Price Effects of an Export Tax: Large Country Case
Suppose the US, the exporting country in free trade, imposes a specific
export tax on exports of wheat. A tax on exports will reduce the flow of
wheat across the border. It will now cost more to move the product from
the US into Mexico.
As a result the supply of wheat to the Mexican market will fall inducing an increase in the price of
wheat. Since the US is assumed to be a "large" country, the price of all wheat sold in Mexico,
both Mexican wheat and US imports will rise in price. The higher price will reduce Mexico's
import demand.
The reduced wheat supply to Mexico will shift supply back to the US market and induce a
reduction in the US price. The lower price will reduce US export supply.
These price effects are identical in direction to the price effects of a tariff, an import quota, and a
voluntary export restraint.
A new tax-ridden equilibrium will be reached when the following two conditions are satisfied.
where T is the export tax, 
is the price in
Mexico after the tax, and
is the price in the
US after the tax.
The first condition represents a price wedge
between the final US price and the Mexican
price, equal to the amount of the export tax. The
prices must differ by the tax because US
suppliers of wheat must receive the same price
for their product, regardless of whether the
product is sold in the US or Mexico and all
wheat sold in Mexico must be sold at the same
price. Since a tax is collected at the border, the
only way for these price equalities within countries to arise is if the price differs across countries
by the amount of the tax.
The second condition states that the amount the US wants to export at its new lower price must
be equal to the amount Mexico wants to import at its new higher price. This condition guarantees
that world supply of wheat equals world demand for wheat.
The export tax equilibrium is depicted graphically on the adjoining graph. The Mexican price of
wheat rises from PFT to
which reduces its import demand from QFT to QT. The US price of
wheat falls from PFT to
which reduces its export supply, also from QFT to QT. The
difference in the prices between the two markets is equal to the export tax rate T.
Notice that there is a unique set of prices which satisfies the equilibrium conditions for every
potential export tax that is set. If the tax were set higher than T, the price wedge would rise
causing a further increase in the Mexican price, a further decrease in the US price and a further
reduction in the quantity traded.
At the extreme, if the x were set equal to the difference in autarky prices, (i.e.
) then the quantity traded would fall to zero. In other words the export
tax would prohibit trade. Indeed any tax set greater than or equal to the difference in autarky
prices would eliminate trade and cause the countries to revert to autarky in that market. Thus we
define a prohibitive export tax as any tax, Tpro, such that,
International Trade Theory and Policy - Chapter 90-22: Last
Updated on 2/25/97
