Determinants of Trade

AG BM 102

Introduction

• Trade - an integral part of food system• Major market for our products – corn,

cotton, soybeans, chicken• Major source of products for our diet –

bananas, coffee, cocoa, vegetables, spices

• Issues to be examined– Demand and supply of traded products– Exchange rates and trade policy

Key concept - excess demand

Excess demand is the amount by which quantity demanded exceeds quantity supplied at a particular price

An example – beef demand

Price/lb Quantity

lbs/cap

Price/lb Quantity

lbs/cap

$5.00 50 $3.75 75

$4.75 55 $3.50 80

$4.50 60 $3.25 85

$4.25 65 $3.00 90

$4.00 70 $2.75 95

An example – beef supply

Price/lb Quantity

lbs/cap

Price/lb Quantity lbs/cap

$3.00 60 $4.25 72.5

$3.25 62.5 $4.50 75

$3.50 65 $4.75 77.5

$3.75 67.5 $5.00 80

$4.00 70 $5.25 82.5

Excess beef demandPrice Q Demand Q Supply E Demand

$5.00 50 80 -30

$4.75 55 77.5 -22.5

$4.50 60 75 -15

$4.25 65 72.5 -7.5

$4.00 70 70 0

$3.75 75 67.5 7.5

$3.50 80 65 15

$3.25 85 62.5 22.5

$3.00 90 60 30

Some points about excess demand

• Much more elastic than regular demand since it reflects simultaneous changes in domestic supply and demand

• Excess demand defines the demand curve for imports by a country

Excess supply

• Opposite of excess demand

• Excess Supply = Quantity Supplied – Quantity Demanded

Notes on excess supply

• Much more elastic than regular supply since reflects changes in both domestic supply and demand

• Defines the potential supply of exports by a country

Excess supply of Mexican beef

Quantity Price Dollars Price Pesos

10 pesos/$1

30 $4.00 40

22.5 $3.75 37.5

15 $3.50 35

7.5 $3.25 32.5

0 $3.00 30

0 7.5 15 22.5 30 37.5 45$0.00

$1.00

$2.00

$3.00

$4.00

$5.00

Beef Market

ESMexico

EDUS

Qtrade

P*

Notes about trade

• At $3.50, amount that US is short (in deficit) is exactly the amount that rest of world (Mexico) is long (willing to supply)

• No coincidence, based on excess demand for US and excess supply for ROW

• With trade - price is lower in the United States than without trade for what we import

Exports

• When our price is lower than the world price, we will export – corn

• This removes corn from our market – raises our price

• It puts U.S. corn in other markets – lowers their price

Exchange Rates

• Suppose the Dollar rises in value compared to Peso, $1 buys more Pesos – it bought 10 before, now it buys 20

• This means that something priced at 40 pesos costs a U.S. buyer less than before when paid for in dollars

• Take the case where $1 now buys 20 Pesos• Mexican beef priced at 40 pesos now costs

$2.00 per pound, not $4.00• Everything we buy from Mexico is now on sale

Excess supply of Mexican beefQuantity Price

Dollars 10/1

Price Pesos

Price Dollars

20/1

30 $4.00 40 $2.00

22.5 $3.75 37.5 $1.875

15 $3.50 35 $1.75

7.5 $3.25 32.5 $1.625

0 $3.00 30 $1.50

0 7.5 15 22.5 30 37.5 45 52.5 60$0.00

$1.00

$2.00

$3.00

$4.00

$5.00

Beef MarketCheap Peso

ESMexico

EDUS

Qtrade

P*

ESMexico'

P**

Q**trade

More on exchange rates

• If Peso falls in value (dollar rises in value = strong dollar) everything we buy from Mexico costs less and everything Mexico buys from us costs more

• If Peso rises in value (dollar falls in value – weak dollar) everything we buy from Mexico costs more and everything Mexico buys from us costs less

More on exchange rates• Strong dollar shifts supply curve for U.S. imports

down (to the right) and rotates the curve clockwise

• Weak dollar shifts the supply curve for U.S. imports up (to the left) and rotates the curve counterclockwise

• Strong dollar shifts supply curve for U.S. exports up (to the left) and rotates the curve counterclockwise

• Weak dollar shifts supply for U.S. exports down (to the right) and rotates the curve clockwise

Yugoslavian Banknote

Conclusions

• Excess supply and demand curves are the basis for determining the volume of trade

• The position and shape of the curves are affected by currency values (exchange rates) in addition to all the factors that affect the underlying domestic and foreign supply and demand curves