Question

Here we have again Piresia, this beautiful country. As suggested by previous advisors, the country released all trade barriers and now it follows a free trade policy with all its trading partners. Recently, the domestic marble ball producers approached the government with their concern that traditional marble ball production and the export products lose their competitiveness on the global market. Government decision makers thus think about applying export subsidies on marble ball exports to other countries. The world market price of marble balls is $5 per piece right now and the Piresian marble ball industry produces 30,000 pieces a year from which 10,000 is exported. The global market for marble balls (including the Piresian market) buys 1,000,000 pieces a year.

1. What will happen to the domestic and world market prices of marble balls if the Piresian government applies the export subsidy?
2. What is the expected welfare effect? Who wins and who loses with this policy?3
3. What level of export subsidy would you suggest?

Answer 1

1. After the kind approach of the domestic marble ball producers of Piresia to their government, if the government decision-makers started applying export subsidies on marble ball exports to other countries, this will affect that particular industry including domestic as well as global market. Export subsidies to the marble ball industry will increase prices in the domestic market and simultaneously reduce Piresia’s marble ball price in the global market. It means after export subsidy the world market price of marble balls which is $5 per piece currently will go up.

2. An export subsidy leaves a welfare effect to the society as a whole. It effectively decreases the consumer surplus and increases the export sector producer surplus. Normally, when a big nation imposes export subsidy national welfare drop but since Piresia is not so big in fact it’s a small one so it won’t face major drop.

In short, the export subsidy policy of the Piresian government applied to the marble ball industry will basically increase the producer surplus on the export market and simultaneously reduces it in the economy of countries that will import marble ball. So, the winner of the policy will be Piresia itself and losers will be its importers.

3. For promoting its marble ball in foreign market Piresian government may apply export subsidy policy to the domestic marble ball industry. But to what extent this subsidy should be provided will depend on whether the marble ball industry is perfectly competitive or less than perfectly competitive. If the industry is perfectly competitive then the firms within it fail to justify the export subsidy because of involvement or existence of externality. Conversely, If the industry is imperfectly competitive then the government should provide a high level of export subsidy in order to grab the foreign market. But while doing so Piresian government must keep in mind that whether their importers are strong or not because subsidy works when the importers are weaker than them.