Export Subsidy: Two Countries

Udayan Roy

http://myweb.liu.edu/~uroy/eco41

September 2006

Price (in Europe)

A

B C

E

D

F G

H IJ

Europe Japan Quantity

Japan implements an export subsidy

This causes its supply to, in a sense, fall by the extent of the subsidy.

The price for Japan’s producers increases, but by less than the subsidy.

The price in Europe falls.

Exports

Imports

Net Trade

Export Subsidy: Two Countries CaseEurope Japan

Before After Before After

Consumer Surplus

A ABC F FHI

Producer Surplus

BD D HJ EFHJ

Subsidy -- -- -- -EFGHI

Total Surplus ABD ABCD FHJ FHJ-G

Export Subsidies Create Fake Trade

• Subsidies are the opposite of a tax; they reward rather than punish

• Export subsidies reward domestic producers for the goods that they export

• This artificially boosts the nation’s levels of trade

• The country may export its entire output of a commodity and then import back the same commodity for its own use!

Fake Trade is Bad

• The fake trade induced by export subsidies reduces the nation’s welfare (by G) and …

• … may even leave it worse off under trade than in autarky

Gains and Losses

• When a country imposes an export subsidy, it is affected as follows:– Producers gain (EF)– Consumers gain (HI)– The country as a whole loses (G), because

the cost of the subsidy (EFGHI) are not worth the benefits (EFHI)

Gains and Losses

• When a country imposes an export subsidy, the other country is affected as follows:– The price of its imported good decreases. As

a result, – Consumers gain (BC)– Producers lose (B)– The country as a whole is better off (C)

Export Subsidy and Welfare

• When one country implements an export subsidy, that country is worse off (G)

• The other country is better off (C)

• The losses of the worse-off country (G) are larger than the gains of the better-off country (C). So, the world as a whole is worse off.

Textbook

• For more on this topic, see “Export Subsidies: Theory” in Chapter 8, pages 197-199.