(1) Suppose that the government of Pacifica, a small island developing country (population 0.5 million, GDP per capita $1000), is considering the removal of a 25% tariff on canned baked beans. Pacifica is a low income developing country and canned baked beans are a significant item in the diet of its consumers, most of whom live in the rural sector, which accounts for a significant share of Pacifica’s exports. The export industries, many of which are located in the rural sector, experience chronic difficulties in attracting sufficient labour to maintain production at the level needed to meet demand for their products.
The tariff was originally imposed to support a proposal by the operators of a local cannery, Nambawan Foods Ltd, to expand its range of products to include canned baked beans. Canned baked beans subsequently became the principal product of this cannery, which is the sole producer of canned baked beans in Pacifica.
The cannery is located in Pacifica’s main port and urban centre.
Currently 100,000 cartons of baked beans are imported per year, out of a total annual consumption of 200,000 cartons. The import cost (i.e. without the tariff applied) is $24 per carton of baked beans. At that price it is estimated that total consumption would increase to 240,000 cartons of baked beans per year, of which 200,000 cartons would be imported.
(a) Calculate how the removal of the tariff would affect:
(i) consumer surplus
(ii) producer surplus
(iii) government revenue
(iv) net national welfare
(b) Illustrate your answer by means of a diagram. (4 marks)
(c) Comment briefly (1 sentence) on the implications of your results for real incomes in Pacifica. (1 mark)
(2) In addition to the production of canned baked beans, another cannery and fish processing plant in Pacifica, operated by Seafresh Ltd, produces high quality canned tuna for export, which is another significant Pacifica export. In order to be internationally competitive this product must be sold at the world market price of $40 per carton. Seafresh is the sole producer of canned tuna in Pacifica.
Whole chilled tuna, the raw material for Seafresh’s operation, are landed at Pacifica’s main port from foreign fishing vessels, and are not subject to any duty or other tax. The whole fish are purchased by Seafresh at the world market price for whole tuna. At this price the cost of the quantity of whole fish required to produce one carton of whole tuna is $10. The whole fish are first processed into cooked tuna loins, which are then canned. Seafresh also export cooked tuna loins, which are sold at the world market price for this product, and for internal costing purposes (as well as for purposes of economic analysis) the tuna loins used in the canning operation are also valued at the world market price. At this price the loins needed to produce a carton of canned tuna have a value of $20. The basic cost structure for the production of a carton of canned tuna is thus:
Whole fish $10
Loining $10 ($20-$10)
Canning $20 (including cost of imported materials)
The domestic value added in producing a carton of canned tuna consists of the cost of the loining and canning operations, less the cost of imported materials.
The tuna loining and canning operations are very labour intensive. Production of canned baked beans is also labour-intensive, but less so than the tuna cannery operation. Seafresh currently produces 2 million cartons (20,000 tonnes) of canned tuna per year, almost all of which is exported.
Seafresh Ltd has the capacity to substantially increase production of canned tuna if suitable markets can be developed. It is currently evaluating several potential new market opportunities, one of which is presented for analysis in (4) below. The main obstacle to expanding production in response to new market opportunities is the serious difficulty in attracting a sufficient supply of labour, which has in the past created problems for maintaining even the existing level of operation.
Suppose that the packaging materials used in both canneries (metal cans, labels and cardboard cartons) are subject to a tariff of 10%. The tariff was intended to encourage the development of a local packaging industry but in fact all packaging materials continue to be imported. The raw beans used in the production of canned baked beans are also subject to a tariff of 10%, although beans are not grown locally. Imported oil used in the production of canned tuna is also subject to a 10% tariff. In the case of canned baked beans, the inputs that are subject to the 10% tariff (raw beans, metal cans, labels and cardboard cartons) would cost $20 per carton of baked beans if imported duty-free. The packaging materials (metal cans, labels and cardboard cartons) and oil used in the production of canned tuna would cost $10 per carton if imported duty-free.
Answer the following:
(a) Calculate the effective rates of protection in Pacifica for the production of
(i) canned baked beans and
(ii) canned tuna.
(b) Comment briefly on the implications of your results for:
(i) sustainable cost of production in each industry, relative to internationally competitive levels as indicated by the difference between world prices of the finished goods and inputs. (4 marks)
(ii) efficiency of each industry. (2 marks)
(iii) impact on each industry in terms of returns to factors of production and suppliers of non-tradeable inputs, and in terms of likely impact on level of output. (4 marks)
(iv) the economy-wide pattern of production and allocation of resources.
(3) Nambawan Foods Ltd, the producer of canned baked beans is arguing for the removal of the tariffs on packaging materials and raw beans. Seafresh Ltd supports the removal of the tariffs on packaging materials. Nambawan Foods Ltd also argues that the 25% tariff on canned baked beans should remain in place. Government advisers on the other hand have been arguing that the 25% tariff on canned baked beans should also be removed, in order to increase real wages in the export industries.
Answer the following:
(i) the effective rate of protection for canned tuna if the 10% tariff on packaging materials is removed. (2 marks)
(ii) the effective rate of protection for canned baked beans in the event that the 10% tariff on packaging materials and raw beans is removed, (a) if the 25% tariff on canned baked beans is also removed, as the government’s advisers have recommended and (b) if the 25% tariff on canned baked beans is left in place, as Nambawan Foods Ltd proposes.
(b) Comment briefly on the implications of the results of your calculations for:
(i) the competitive position of each industry in their respective markets, if tariffs are removed on inputs for both industries and also on canned baked beans, as recommended by the government advisers.
(ii) relative returns to factors of production and non-tradeable inputs in each industry, and for the economy-wide production pattern and allocation of resources, if tariffs are removed on inputs for both industries and also on canned baked beans. (4 marks)
(iii) efficiency and returns to factors of production and non-tradeable inputs in the baked bean industry, and for the economy-wide production pattern and allocation of resources, if tariffs are removed on inputs in the baked bean industry but retained on canned baked beans, as Nambawan Foods Ltd proposes. (4 marks)
(c) Why do you think the government advisers emphasise the effect on real wages in the export industries as one of the arguments for removing the tariff on canned baked beans? (2 marks)
(4) Among the new trade initiatives being pursued by Pacifica’s government, it has joined a new trade group known as the “Tuna 6”, comprising the world’s six largest exporters of canned tuna, which aims to negotiate a free trade agreement (FTA) with Eagletop, a large industrialised country (population 200 million) that is the world’s largest importer of canned tuna.
The “Tuna 6” are all small developing economies (combined population 10 million), who account for over 98% of the world exports of canned tuna, so that for practical purposes of analysis they can be regarded as representing the entire world market supply of canned tuna. A principle objective of the “Tuna 6” in the proposed FTA with Eagletop is to secure duty free access to the Eagletop market for canned tuna.
Currently Eagletop applies a 35% tariff to imports of canned tuna in order to protect its own canned tuna producers. Imports enter Eagletop at the world price of $40 per carton, and both imports and domestically produced canned tuna sell in the Eagletop market at $54 per carton ($40 x 1.35). Although wages in Eagletop canneries are an average of five times higher than wages in the “Tuna 6” canneries, Eagletop canneries have been able to remain competitive in their domestic market through a combination of extensive automation of their production processes and the protection of the 35% tariff.
Eagletop canneries do not carry out loining operations but reply on supplies of loins purchased at the world market price for loins of $20 per carton from producers in the “Tuna 6” countries and in Eagletop’s own overseas territories. They are also able to obtain their requirements for packaging materials and oil at world market prices (i.e. $10 per carton of canned tuna) without any taxes or tariffs being applied. Evaluated at world market prices, value added in Eagletop canneries is thus $10 per carton (world price of canned tuna: $40 per carton, less world price of equivalent quantity of tuna loins: $20 and packaging materials and oil: $10).
Answer the following:
(a) Calculate the effective rate of protection for tuna canneries in Eagletop.
(b) Comment briefly on the implications for efficiency of tuna canning in Eagletop, relative to internationally competitive levels as indicated by the difference between world prices of the finished goods and inputs.
(c) How would you summarise Eagletop’s trade policy toward the tuna industry?
(5) Assume for purposes of analysis that Eagletop and the Tuna 6 can treated as a self-contained “global” market, and that the current “world price” as experienced by Pacifica can be regarded as the equilibrium price established in this “global” market, given Eagletop’s 35% tariff. Changes in Eagletop’s tariff rate are expected to affect the overall price and quantity of exports from the Tuna 6 countries to Eagletop i.e. Eagletop exerts a “large country” influence over exports from the Tuna 6, so that the combined export supply curve of the “Tuna 6” countries to the Eagletop market is upward sloping.
At present (prior to the proposed FTA) the following information applies to the Eagletop market (annual figures): ]
Domestic Consumption: 20 million cartons (200,000 tonnes)*
Domestic Production: 18 million cartons (180,000 tonnes)
Imports (from “Tuna 6” countries): 2 million cartons (20,000 tonnes)
* 1 tonne = 100 cartons (10 kg per carton)
Imports of tuna loins from “Tuna 6” countries are 12 million carton equivalents at $20 per carton (a carton equivalent is the quantity of tuna loins required to produce one carton of canned tuna)
Pacifica has a 10% share of the import market, exporting 0.2 million cartons (2,000 tonnes) to Eagletop each year at $40 per carton. It also exports 1.2 million carton equivalents of tuna loins to Eagletop.
A detailed study of the FTA proposal predicts that under the FTA proposal, with the 35% tariff eliminated, the price of Eagletop’s imports from the “Tuna 6” will rise to $48 per carton, imports will increase to 10 million cartons (100,000 cartons), Eagletop’s consumption will rise to 25 million cartons (250,000 tonnes), and its domestic production will fall to 15 million cartons (150,000 tonnes). It is predicted that the world price of tuna loins will remain unchanged at $20 per carton equivalent, but imports of tuna loins from the “Tuna 6” are predicted to fall from 12 million to 10 million carton equivalents, reflecting the reduced production of canned tuna in Eagletop (the remainder of the reduction in demand for tuna loins by Eagletop canneries will fall on their other suppliers)
It is predicted that Pacifica will retain its 10% share of Eagletop’s import market, exporting 1.0 million cartons (10,000 tonnes) at $48 per carton, provided that it can increase its supply to meet the increased demand. Pacifica’s sole producer, Seafresh Ltd, has sufficient capacity to supply the increase without any further investment, provided it can attract the necessary additional labour to work in its processing plant. Pacifica is also predicted to retain its 10% share of “Tuna 6” exports of tuna loins to Eagletop, so that under the FTA it will export 1 million carton equivalents of tuna loins to Eagletop (down from 1.2 million carton equivalents before the FTA).
Answer the following [Note: for all calculations required below, show your answers in both total dollar terms and per capita (i.e.dollars per head of population) terms. In drawing your diagrams, begin the vertical axis at $36, to avoid unnecessary blank spaces in the diagrams]:
(a) Draw a diagram, showing Eagletop’s import demand curve and the “Tuna 6” export supply curve, to illustrate the impact on national welfare in Eagletop and the “Tuna 6” of the changes in imports and exports of canned tuna resulting from the FTA. (4 marks)
(b) Using the information from the diagram, calculate the effect of the changes in the canned tuna market on the national welfare of Eagletop and the combined national welfare of the Tuna 6 countries. Calculate also the effect on the national welfare of Pacifica. (9 marks)
(c) Explain your results in (b). (4 marks)
(d) Then construct a further diagram incorporating Eagletop’s domestic demand and supply curves, showing the overall impact on Eagletop’s home market of the changes in its canned tuna trade with the “Tuna 6” resulting from the FTA. (5 marks)
(e) Calculate the effect of the changes on Eagletop’s consumer surplus, producer surplus, and government revenue, as well as the change in national welfare broken down into its component parts.
(f) Explain your results in (e). (3 marks)
(g) Assuming no change in the world price of tuna loins or whole tuna, and no change in Pacifica’s production of canned tuna and tuna loins for markets other than Eagletop, calculate the change in value added in Pacifica’s tuna processing industry, taking into account both the increase in its canned tuna exports and the decrease in its tuna loin exports, and assuming the elimination of the duty on its imported inputs (packaging materials, oil) goes ahead. What percentage of Pacific’s overall GDP per capita ($1000) is represented by your result in per capita terms? (3 marks)
(h) Write two paragraphs assessing the overall trade policy situation depicted by your analysis in (a) to (d) above. Consider aspects such as the indicated extent of the effect on Eagletop’s existing (pre-FTA) policy on the “Tuna 6” and Pacifica in particular, and the relative impact (benefits, costs, welfare effects, and the relative size of these) on the parties of reversing that policy by implementing the FTA. What if anything does Eagletop have to lose (in relation to the tuna sector) by agreeing to the FTA? (6 marks)
(6) Meanwhile, back in Pacifica, Nambawan Foods Ltd has been running an aggressive campaign against the proposed removal of the tariff on baked beans, attracting considerable support through strident claims that removal of the tariff will cause a substantial increase in unemployment and worsening of Pacifica’s balance of payments. How would you answer these claims? (6 marks)