Economic Analysis under World and Domestic Price System (C&W Chapter 5, 6) R. Jongeneel.
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Transcript of Economic Analysis under World and Domestic Price System (C&W Chapter 5, 6) R. Jongeneel.
Lecture Plan World price system analysis
inputs/outputs (tradable/non-tradable)labourlandcapital (discount rate)
domestic price system analysisshadow exchange ratetraded/non-traded goodslabour(land, discount rate)
World Prize System-Analysis Main objectives:
efficient utilization & existing resources
growth of resources
improving distribution (equity)
Trade-offs
short-run optimization
long-run optimization
World Price System-Analysis Main focus: efficiency analysis focus on
efficient resource utilization
Opportunity costs: defined in terms of
benefits foregone from the use of existing
resources in one project rather than in their
most likely alternative use
World Price System-Analysis
World price numeraire choice
Focus is on projects that produce traded
goods and whose main benefits are in
foreign exchange (trade efficiency)
Assessing Costs and Benefitstradable Non-tradable
outputs
Project
inputs
tradable Non-tradable
labour land capital
Traded and non-traded goods
Tradables project affects country’s balance
of payments
classification depends on government’s
trade policy
non-tradables goods may be non-traded for
various reasons
Valuation of traded goods
Border parity pricing: use border prices and
add domestic margins (transport,
distribution) to obtain border prices at
project level
export output: fob price - value T + D
import input: cif price + value T + D
Value of traded goods
T 1+D 1
Project size Production centre
domestic proj. inputs
Border
Port
T2+D2
T4+D4
T5+D5T3+D3
Cons. Centre
project outputs
Value of traded goods
Price: convert world prices into local currency
at official exchange rate
Shadow price:
SPi = (Wpi x OER) + (Ti CFT + Di CFD)
CFi = SPi / DPi
Valuation of non-traded goods
Non-traded goods
Variable supply
increase supply
(price )
Fixed supply
Replacement, subst.
price
Non-traded inputs: variable supply
Shadow price: long-run marginal costs of additional supply (in world price equivalents)
traded non-traded labor
input input
i n l
LLLjnnjniiijj CFWaCFPaCFPaSP ......
Example: non-traded electricity production
Cost at domestic price R3/kWH
CF
Cost at shadow price Rs/kWH
Operating costs Fuel Local materials
30.00 60.00
0.961 0.670
28.83 40.20
Labour: skilled Labour: unskilled
80.00 60.00
0.900 0.500
72.00
5.00 Capital: equipm. Capital: buildings
60.00 60.00
0.950 0.737
57.00 44.22
300.00
247.25
CF electricity = 247.25 = 0.824 300
Non-traded inputs: fixed supply Use average conversion factor for the
whole economy since more detailed info is absent
ACF = M + X _
(M+TM-SM)+(X+TX+SX)
Limitations: “average” instead of “marginal”, relies only on traded goods, omits effect of trade controlls (quota)
Labour valuation
Possible distinctionsskilled vs. unskilledworkers in excess supply vs. workers
in excess demand
Problem: ill-functioning labour market, immobility of labour
Labour: workers in excess supply
Opportunity costs: value of the output produced in the alternative occupation (which may offer only part-time work or underemployment)
wagemarket
SWR
MWR
SWRCF
CFmaSWR
L
iii
..
Labour: workers in excess demand
Two options: 1: attract labour from other activities2: increase labour supply by training or immigration
Option 1:
Option 2:
i
ii ACFmaMWR
(1 )foreign F FSWR rMWR r MWR CCF
Land
Comp. Land market price: equal to the expected future gain from the land purchased / rented
problem: land market subject to regulation / speculation
Example: land valuation cotton/sugarcane
Domestic marketprices Rs/acre
CF World pricesRs/acre
Cotton outputFamily labourFertilizerPesticidesBullocksWaterNet return
56.020.05.55.5
11.05.58.5
1.251.250.950.950.800.80
70.025.05.25.08.84.4
21.6
Capital: discount rate
Where do funds come from...?
Determines relevant opportunity costs
Opportunity costs (examples) return on the marginal project return obtained in the private sector weighted average of discount rates (real)
in domestic and foreign markets
Domestic price system-analysis
Choice of price unit in itself does not determine the opportunity cost of an item
Using DPS does not mean that domestic prices determine opportunity costs of (non-traded) goods
The difference between WPS and DPS arises because in general Pwm and Pdom differ by more that the margin for T+D-costs
Shadow exchange rate
If domestic prices are the numeraire allowance must be made for any general divergence between domestic and world prices in the economy
Solution: use shadow exchange rate
Example: Shadow Exchange Rate
Commodities $ value Weights Domestic price Rs
World price Rs
Price ratio
Rice Wheat Machines SER/OER
20 16 14
0.33 0.12 0.55
1100 1440 2000
1000 1200 1500
weighted average
1.10 1.20 1.33 1.24
OER = Rs10/US$
Approximations in DPS-Analysis
Classificationforeign exchange (F)domestic resources (N)unskilled labour (LU)skilled labour (LS)transfer payments (T)
(F): traded goods valued at Pwm (OER)
(N): non-traded goods valued at Pdm
NPV and DPS-analysis
At project level NPV=F+N+LU+LS+T
At national economic level ENPV=F.CFF+N.CFN+LU.CFLU+LS.CFLS
More detail: further decompose N
Traded goods: valuation at DPS
Derive CF (conversion factors)
DPSPi=(WPi.OER).CFF+(Ti.DPCFT+Di.DPCFD)
but CFF=SER/OER
thus DPSPi=(WPi.SER)+(Ti.DPCFT+Di.DPCFD)
Non-traded goods in DPS
Principle: value inputs in variable supply at long-run MC
j
jj
i n LLLLjnnnjiiijj
DP
DPSPDPCF
and
DPCFWaDPCFPaDPCFPaDPSP
...
Labour valuation at DPS
Labour: shadow wage is based on output foregone
Unskilled:
Skilled:
i
iii DPCFMaDPSWR ..
FFFF
FFFF
MWRrCFMWRrDPSWR
or
CFCCFMWRrrMWRDPSWR
).1()..(
..)1(
Comparing DPS with WPS
Identical decisions are made in both systems
NPVDP>0 when NPVWP>0
and
NPVDP = NPVWP x CFF
with CFF = SER / OER