Price Effects of a Voluntary Export Restraint:
Large Country Case

by Steven Suranovic ©1997-2004

Trade 90-17  





Suppose the US, an exporting country in free trade, imposes a binding voluntary export restraint (VER) on wheat exports to Mexico. The VER will restrict the flow of wheat across the border. Since the US is a large exporter, the supply of wheat to the Mexican market will fall and if the price remained the same it would cause excess demand for wheat in the market. The excess demand will induce an increase in the price of wheat. Since wheat is homogeneous and the market is perfectly competitive the price of all wheat sold in Mexico, both Mexican wheat and US imports will rise in price. The higher price will, in turn, reduce demand and increase domestic supply causing a reduction in Mexico's import demand.

The restricted wheat supply to Mexico will shift supply back to the US market causing excess supply in the US market at the original price and a reduction in the US price. The lower price will, in turn, reduce US supply, raise US demand and cause a reduction in US export supply.

These price effects are identical in direction to the price effects of an import tax, an import quota and an export tax.

A new VER equilibrium will be reached when the following two conditions are satisfied.

where is the quantity at which the VER is set, is the price in Mexico after the VER, andis the price in the US after the VER.

The first condition says that the price must change in Mexico such that import demand falls to the VER level . In order for this to occur the price in Mexico rises. The second condition says that the price must change in the US such that export supply falls to the VER level . In order for this to occur the price in the US falls.

The VER equilibrium is depicted graphically on the adjoining graph. The Mexican price of wheat rises from PFT to which is sufficient to reduce its import demand from QFT to . The US price of wheat falls from PFT to which is sufficient to reduce its export supply also from QFT to .

Notice that there is a unique set of prices which satisfies the equilibrium conditions for every potential VER that is set. If the VER were set lower than , the price wedge would rise causing a further increase in the Mexican price and a further decrease in the US price.

At the extreme, if the VER were set equal to zero then the prices in each country would revert to their autarky levels. In this case the VER would prohibit trade. This situation is similar to an export embargo.

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International Trade Theory and Policy Lecture Notes: ©1997-2004 Steven M. Suranovic
Last Updated on 10/15/00