About twice as expensive as sugar
outside the country (at wholesale
prices).
!   Helps discourage candy manufacturing
in the US.
!   Closing of Lifesavers plant in Holland,
MI, in 2003.
!   In addition, the high price of sugar
helped create the giant corn-syrup
industry.
! 
Why Doesn’t Our Government
Want Us to Import Sugar?
Main reason: US sugar program.
!   A complicated scheme for restricting imports
of sugar into the country.
!   We’ll analyze this program and try to
speculate about the reasons for its existence.
!   First, some basics.
! 
The US sugar program is a “tariff rate
quota” (TRQ).
!   A combination of two simpler programs
called a tariff and a quota.
!   A tariff is a tax on imports.
!   A quota is a quantitative restriction on
imports.
! 
Specific tariff: Charged per unit of
quantity.
!   E.g., 12.38¢ per pound of sugar
imported.
!   Ad valorem tariff: Charged as a fraction
of value.
!   E.g., 10% of invoice value.
!   Nowadays, ad valorem tariffs are more
common, but the US sugar program
uses specific tariffs.
! 
Prohibition on imports beyond a specified
quantity.
!   Classical quota: Importing country would
issue import licenses;
!   you can’t import without a license, and each
license limits you to a fixed quantity.
! 
Under a TRQ, imports are permitted at a low
tariff up to a fixed quota;
!   Imports beyond that quantity are subject to a
higher tariff (the ‘out-of-quota’ tariff).
! 
Important variant: Voluntary Export Restraint
(VER).
!   A VER is a quota in which the exportingcountry government restricts its exports by
issuing export licenses to its own exporters.
!   There is an important element of this in the
US sugar program as well.
! 
The US sugar program has elements of
a specific tariff and a quota of the VER
type, bundled into a TRQ.
!   This is pretty complicated, so we will
analyze it first as if it was a simple
tariff, then a simple quota. Then it will
be clear how to put the pieces together
to understand the TRQ.
!   First, a simple model of the world sugar
market.
! 
US demand for sugar:
DUS = 2.56x1010 - 2.79x108P
!   Includes final consumers using sugar to
bake cakes, put in coffee, etc.
!   Also industrial users such as Kraft
Foods (owner of LifeSavers brand),
Hersheys, General Mills, etc.
! 
! 
Look at a highly simplified version of
the GAO-University of Iowa model
prepared in 2000 to help Congress
make informed choices.
!   Partial-equilibrium version.
! 
US supply of sugar:
!   SUS = 1.48x1010 + 5.44x107P
!   Includes cane sugar producers in
Florida, Texas, Louisiana and Hawaii
!   Also beet sugar producers in northern
states.
! 
US import demand for sugar:
Consumer demand at a price P minus
supply at that same price:
!   MDUS = 1.08x1010 - 3.33x108P.
! 
! 
ROW demand for sugar:
!   DROW = 3.21x1011 - 2.45x109P
!   Includes all consuming countries except
the US.
! 
ROW supply of sugar:
SROW = 3.00x1011 + 5.44x107P
!   Includes major exporters such as the
Dominican Republic, Brazil, and the
Philippines, along with many smaller
producers.
ROW export supply of sugar:
Supply at a price P minus consumer
demand at that same price:
!   XSROW = -2.08x1010 + 2.5x109P.
! 
! 
! 
! 
The free-trade price of sugar is the price at
which the import demand from the US equals
the export supply from the rest of the world.
!   In this model, that’s about 11.14¢ per
pound.
! 
Suppose the US government imposes a tariff
of 12.38¢ per pound of sugar imported.
!   (Chosen because it produces a pretty good
approximation to the actual effect of the US
sugar program.)
!   The tariff introduces a wedge between the
world price of sugar and the domestic US
price.
! 
Now, anyone wanting to import a pound of
sugar will need to pay 12.38¢ more than the
world price.
!   If domestic suppliers don’t raise their price as
well, no US consumer will import any sugar;
they’ll buy only domestically-produced sugar.
!   But this can’t satisfy demand: Recall Figure
7.1.
!   To get the market to clear again, we need the
domestic price to rise until consumers are
once again willing to import.
! 
In other words, for both US consumers and
US producers, the domestic price of sugar
will be equal to the world price plus the
tariff, 12.38¢.
!   This has the effect of shifting the US import
demand curve down by 12.38¢.
! 
The tariff pushes down the world price of sugar
(from 11.14¢/lb. to 9.68¢/lb.).
!   Note that this drop in price (11.14¢-9.68¢ =
1.46¢) is less than the amount of the tariff;
check Figure 7.5: It has to be.
!   It also reduces ROW exports to the US, from 7.04
billion lb. to 3.40 billion lb.
!   Essentially, the tariff discourages people from
exporting to the US, so they export less to the
US, and push down prices in other markets as
they sell more of their sugar in those other
locations.
! 
! 
(Think of the vertical axis in Figure 7.5 as
measuring the world price of sugar, not the
domestic US price.)
Recall: Under the tariff, the domestic price in
the US (for everybody) is equal to the world
price plus the tariff.
!   The world price has fallen, by less than the
tariff.
!   Therefore, the domestic US price has gone
up.
! 
Area B is called the production distortion.
!   It’s the gap between the marginal cost of
production of sugar (height of the supply
curve) and the true social cost of procuring
sugar (the free-trade world price), added up
over the range of sugar output that is
produced under the tariff but not under free
trade.
!   This is a measure of the cost to the US of
over-producing this commodity due to the
tariff.
! 
Area E is called the terms-of-trade benefit.
It measures the extent to which the sugar
Americans buy is getting cheaper.
!   Drop in world price times the quantity
Americans buy of it.
!   Unambiguously a benefit to US welfare.
! 
! 
Area D is called the consumption distortion.
It’s the gap between the marginal utility of
consumption of sugar (height of the demand
curve) and the true social cost of procuring
sugar (the free-trade world price), added up
over the range of sugar output that is consumed
under free trade but not under the tariff.
!   This is a measure of the cost to the US of underconsuming this commodity due to the tariff.
! 
! 
! 
The effect on the rest of the world is
unambiguously negative.
US consumers are hurt by the rise in price,
US producers benefit by that same rise in
price, and US taxpayers benefit from the
revenue the government collects (which can
replace other taxes that would have been
collected).
!   Overall, US social welfare goes up if E is
bigger than B+D.
!   Not true in this case, but it could have been,
if the tariff had been much lower.
! 
! 
Note: The terms-of-trade gain to the US is a
terms-of-trade loss to the rest of the world.
! 
Consider the effects of a small increase in
the tariff on US welfare.
When the tariff is at the optimal level (for the
US), the marginal benefit of an increase in the
tariff equals the marginal cost.
!   This amounts to a condition that:
! 
! 
Suppose that the US economy was a tiny
share of the world supply of and demand for
sugar.
!   Then it would face a horizontal XSROW curve.
!   No effect on terms of trade.
!   Area E disappears, but B and D do not.
!   In this case, the US could only lower its
welfare with a tariff.
! 
! 
where ! is the ad valorem tariff and " is the
elasticity of ROW export supply.
In other words, the optimal tariff for a small
economy is zero.
Now, suppose that instead of a tariff, the
government imposes a quota that reduces
imports to the same degree.
!   In other words, suppose the government
caps imports of sugar at 3.4 billion pounds.
!   Suppose (for now) that the government
implements this by printing import licenses,
distributed to US importers.
! 
! 
This truncates the US sugar import-demand
curve at the quantity 3.4 billion lb.
Note that the effect on the world market is
identical to the effect with the tariff. They
both move the equilibrium along the ROW
export supply curve.
!   Note that the effect on the US domestic price
will be identical as well: The US domestic
price rises until US import demand is equal
to 3.4 billion pounds.
! 
Note as well that the effect on US
welfare will be identical, once you take
account of profits earned by licensed
US importers. Specifically:
!   Each licensed importer gets to buy rice
on the world market for 9.68¢/lb., and
sell it in the US for 22.38¢/lb.
!   This is a tidy profit, and is called quota
rents.
!   The total quota rents are exactly what
tariff revenues would have been if we
had a tariff instead of a quota.
! 
In other words, in a model of this sort, tariffs
and quotas are equivalent: They have the
same effects on prices, trade volumes, and
welfare, except that private importers get
quota rents instead of government getting
tariff revenue.
!   Since US welfare falls under the tariff, we
conclude that it falls under the quota as well.
! 
Whether the US sugar program is
approximated by a tariff or a quota, the
model suggests that it creates a terms-oftrade benefit to Americans that must be
weighed against the inefficiencies of overproduction and under-consumption of
sugar.
!   The analysis suggests that the terms-oftrade effect is too small to justify the policy
from the point of view of US social welfare.
! 
The quota licenses for the US sugar program
are actually managed by the exporting
countries, not the US.
!   That means that foreign exporters get the
licenses, and hence the quota rents, and not
US importers.
!   Foreign exporters get to buy at the low world
price and sell in the US at the high US price.
! 
This makes the program function like a VER.
!   The welfare effects are shown in Figures 7.10
and 7.11.
! 
You can see why a VER can indeed be
“voluntary:”
!   Exporting countries can easily be made
better off by the restrictive policy
because of the quota rents.
!   GAO estimates that the US sugar
program transfers around $400 million
of quota rents to sugar exporting
countries each year.
!   But note that it is not the farmers who
benefit.
! 
These guys don’t get any piece of that giant green rectangle.
Cane workers in the Dominican Republic. Photo by Maggie
Steber, National Geographic.!
! 
Neither does this Pakistani sugar farmer. Photo copyright
Albert Moldvay, National Geographic.!
Two possible theories:
!   I.
! 
Terms-of-trade motive.
Interest-group motive.
The policy benefits US sugar growers and
corn-syrup manufacturers at the expense
of everybody else in the country.
!   Perhaps the story is that those people
have managed to acquire
disproportionate political influence.
But GAO figures suggest that the
consumption and production
distortions are much too big to justify
the terms-of-trade benefit in this case.
!   The whole terms-of-trade benefit is
given away to foreign countries as part
of the quota rent, anyhow.
! 
! 
! 
From Gökçekus, Knowles, and Tower (2003)!
Two possible theories:
!   II.
Overall, interest-group politics seems like
the most plausible explanation.
Either a tariff or a quota can be used by an
importing country to improve its terms of trade
(provided it is big enough to effect its terms of
trade).
!   But this gain must be weighed against the
distortion of domestic production and
consumption decisions caused by the wedge
between domestic and world prices.
!   Ands the terms of trade gain to the importing
country is a terms-of-trade loss to the rest of
the world.
! 
This has all been discussed in the context of
a partial-equilibrium model.
!   The same ideas hold up in a generalequilibrium model.
!   First, we’ll look at a small open economy,
then a large one.
! 
! 
And the terms-of-trade gain to the
importing country is a terms-of-trade loss to
the rest of the world.
Now, in equilibrium the value of aggregate
consumption must equal the value of
aggregate production at world prices.
!   This is the balanced-trade condition.
! 
Now, the case of a large economy.
!   Recall that a large economy is defined as one
that can affect its terms of trade.
!