Ac*Tcy+Ad*Tdy)

/ (Ac+Ad-Ay)

isolated market: comments

The equilibrium point is obtained when total production in the two centers equals the amount demanded by the consumers at the equilibrium price

To calculate producer prices in the two areas we have to subtract the transport costs

The inclusion of transport costs causes an upwards shift of the supply curve, i.e. a fixed increase in the price per each given quantity

The inclusion of a second production center causes a shift of the supply curve towards the right, i.e. a change in the price-quantity relation

other regions

Calculation for region 2

Consumption Center Z Production Centers B and A

Demand function Supply functions

(4) Dz = Dzo + Az*CPz (5) Sb = Sbo + Ab*(CPz- Tbz)

(6) Sa = Sao + Aa *(CPz- Taz)

Dzo = 2000

Az- = -3

with: Sbo = -1000

Ab = 12

Tbz = 7

Sao = -1200

Aa = 16

Taz = 15

other regions, summary

region 3, all regionsConsumption Center X Production Center E

Demand function Supply function

(7) Dx = Dxo + Ax*CPx (8) Se = Seo + Ae*(CPx-Tex)

with: Dxo = 5000

Ax = -5

with: Seo = -1000

Ae = 5

Tex = 7Consumption Centers Production Areas

Y

Reg 1

Price

Quantity

301

1796

C

D

Price

Quantity

Price

Quantity

282

1192

276

604

Z

Reg 2

Price

Quantità

146

1562

B

A

Price

Quantity

Price

Quantity

139

667

131

895

X

Reg 3

Price

Quantity

604

1983

E Price

Quantity

597

1983

other regions, graphs

0

100

200

300

400

500

600

700

800

0 500 1000 1500 2000 2500 3000 3500

Dy (Sc+Sd)+T

0

200

400

600

800

1000

1200

0 500 1000 1500 2000 2500 3000 3500

Dx Se+T

0

100

200

300

400

500

600

700

0 500 1000 1500 2000 2500 3000 3500

Dz (Sb+Sa)+T

Region 1 Region 3

Region 2

isolated markets, comments

Prices in the isolated markets are widely different: from 146 of Region 2 to 604 of Region 3.

This reflects the different production and consumption characteristics of the three regions strong production capacity in region 2 and the strong demand in 3.

Isolated markets do not allow consumers of Region 3 to benefit from production capacity of Region and its low prices.

Isolation can be due to natural reasons (e.g. distance, lack of communication facilities) or to political reasons (e.g. custom banners or other policies (prohibitive barriers) that eliminate trade)

market integration

Suppose that region 3 and region 2 are connected by a road which allows trade

B

A

Z EX

region 3region 2

Region 2 Region 3

Consumption centre Production centres Consumption centres Production centres

Dz = Dzo + Az*CPz

Sb = Sbo + Ab*(CPz- Tbz)

Sa = Sao + Aa *(CPz- Taz)

Dx = Dxo + Ax*CPx Se = Seo + Ae*(CPx-Tex)

with: Dzo = 2000

Az = -3

with: Sbo = -1000

Ab = 12

Tbz = 7

Sao = -1200

Aa = 16

Taz = 15

with: Dxo = 5000

Ax = -5

with: Seo = -1000

Ae = 5

Tex = 7

Txz = 65 Transport cost from X to capital Z Tzx = 65 Transport cost from capital Z to X

market integrationTransport costs are given by

CPz = CPx – TzxPPa = CPx – Tzx – Taz PPb = CPx – Tzx – Tbz PPe = CPx – Tex

total demand = total supply, i.e. Dx + Dz = Se + Sa + Sbwhere:

Dx = Dxo + Ax * CPxDz = Dzo + Az * (CPx -Tzx)Sa = Sao + Aa * (CPx- Taz- Tzx) Sb = Sbo + Ab * (CPx- Tbz- Tzx) Se = Seo + Ae * (CPx-Tex)

solving for CPx

market integration

we obtainAz) -Ax - Aa Ab (Ae

Tzx)] Aa(Taz Tzx) Ab(Tbz AeTex AzTzx - Sao - Sbo - Seo - Dzo [(DxoCpx

(Z and X connected, y isolated) consumption centers Production areas

Y reg 1 price 301.0 C price 282.0

quantity 1796.0 quantity 1192.0 D price 276.0 quantity 604.0

Z reg 2 price 241.7 B price 234.7 quantity 1275.0 quantity 1816.2 A price 226.7 quantity 2426.9

X reg 3 price 306.7 E price 299.7 quantity 3466.6 quantity 498.4

market isolation and integration, prices

Y

CP = 301

X

CP = 604

Z

CP = 146

region 2

region 3region 1

Y

CP = 301

X

CP = 307

Z

CP = 242

region 2

region 3region 1

Tzx =65

market integration, comments

With integration, region 3 consumes 74% more, and region 2 consumes 18% less.

Price decrease by almost 50% in region 3, while it increases by almost 68% in region 2.

Production increases with integration in region 2, by more than 170%, while it decreases by almost 75% in region 3.

Altogether there is an increase of 22% in total consumption, and an 8.7% decrease in production.

With integration, the difference between the two prices is equal to the transport cost.

market integration, welfare effects

The impact of the integration of the two markets on producers and consumers can be measured in terms of surplus.

This is a money metric welfare measure

With linear functions welfare changes can be approximated as

(p0 –p1) * (d0 +d1) / 2 (change in consumer surplus)

(p0 –p1) * (s0 +s1) / 2 (change in producer surplus)

where 0 and 1 are referred to time, p is the price, s is supply and d is demand

The net change in welfare is the difference between the two above (p0 – p1) * [(d0 + d1) – (s0 + s1)] / 2 (net gain or loss)


In graphical terms, consumer surplus in region 2 are the areas FCB and FDE, respectively before and after market integration. The difference is CBED, which represents the losses of the consumers.

Region 2 Region 3

A

BC

D

G

E

F

BA

D

G

C E

F

The producer surplus is GCB and GAD in region 2 respectively before and after trade

Since CBAD, gained by producers, is larger than CBDE, lost by consumers, trade has brought a net benefit to Region 2, equal to BEA.


The opposite will happen in Region 3: with integration consumers will gain and producers will loose.

There will be also

- a transfer of income from Region 3 to Region 2, equal to the amount of purchases made by the latter in the former, and

- an increase in the business of the transport sector, equal to the transport cost.

Summing up, the total welfare change will be

market integration, summary of welfare effects

Region 2

change in Values % of cons Consumer Surplus -135,825 59.6 Producer Surplus 277,922 121.9 Net change of Region 2 142,097 62.3 cons value before trade 227,979 100.0

Region 3 change in Values % of cons Consumer Surplus 808,691 76.1 Producer Surplus -368,189 34.6 Net change of Region 3 440,502 41.4 cons value before trade 1,063,143 100.0

Total change in Values % of cons Consumer Surplus 672,866 47.2 Producer Surplus -90,267 6.3 Net change of Regions 2 & 3 582,599 40.9 cons value before the trade 1,424,418 100.0

welfare effects, comments

Altogether both region have benefited from integration, although region 3 far more than region 2.

The welfare effect is unevenly distributed among social groups: consumers in region 2 and producers in region 3 suffer a loss, which is smaller than the gain of consumers in 3 and producer in 2.

The first statement rests upon the hypothesis that the welfare of all social groups is directly comparable, and equally weighted.

full market integrationCalculation of the equilibrium price for the three regions: supply

Sc = Sco + Ac CPy – Ac Tcy

Sd = Sdo + Ad CPy – Ad Tdy

Sb = Sbo + Ab CPz – Ab Tbz

Sa = Sao + Aa CPz – Aa Taz

Se = Seo + Ae CPx – Ae Tex and given that Cpy = CPz + Tyz

Cpx = CPz + Txz we haveSc = Sco + Ac CPz +Ac Tyz - Ac Tcy

Sd = Sdo + Ad CPz +Ad Tyz – Ad Tdy

Sb = Sbo + Ab CPz – Ab Tbz

Sa = Sao + Aa CPz – Aa Taz

Se = Seo + Ae CPz +Ae Txz – Ae Tex

full market integration

On the demand sideDy = Dyo + Ay CPy

Dz = Dzo + Az CPz

Dx = Dxo + Ax CPx using the relations among regional prices:

Dy = Dyo + Ay CPz + Ay Tyz

Dz = Dzo + Az CPz

Dx = Dxo + Ax CPz + Ax Txz thus

CPz = [ - (Sco + Sdo + Seo+ Sbo + Sao) + (Dyo +Dxo + Dzo) + (Ay Tyz + Ax Txz) +

+ Ac (Tcy – Tyz) + Ad (Tdy – Tyz) + Ae (Tex – Txz) + Ab Tbz + Aa Taz] /

/ (Ac + Ad + Ae + Ab + Aa – Ay – Ax – Az)


Y

CP = 294

X

CP = 309

Z

CP = 244

region 2

region 3region 1

Tzx = 65Tzy = 50

Integrated markets prices demand Y 294 1824 Z 244 1268 X 309 3455

prices production

quantity local

transport cost

production value

C 275 1,150 21,856 316,403 D 269 576 14,405 155,034 B 237 1,845 12,913 437,284 A 229 2,465 36,973 564,590 E 302 510 3,572 154,130 Total 6,546 89,719 1,627,441

production

quantity regional

trade regional transport

cost

imports consumption value

Y 1,727 -97 4,862 0 536,291 Z 4,310 3,042 0 0 309,421 X 510 -2,944 191,390 0 1,067,699 Total 6,546 0 196,251 1,913,412


Considering also consumer prices

Y

CP = 294

X

CP = 309

Z

CP = 244

region 2

region 3region 1

Tzx = 65Tzy = 50

APPa = 229

BPPa = 237

Taz = 15 Tbz = 7

EPPa = 302

Tex = 7

Tdy = 25

DPPd = 269

CPPc = 275

Tcy = 19


The gains of the consumers are greater than the losses of the producers and the costs of transport => market integration is beneficial to the country, although not for everybody.

Summary: Integrated and isolated markets

closed open %change

Total consumption expenditure 1,965,014 1,913,412 -2.6Imports 0 0 0.0Transport 285,971 0.0Producer revenue 1,895,294 1,627,441 -14.1

Producer surplus -91,162 -5.6Consumer surplus 674,214 35.2Net welfare change 583,052 30.5

(small) open economy: production and trade

Even if fully integrated, the previous setting can be considered as being closed to foreign trade.

The country has only one port of entry, in Region 3. The import price is 275 (small open).

Consumers of X will prefer the imported good, which is cheaper than the local, sold at 309, this is sold at the same price of 275.

Since almost 3000 tons sold in X (region 3) is coming from Z (region 2), the maximum price in Z is the price in X minus the transport cost, i.e. 210.

Similarly, the price in region 1, which was also importing from region 2, will be the price of region 2 (210) plus the transportation cost of 50, i.e 260.

(small) open economy: production and trade

Thus we haveprices demand

Y 260 1960Z 210 1370X 275 3625

prices productionquantity

localtransport cost

production value

C 241 946 17,974 227,986D 235 440 11,000 103,400A 203 1436 10,052 291,508B 195 1920 28,800 374,400E 268 340 35,574 91,120total 214 5082 1,088,414

productionquantity

regional trade regionaltransport cost

imports consumptionvalue

Y 1,386 -574 28,700 0 509,600Z 3,356 1,986 0 0 287,700X 340 -1,412 91,780 1873 996,875total 5,082 0 120,480 1873 1,794,175

closed and open economy, comparisonComparison: closed (isolated) and openeconomy

prices productionquantities

Changes inproducersurplus

production values

closed open closed open closed openC 275 241 1,150 946 -35,695 316,403 227,986D 269 235 576 440 -17,303 155,034 103,400B 237 203 1,845 1,436 -55,861 437,284 291,508A 229 195 2,465 1,920 -74,662 564,590 374,400E 302 268 510 340 -14,478 154,130 91,120total 6,546 5,082 -197,999 1,627,441 1,088,414

prices consumedquantities

Changes inconsumersurplus

consumption values

closed open closed open closed openY 294 260 1,824 1,960 64,427 536,291 509,600Z 244 210 1,268 1,370 44,915 309,421 287,700X 309 275 3,455 3,625 120,548 1,067,699 996,875total 6,546 6,955 229,891 1,913,412 1,794,175

closed and open economy, comparison

Opening to trade implies a small welfare gain for consumers, greater than the loss of the producers. The transport sector will be reduced, while foreign producers will be better off.

Summary: closed and openeconomy

closed open % change

Total consumption expenditure 1,913,412

1,794,175 -6.2

Imports 0 515,075 0.0Transport 266,000 190,686 -28.3Producer revenue 1,627,44

11,088,414 -33.1

Producer surplus -197,999 -18.2Consumer surplus 229,891 12.8Net welfare change 31,892 1.8

-500000

0

500000

1000000

1500000

2000000

2500000

To

tal c

on

sum

pti

on

exp

end

itu

re

Imp

ort

s

Tra

spo

rt

Pro

du

cer

rev

enu

e

Pro

du

cer

surp

lus

Co

nsu

mer

su

rplu

s

Net

wel

fare

ch

ang

e

closed

open

pan territorial prices

The Government guarantees the same price to all producers and to all consumers.

It has to be assumed that the Government has a Marketing Board for enforcing the price regime: this pays producers, distributes goods to the consumers, and imports.

The Government sets prices equal to the average of the open market solution: producer price is 275, and consumer price is 214.

The effects on production and trade


prices demand Y 258 1968 Z 258 1226 X 258 3710

prices production

quantity local

transport cost production value

C 214 784 14,896 167,776 D 214 356 8,900 76,184 B 214 1,568 10,976 335,552 A 214 2,224 33,360 475,936 E 214 70 490 14,980 total 5,002 68,622 1,070,428

production

quantity regional trade regional

transport cost imports consumpti

on value

Y 1,140 -828 41,400 0 507,744 Z 3,792 2,566 0 0 316,308 X 70 -1,738 112,970 1902 957,180 total 5,002 0 154,370 1,781,232


prices production quantities

Changes in

producer surplus

production values

open panterrit open panterrit open panterrit C 241 214 946 784 -52,812 227,986 167,776 D 235 214 440 356 -8,358 103,400 76,184 B 203 214 1,436 1,568 16,522 291,508 335,552 A 195 214 1,920 2,224 39,368 374,400 475,936 E 268 214 340 70 -11,070 91,120 14,980 total 5,082 5,002 -16,350 1,088,414 1,070,428

prices consumed quantities

Changes in

consumer surplus

consumption values

open panterrit open panterrit open panterrit Y 260 258 1,960 1,968 3,928 509,600 507,744 Z 210 258 1,370 1,226 -62,304 287,700 316,308 X 275 258 3,625 3,710 62,348 996,875 957,180 total 6,955 6,904 3,972 1,794,175 1,781,232

open ec and pan territorial prices, comparison

Pan-territorial prices imply a net welfare loss compared to the open economy solution, despite prices were set at the same (average) levels. Moreover, the Marketing Board will suffer from a significant loss, that, in turn, will be suffered by taxpayers.

-500,000

0

500,000

1,000,000

1,500,000

2,000,000

To

tal

con

sum

ptio

n e

xpe

ndit

ure

Impo

rts

Tra

spo

rt

Pro

duc

er r

even

ue

Pro

du

cer

surp

lus

Con

sum

er s

urpl

us

Net

wel

fare

ch

ang

e

Net

Bal

ance

of

the

Mar

ket

ing

Bo

ard

open

panterrit

open panterrit % change

Total consumption expenditure

1,794,175 1,781,232 -0.7

Imports 515,075 523,050 1.5 Trasport 190,686 222,992 16.9 Producer revenue 1,088,414 1,070,428 -1.7 Marketing Board 0 35,238

Producer surplus -16,350 -1.5 Consumer surplus 3,972 0.2 Net welfare change

-12,379 -0.7

pan territorial prices, comments

Administrative costs must be added to the loss of the Marketing Board, suffered by taxpayers.

The implementation of this policy would not be easy: it will be difficult to impose the prices to producers and consumers.

In regions 1 and 3 the it will be more profitable selling directly to the consumers, because the difference between producer and consumer price (44) is greater that the local transport cost.

Similarly consumers of region 2 will find more convenient to buy the product directly from the farmers.

Implementation difficulties are likely to generate additional administrative costs.

import parity prices

The Government raises the producer price to the "import parity” level, e.g. to 275 for all producers in the country.

This kind of provision can be adopted with several aims: e.g.

• to promote an increase in the degree of self-sufficiency of the country

• to support farmers income, if poor groups are mostly net food sellers.

• in view of expanding the export capacity of the country.

The effects on production and trade:

import parity prices

prices demand Y 275 1700 Z 275 1175 X 275 3300

275 6175

pricesproduction

quantity

local transport

cost

production value

C 256 1,336 25,384 342,016D 250 700 17,500 175,000B 268 2,216 15,512 593,888A 260 2,960 44,400 769,600E 268 665 4,655 178,220total 261 7,877 107,451 2,058,724

production

quantityregional

trade

regional transport

costimports

consumption value

Y 2,036 336 -16,800 0 467,500Z 5,176 4,001 0 0 323,125X 665 -4,337 281,905 -1702 907,500total 7,877 0 265,105 1,698,125

import parity pricesChanges in producer surplus

C 241 256 946 1,336 17,115 227,986 342,016D 235 250 440 700 8,550 103,400 175,000B 203 268 1,436 2,216 118,690 291,508 593,888A 195 260 1,920 2,960 158,600 374,400 769,600E 268 268 340 665 0 91,120 178,220total 5,082 7,877 302,955 1,088,414 2,058,724

Changes in consumer surplus

Y 260 275 1,960 1,700 -27,450 509,600 467,500Z 210 275 1,370 1,175 -82,713 287,700 323,125X 275 275 3,625 3,300 0 996,875 907,500total 6,955 6,175 -110,163 1,794,175 1,698,125

prices production quantities production values

prices consumed quantitiesconsumption

values

open ec and import parity prices, comparison

The country becomes an exporter. Gains for producers are larger than losses for consumers; but the high transport costs imply a significant loss for the Marketing Board. The transport business almost doubles its revenue.

-1,000,000

-500,000

0

500,000

1,000,000

1,500,000

2,000,000

2,500,000

Total c

onsum

ption e

xpen

diture

Impor

ts

Trasport

Produc

er rev

enue

Produ

cer s

urplus

Consu

mer su

rplus

Net welf

are ch

ange

Net Bala

nce o

f the

Mark

eting B

oard

open

import parity

open import parity % change

Total consumption expenditure 1,794,175 1,698,125 -5.4Imports 515,075 -468,050 -190.9Trasport 190,686 372,556 95.4Producer revenue 1,088,414 2,058,724 89.1

Change in Producer surplus 302,955 14.7Change in Consumer surplus -110,163 -6.5Net welfare change 192,793 11.4

Marketing Boarddiff between cons & prod 107,451transports -372,556loss on imports 0Net Balance of the Marketing Board -265,105

import parity prices, comments

The overall welfare effect of the parity import price policy is negative, since the loss suffered by taxpayers (through the Marketing Board) are by far higher than the net welfare balance of producers and consumers.

Consumption decreases by than 5.4% in terms of expenditure, and by 11% in physical terms. This can indicate that consumers are in a condition of relative abundance, since they reduced consumption rather than substituting food with cheaper alternatives.

production and consumption subsidies

The Government raises the producer price to the highest level in the country, i.e. to 268 (the level of region 3) for all producers in the country.

The Government also wishes to support consumers, by fixing prices at the lowest level in the country, i.e. 210 (that of region 2).

The country is a price taker, and world price is 275

This provision is adopted with the aim of supporting both agricultural producers and poor consumers, and to stimulate the growth of domestic supply.


production and consumption subsidies prices demand Y 210 2160 Z 210 1370 X 210 3950

210 7480

pricesproduction

quantitylocal transport

costproduction

value

C 268 1,294 24,586 346,792D 268 672 16,800 180,096B 268 2,132 14,924 571,376A 268 2,848 42,720 763,264E 268 630 4,410 168,840total 268 7,576 103,440 2,030,368

production

quantityregional trade

regional transport cost

importsconsumption

value

Y 1,966 -194 9,700 0 453,600Z 4,980 3,610 0 0 287,700X 630 -3,416 222,040 -96 829,500total 7,576 0 231,740 1,570,800

production and consumption subsidiesChanges in producer surplus

open open openC 241 268 946 1,294 30,240 227,986 346,792D 235 268 440 672 18,348 103,400 180,096B 203 268 1,436 2,132 115,960 291,508 571,376A 195 268 1,920 2,848 174,032 374,400 763,264E 268 268 340 630 0 91,120 168,840total 5,082 7,576 338,580 1,088,414 2,030,368

Changes in consumer

surplusopen open open

Y 260 210 1,960 2,160 103,000 509,600 453,600Z 210 210 1,370 1,370 0 287,700 287,700X 275 210 3,625 3,950 246,188 996,875 829,500total 6,955 7,480 349,188 1,794,175 1,570,800


prices consumed quantities consumption values

open ec vs prod&cons subsidies, comparison

Also in this case the country becomes an exporter, there are welfare gains for both producers and consumers; but the high transport costs and the price subsidies for both producers and consumers imply a significant loss for the Marketing Board.

-1,000,000

-500,000

0

500,000

1,000,000

1,500,000

2,000,000

2,500,000

open

cons&prod subs

open cons&prod subs % change

Total consumption expenditure 1,794,175 1,570,800 -12.5Imports 515,075 -26,400 -105.1Trasport 190,686 335,180 75.8Producer revenue 1,088,414 2,030,368 86.5

Change in Producer surplus 338,580 16.7Change in Consumer surplus 349,188 22.2Net welfare change 687,768 43.8

Marketing Boarddiff between cons & prod -439,408transports -335,180loss on imports 672Net Balance of the Marketing Board -773,916Total net balance -86,149

production and consumption subsidies, comments

The overall balance of the policy is negative: the loss suffered by taxpayers (financing the Marketing Board) is greater than the net welfare gains of producers and consumers. There is a deadweight loss arising from resource misallocation.

Both poduction and consumption increase significantly; in the long run this may give rise to investment in agriculture, and to further supply increases, while demand may slow down, as the population approaches satiety.

adverse weather

The same simplified model can be used to analyse other phenomena, like, e.g. supply or demand shocks.

An example is that of weather condition, that affect agricultural supply.

Bad weather affecting production can be represented through a supply shift.


adverse weather prices demand Y 260 1960 Z 210 1370 X 275 3625

258 6955

pricesproduction

quantitylocal transport

costproduction

value

C 241 696 13,224 167,736D 235 190 4,750 44,650B 203 936 6,552 190,008A 195 1,320 19,800 257,400E 268 90 630 24,120total 212 3,232 44,956 683,914

production

quantityregional trade

regional transport cost

importsconsumption

value

Y 886 -1,074 53,700 0 509,600Z 2,256 886 0 0 287,700X 90 188 -12,220 3723 996,875total 3,232 0 41,480 1,794,175

adverse weather

Changes in producer surplus

open adverse weather open adverse weather open adverse weatherC 241 241 946 696 -34,208 227,986 167,736D 235 235 440 190 -19,688 103,400 44,650B 203 203 1,436 936 -49,417 291,508 190,008A 195 195 1,920 1,320 -60,750 374,400 257,400E 268 268 340 90 -10,750 91,120 24,120total 5,082 3,232 -174,813 1,088,414 683,914

Changes in consumer

surplusopen adverse weather open adverse weather open adverse weather

Y 260 260 1,960 1,960 0 509,600 509,600Z 210 210 1,370 1,370 0 287,700 287,700X 275 275 3,625 3,625 0 996,875 996,875total 6,955 6,955 0 1,794,175 1,794,175



open ec vs adverse weather, comparison

In this case there is only a change in producer surplus, since consumers remain in the same position, thanks to increased imports

-500,000

0

500,000

1,000,000

1,500,000

2,000,000

Total c

onsu

mpti

on ex

pend

iture

Impo

rts

Traspo

rt

Produ

cer r

even

ue

Produ

cer s

urpl

us

Consu

mer su

rplu

s

Net welf

are ch

ange

Net Bala

nce o

f the

Mark

eting

Boa

rd

open

adverse weather

open adverse weather % change

Total consumption expenditure 1,794,175 1,794,175 0.0Imports 515,075 1,023,825 98.8Trasport 190,686 86,436 -54.7Producer revenue 1,088,414 683,914 -37.2

Change in Producer surplus -174,813 -25.6Change in Consumer surplus 0 0.0Net welfare change -174,813 -9.7

adverse weather, comments

The small open economy hypothesis allows for prices to remain unchanged after the adverse weather: imports substitute for domestic production, thus consumer surplus does not change.

technical change

In this simplified model technical change can be introduced as a supply shift, i.e. just as the opposite of the previous example of adverse weather.


technical change p rices demand Y 260 1960 Z 210 1370 X 275 3625

258 6955

p ricesp roductio n

qu an tity

local trans po rt

cos t

p roduction v alue

C 241 1,071 20,349 258,111D 235 565 14,125 132,775B 203 1,686 11,802 342,258A 195 2,220 33,300 432,900E 268 590 4,130 158,120to tal 216 6,132 83,706 1,324,164

p roductio n

qu an tityreg ional

trade

reg io nal trans po rt

cos timports

cons umption value

Y 1,636 -324 16,200 0 509,600Z 3,906 2,536 0 0 287,700X 590 -2,212 143,780 823 996,875to tal 6,132 0 159,980 1,794,175

technical change

Changes in producer surplus

open technical change open technical change open technical changeC 241 241 946 1,071 21,010 227,986 258,111D 235 235 440 565 15,703 103,400 132,775B 203 203 1,436 1,686 32,521 291,508 342,258A 195 195 1,920 2,220 38,813 374,400 432,900E 268 268 340 590 23,250 91,120 158,120total 5,082 6,132 131,297 1,088,414 1,324,164

Changes in consumer

surplusopen technical change open technical change open technical change

Y 260 260 1,960 1,960 0 509,600 509,600Z 210 210 1,370 1,370 0 287,700 287,700X 275 275 3,625 3,625 0 996,875 996,875total 6,955 6,955 0 1,794,175 1,794,175



open ec vs technical change, comparison

Imports in this case decreases, since more domestic production is available at the same price

0

200,000

400,000

600,000

800,000

1,000,000

1,200,000

1,400,000

1,600,000

1,800,000

2,000,000

Total c

onsu

mpti

on ex

pend

iture

Impo

rts

Traspo

rt

Produ

cer r

even

ue

Produ

cer s

urpl

us

Consu

mer su

rplu

s

Net welf

are ch

ange

Net Bala

nce o

f the

Mark

eting

Boa

rd

open

technical change

open technical change % change

Total consumption expenditure 1,794,175 1,794,175 0.0Imports 515,075 226,325 -56.1Trasport 190,686 243,686 27.8Producer revenue 1,088,414 1,324,164 21.7

Change in Producer surplus 131,297 9.9Change in Consumer surplus 0 0.0Net welfare change 131,297 7.3

technical change, comments

Also in this case, the small open economy hypothesis allows for prices to remain unchanged after the technical change injection, thus consumer surplus does not change, as they substitute one to one domestically produced goods for imported ones.

This means that producers get the entire benefit arising from technical change.

As it will be shown, this is a very simplified representation.

beyond the static single market model

Aim: providing hints on more sophisticated equilibrium modeling frameworks• MODEXC, dynamic model for the analysis of technical change

• large multi market multi country frameworks employed in the analysis of agricultural policies

•the functioning and the scope of general equilibrium models and CGEs

MODEXC

A more sophisticated treatment compared to what was shown up to now. MODEXC:

• calculates and analyzes the effects of technological change, measured as surplus of producers and consumers

• allows for the treatment of different types of technical change, other than a parallel supply shift

• has a slightly more sophisticated functional form

• is a recursive dynamic model

• assumes free market conditions and the absence of policies. It can be used for modelling both closed and (small) open economy conditions

• distinguishes technical change from other supply shifters

MODEXC functional form

supply

demand

gppcs m )(0

pbd 0

withpm = minimum bid pricep = pricec, g, b = constants = own price elasticity

MODEXC dynamics

Expected prices are defined according to Nerlove (1958) under a scheme of distributed lags as:

where:

= expected price in period "t",

pt-1...pt-n = lagged prices from period "t-1" to period "t-n", and

1….n = weighted factors of lagged prices.

5544332211*

tttttt pppppp

*tp

MODEXC and tech change

• The model considers technical change as a horizontal supply shift, i.e. as a percentage increase of production

• if k is expressed as a percentage change of production costs (kc), it can be converted to its equivalent in terms of production expansion (kp) through supply elasticity

(p = price elasticity of supply) and

with q = increase in production due to the new

technology

pcp kk

0

0

0

010

q

qq

q

qqqk


Three types of supply shift depending on the position k takes within the original function.

• pivotal shift:

• divergent shift:

• convergent shift:

The general form of shifted supply is:

gppcks m )(1

gpkpcs m )(1

gk

ppcs m )( 01

gk

ppkcks m )(

3211

MODEXC and tech change: surplus

• The area p0p1E0E1 represents this gain of consumers

• producers are affected by lower marginal costs (pmFE1) and by price reduction p0E0Fp1; thus total producer surplus change is pmFE1 – p0E0Fp1.

• pmE0E1 represents the net social surplus

• the final effect depends on elasticities; particularly, if demand elasticity is low producers gains are most probably small, if not negative

F

S p

of output

qq q1

E1

d0

S1

Priceper unit

E0

p0

p1

pm

Quantity of output


The model assumes that the rate of adoption of technical change is

• slow the initial stages,

• then increases as the technology is more widely adopted and its performance and benefits are better known,

• hen decreases in advanced stages of the adoption process,

• and finally becomes stabilized

This is represented assuming that the supply shift factor, k, obeys a logistic-type pattern


The model allows to consider both supply and demand shifters, independent of thecnical change. These are

demand shifter (e.g. population, income)

supply shifter (tech change in other sectors)

If differs from zero, the annual k value is adjusted because is applied on a greater base than that used to estimate the final value of k.

td AGRDk

t)1(

t

tk )1(0

hints on large multi market PE

Reference to AGLINK, FAPRI frameworks employed in agricultural policy analysis and ag market projections.

A typical large PE model consists of sets of

behavioral equations,

equilibrium relations, and

identities

Equations can be grouped into a supply component, a demand or utilisation component, and a foreign trade component;

This pattern is repeated for each region and product included in the models.

Moreover there are price transmission equations, linking world to domestic prices, and

world market equilibrium conditions that close the models.

Crop products livestock product

supply (1) si,n = s(pv,i,n, pv,j,n, Pols) (8) ci,n = c(pz,i,n, pz,j,n, Polc) (2) rv,i,n =r(pv,i,n, PR) (9) AL = al(pv,i,n, pv,j,n) (3) Qov,i,n = si,n rv,i,n (10) rz,i,n = r(pz,i,n, AL, PR) (11) Qoz,i,n = ci,n rz,i,n demand (4) Cuv,i,n = cu(pv,i,n, Yn, POPn) (12) Qd z,i,n = qd(pz,i,n, Yn, POPn) (5) AAv,i,n = aa(Qoz,i,n) (6) SEv,i,n = se(sv,i,n) (7) Qdv,i,n = Cuv,i,n + AAv,i,n + SEv,i,n price transmission

(13) pi,n = p(pi,w, tc, Polp) trade

(14) (E i,n - Ii,n) = Qoi,n - Qd i,n closure

(15) (E i,n - Ii,n) = 0 where: i, j = products; E = exports Pols = policies based on land; v = crops; I = imports; Polc = policies based on livestock heads; z = livestock; tc = exchange rate Qo = supply; n = country; PR = yield trend; pn = price in country n; and Y = GDP; pw= world price; s = land (hectares); POP = population; Cu = demand for human consumption; c = heads (number); AA = demand for feed; SE = demand for seeds; AL = index of feed cost; Qd = total demand. r = yield (per hectare or per head); Polp = policies directly affecting prices;


modeling is simplified in several respects:

• production is entirely deterministic (no uncertainty factors farmers’ attitude toward risk)

• input demand only for land, herds, and where primary products are employed as inputs in the production of other goods included in the model, (feed crops, oilseeds, dairy)

• land use and herd depends solely on the price obtained for agricultural products.

• technical change is a trend variable (rather poor representation)


• goods produced in different countries are be perfectly homogeneous (only net trade position, no inra-industry trade)

• price changes occurring in one market are always transmitted to all the other

• the closure rule is defined by excess supplies, that must add up to zero in all markets

• the PE assumption implies that feedbacks from agriculture to the other sectors are not described. The effects on agriculture of what happens in other sectors (and in macroeconomic variables) is usually included as exogenous shocks.


The typical model is comparative static: it compares the two equilibrium solutions under the hypothesis that adjustment of endogenous variables is complete

However, large size multi country multi commodity models often include some elements of dynamics

This is modelled simply by including lagged variables in the equations, according to a recursive criteria: equilibrium solutions are based on the forecast of exogenous variables, and on the value of the endogenous variables obtained in the previous period.

This implies that agents’ behaviour is optimal with reference to each single period, but not through time.

hints on GE modelsAll productive sectors of the economy are represented.

Blocks of relations dealing with production, consumption and factor use

The simplest example is a setting including 2 good, 2 factors and 2 consumers

production

Goods - sectors Production function

agriculture XSagr = f (L, K)

textiles XStex = f (L, K)

consumption

Agents Utility function

rural Urur = f (Xagr, Xtex)

urban Uurr = f (Xagr, Xtex)

Factors of production

endow ments

labour L = L

capital K = K

hints on GE modelsEquations of the basic model

real flows expenditure

XSi = f(DLi, DKi) supply of good i hXD

i = ahi (Yh / pi) demand for i

w = (

XSi /

DLi) pi labour demand

r = (

XSi /

DKi) pi capital demand equilibrium conditions

XSi =

h

hXDi demand equal supply

i

DLi =

h

LSh demand for labour

equals labour endowement

income flows

Yh = w LSh + r KS

h

i

DKi =

h

KSh Demand for capital

equals capital endowement

identities

Pi XS

i = DLi w + DKi r

Yh =

i

hXDi pi

hints on GE models

Equilibrium conditions allow to “close” the model, and a set of identities ensure that income does not exceed expenditure, and that it equals that of the factors of production.

In this simplified model only the initial factor endowments and the utility function parameter are exogenous, while all the rest is calculated by the model

This can be solved by by imposing equilibrium conditions on all markets:

supply (from the production functions) equals demand of the two consumers (from their utility maximisation).

GE and CGE models

In order to be "computable" a general equilibrium model requires

a database describing the flows of resources in the economy at the level of aggregation considered in the model;

a set of parameters for the behavioral relations of the model

The database for a CGE model is knonw as Social Accounting Matrix (a set of accounts describing resource flows between consumers producers, the government and foreign economies

Parameters can be obtained through calibration or estimation

calibration vs estimation

calibration = deterministic procedure normally used to estimate some or all parameters; the base year database is used to determine the values of the parameters that are compatible with the exogenous and the endogenous variables

This does not allow a statistical control of the parameters

Econometric estimation (especially through symultaneous equations) is unfeasible most of the times, due to models’ size and limited number of observations

Block econometric estimation and sensitivity analysis are frequent alternatives.

advantages and drawbacks of GE vs PE approachNo approach is “better” in absolute terms: all depends on the problem to be analysed

Compared to the PE, the GE approach removes a simplifying hypothesis: that what happens the sector that are considered in the model do not affect demand and supply in sectors that are not considered, and vice versa.

Thus the GE approach can be effective

to highlight the effects of a general budget constraint in the economy

to consider the feedback from (e.g.) agriculture to other sectors, and the second round effects

the importance of feedback effects is related to (i) the relative size of agriculture compared to the other sectors; (ii) the degree of integration between (e.g.) agriculture and the rest of the economy

advantages and drawbacks of GE vs PE approach

...specifying a GE instead of a PE model appear to be worthwhile when the benefits in terms of additional information compared to the treatment of the same problem within a PE framework is greater than the increase in the “costs” associated with the time spent in data processing and the more complex specification of the mode

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