Export Demand and Large/Small Countries (15 minute read)
Learning Outcome:
You will learn how export demand is described in single-country models like the UNI-CGE model, and the role of the export demand elasticity in defining large and small countries.
Foreign Demand in a Single-Country CGE Model
Producers in single-country CGE models export some of their products to foreign markets. Because consumer demand in foreign countries is not described in the models, some assumptions must be made about how foreign demand behaves if there is a change in export prices or export supply.
Many single-country CGE models, including the UNI-CGE model, describe foreign market demand using a simple, linear demand equation in which foreign demand can change if the home country's export price changes, as shown in Equation 1. In the equation, the percent change in quantity of foreign demand for each exported commodity (QEc) is a function of an elasticity parameter (edec) of foreign demand for commodity c (ede has a negative sign) and the percent change in the home country's world export price of c (PWEc):
(1) % Change in QEc = edec * % change in PWEc
For example, if you observe an 8% fall in the home country's export price and the foreign demand elasticity is -2, then the export quantity will increase by 16% (16 = -2 * -8). The modeler's definition of the ede parameter value is an important assumption in a CGE model. The larger the absolute value of the ede parameter, the larger the change in export quantities of commodity c following a price change, and the larger the effects on the rest of the economy.
EDE, Export Price Changes, and Large versus Small Countries
The value of the foreign demand elasticity can tell us whether the country is large or small in world markets. If a country has a large share of a commodity in world markets, then foreign consumers have few alternative sources for their imports. There will be only small changes in foreign demand if export prices change. A large country is therefore described by a low EDE value because demand for its exports is inelastic. For example, an EDE parameter value of -.2 and an increase in a country's world export price of 10% would cause export demand to fall 2%.
A high EDE parameter value describes a country that is small in world markets. The intuition is that the country faces a lot of competition in its export market. If it raises its export price, its customers will readily shift to alternative sources and its export quantity will fall by a large amount. A high EDE parameter value means that foreign demand is very elastic. For example, an EDE parameter value of -5 and an increase in its world export price of 10% would cause its export quantity to fall 50%.
EDE, Export Quantity Changes and Large versus Small Countries
The EDE parameter value also influences the effects of a change in a country's export supply on its export price. If export demand is inelastic, with a low value of EDE, then a change in export supply will have a large effect on the export price. For example, China is a large exporter of electronics, with a low value of EDE for that commodity. Because its foreign market demand is inelastic, it must lower its price substantially to persuade its buyers to purchase more electronics. And if its supply of electronics falls then its export price will increase substantially as consumers compete for its product.
When the EDE parameter value is high, changes in a country's export quantities will have little effect on its price. The country is too small in world markets for its supply changes to affect world prices.
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