Price Effects of a Voluntary Export Restraint:
Large Country Case
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,
and
is 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.
International Trade Theory and Policy - Chapter 90-17: Last
Updated on 10/15/00
