Under pressure from the sugar lobby, which feared a flood of sugar entering thro

Question

Under pressure from the sugar lobby, which feared a flood of sugar entering through Mexico, the U.S. Congress demanded limits on the amount of sugar that Mexico could export to the U.S. as a condition for passing the North American Free Trade Agreement (NAFTA) in 1993. When those limits expired, which occurred at the beginning of 2008, Mexicans or the Mexican government could have, in principle, purchased sugar on the world market to re-export to the U.S. to sell at the higher, quota-supported U.S. sugar price. Mexican sugar exports to the U.S. did indeed increase following expiration of the limits, from about 4.9 million cwt in 2007 to 14 million cwt in 2008 and then to 28 million cwt in 2009, before falling back to 16 million cwt in 2010. Since 2008, U.S. policymakers have complained that the growth and high variability of Mexican sugar exports to the U.S. have complicated their ability to set quota levels to achieve desired sugar prices, leading to calls for some form of coordination between Mexico and the U.S. One such proposal would have required the U.S. and Mexican governments to consult at least every three months to review data on both countries’ sugar markets; to establish a permanent joint sugar commission to coordinate national sugar policies, monitor implementation of the framework’s objectives, and handle any disputes that may arise under the framework; to consult about the likely impact of future trade agreements on how their sugar programs work; and to work together to improve the collection and publication of reliable data on each country’s sugar supply and use, including mandatory and enforceable reporting requirements for sugar producers. At the time of the expiration of limits on Mexican sugar exports to the U.S.,

the U.S. consumed 200 million cwt (“hundred weights” = 100 lbs) of sugar per year, of which U.S. producers produced 160 million cwt, with the remainder, including 4.9 million cwt from Mexico, imported from other countries holding U.S. quota rights;

- the price of sugar in the U.S. was $20.00 per cwt (20 cents per pound)

- the world market price of sugar was $14.00 per cwt

- the elasticity of demand for sugar in the U.S. was 0.15;

- the U.S. elasticity of sugar supply was 0.25

. Since U.S. consumes only about 4% of world sugar production, assume that changes in U.S. sugar imports will not affect the world market price.

Question 1. [50 points] If anyone in Mexico could have bought sugar on the world market and then exported it to the U.S., following the expiration of limits on Mexican sugar exports to the U.S., calculate the U.S. production and consumption of sugar.

Question 2. [50 points] Like the U.S., Mexico sets quotas on sugar imports and, consequently, Mexicans cannot in fact buy as much sugar as they would like on the world market. As a result, the amount of sugar available for Mexico to export to the U.S. depends on Mexican consumption relative to its own domestic sugar production plus imports allowed under its quota. Not surprisingly, Mexican sugar producers prefer to sell their sugar in the U.S. when the U.S. price is higher than the Mexican price, and vice versa. Assuming that the U.S. keeps the quota for sugar imports from countries other than Mexico unchanged (that is, at 40 million cwt – 4.9 million cwt = 35.1 cwt), calculate the effect of the increase in Mexican exports to the U.S. in 2008 to 14 million cwt (from 4.9 million cwt the previous year) on the price of sugar in the U.S.

Question 3. [50 points] Suppose, following the expiration of limits on Mexican sugar exports to the U.S., anyone in Mexico could have bought sugar on the world market and then exported it to the U.S. Calculate the effect this would have on the U.S. consumer surplus.

Explanation / Answer

Question 1

Before the expiration of quota limits, U.S. consumed 200 million cwt of sugar per year, of which U.S. producers produced 160 million cwt, with the remainder, including 4.9 million cwt from Mexico, imported from other countries holding U.S. quota rights. At that time, the price of sugar in the U.S. was $20.00 per cwt while the world market price of sugar was $14.00 per cwt.

Since U.S. consumes only about 4% of world sugar production, changes in U.S. sugar imports will not affect the world market price.

However, as soon as the quota limits expired, anyone in Mexico could export to the US by purchasing sugar from world market and selling it in the United States. This would drive the price down in the United States but world price will remain intact. Mexican exports of sugar will continue till no one in Mexico gains from such trade and this happens only when world price and US price of sugar is same.

When the domestic price of sugar reaches the world price of $14, there is a reduction of $6 per cwt, a percentage fall of 30.

Given that the elasticity of demand is -0.15, a 30 percent fall in the price will increase the demand for sugar by 4.5 percent or precisely 200*4.5/100 = 9 million cwt.

Similarly, the elasticity of supply is -0.25, a 30 percent fall in the price will decrease the domestic supply of sugar by 7.5 percent or precisely 160*7.5/100 = 12 million cwt.

Thus, if anyone in Mexico could have bought sugar on the world market and then exported it to the U.S., following the expiration of limits on Mexican sugar exports to the U.S., the U.S. production of sugar will fall by 12 million cwt to 148 million cwt and consumption of sugar increases by 9 million cwt to reach 209 million cwt.

Question 2

Now when it comes to Mexico, Mexican sugar producers prefer to sell their sugar in the U.S. when the U.S. price is higher than the Mexican price and currently, sugar price in the US is above the world price and Mexican sugar price. Assuming that the U.S. keeps the quota for sugar imports from countries other than Mexico unchanged at 35.1 million cwt. The implication is that when the Mexican exports increase from 4.9 million cwt to 14 million cwt, there is 185.71 percent increase in the quantity of Mexican sugar supplied to the US. Consumers now face a total supply of 160 + 35.1 + 14 = 209.1 million cwt. Currently, they demand 200 million cwt at $20 per cwt of sugar.

With the elasticity of the demand for sugar in the U.S. being -0.15, to demand this additional 9.1 million cwt, around 4.55% rise in quantity demanded, the percentage fall in the price is 4.55/ -0.15 or a fall of 30.33 percent. Hence the price of sugar in the US will fall by 30.33 percent to reach $14 per cwt.

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