The purpose of this note is to develop a very simple, yet consistent structural model of the
Norwegian seafood trade that highlights how trade flows and prices are affected by changes
in exchange rates. By using a class of models called Equilibrium Displacement Models
(EDM’s) the model is solved for the reduced-form elasticities to indicate the effects exchange
rates changes has on producer surplus. Our “best-guess” estimate of the short-run currency
effect during the first eight months of 2002 indicate that the exchange caused an initial
reduction in Norwegian producer surplus equal to 1.158 million kroner

Myrland, Øystein

NORA - Norwegian Open Research Archives

A note on measuring the effects of exchange rate changes on Norwegian exports of seafood

The purpose of this note is to develop a very simple, yet consistent structural model of the
Norwegian seafood trade that highlights how trade flows and prices are affected by changes
in exchange rates. By using a class of models called Equilibrium Displacement Models
(EDM’s) the model is solved for the reduced-form elasticities to indicate the effects exchange
rates changes has on producer surplus. Our “best-guess” estimate of the short-run currency
effect during the first eight months of 2002 indicate that the exchange caused an initial
reduction in Norwegian producer surplus equal to 1.158 million kroner

Munin - Open Research Archive

A Note on Measuring the Effects of Exchange Rate Changeson Norwegian Exports of SeafoodbyØystein MyrlandWorking Paper Series in Economics and ManagementNo. 01/02, September 2002Department of Economics and ManagementNorwegian College of Fishery ScienceUniversity of TromsøNorway2A Note on Measuring the Effects of Exchange Rate Changeson Norwegian Exports of Seafood*Øystein Myrland, Associate professor in the Department of Economics and Management,Norwegian College of Fisheries Science, University of Tromsø, Norway.E-mail: oysteinm@nfh.uit.no, phone: +47 77 64 61 24, fax: +47 77 64 60 20.*This paper is distributed for discussion purposes. Its contents should be consideredpreliminary and should not be referred to or quoted without the author’s permission. Appreciation is expressed to Jan Trollvik and Terje Vassdal for constructive criticism. Responsibility for final content, however, rest strictly with the author.AbstractThe purpose of this note is to develop a very simple, yet consistent structural model of theNorwegian seafood trade that highlights how trade flows and prices are affected by changesin exchange rates.  By using a class of models called Equilibrium Displacement Models(EDM’s) the model is solved for the reduced-form elasticities to indicate the effects exchangerates changes has on producer surplus. Our “best-guess” estimate of the short-run currencyeffect during the first eight months of 2002 indicate that the exchange caused an initialreduction in Norwegian producer surplus equal to 1.158 million kroner.3A Note on Measuring the Effects of Exchange Rate Impactson Norwegian Exports of Seafood“Exchange rate movements can easily swamp or obscure the desired price, trade, orproduction effects of any specific agricultural commodity policy.”Houck, 1986, p. 158IntroductionDuring the first eight months of 2002 currency re-alignments are suspected of having a majoreffect on Norwegian trade of seafood.  The purpose of this note is to develop a very simple, yetconsistent structural model of the Norwegian seafood trade that highlights how trade flows andprices are affected by changes in exchange rates.  The model is solved for the reduced-formelasticities to indicate the effects exchange rates changes has on producer surplus.Structural ModelThe basic model that describes initial equilibrium in the Norwegian seafood sector is as follows:(1) qN = D(pN) (Norway demand)(2) qW = D(pW) (World demand)(3) pW = f(pN, ZW) (World price)(4) xS = S(pN) (Norway supply)(5) xS = κqN + κqR (Market clearing)4Equations (1) - (5) represent a vertical market with horizontal separation on the demand side.  Ahorizontal separation is specified to reflect the potential market-specific responses to exchangerates, and international price transmission. The price-transmission in equation (3) is specified to be consistent with the hypothesisthat prices are determined in a free market (Bredahl, Meyers, and Collins; Dutton and Grennes), amaintained hypothesis in this study.  The market clearing condition (5) is based on the implicitassumption that the aggregate supply production function exhibits fixed proportions.  The modelis static in the sense that stocks, which are assumed to represent working or “pipeline”inventories, are ignored.The model contains five endogenous variables (qN, qW, xS, pN, pW) and one exogenousvariable (ZW) controlled by market forces external to the Norwegian seafood industry. The model can be expressed in terms of percentage changes by totally differentiating thesystem to yield:(1') qN* = ηN pN*(2') qW* = ήW pW*(3') pW* = ψN pN* + ξW ZW*(4') xS* = εN pN*(5') xS* = κN qN* + κW qW*where the asterisked variables refer to relative changes (e.g., qN* = dqN/qN), and the parametersare as defined in table 1. A special distinction must be given to equation (2') , which represent aimport (or “excess”) demand curve.  This distinction is important because excess demandelasticities can be substantially larger than domestic demand elasticities, a fact that is germane in5the specification of elasticities to be discussed later.  The κN and κW assign the share of supplyconsumed domestically or exported.  In this study we use the values .02 and .98 respectively.Equations (1') - (5') belong to the class of models called Equilibrium DisplacementModels (EDMs).  EDMs’ strengths and weaknesses for policy analysis are described by Piggott(see also Davis and Espinoza).  Their main virtue is the ease with which reduced-form elasticitiescan be computed.  To obtain these, the model is first expressed in matrix notation as follows:(6) Π Y = Γ Z,where Π is an 5 x 5 matrix of parameters corresponding to the model’s endogenous parameters,Y is an 5 x 1 vector of endogenous variables,  Γ is an 5 x 1 matrix of parameters correspondingto the model’s exogenous variable, and Z is a 1 x 1 vector containing the exogenous variable. Premultiplying (7) by Π’s inverse yields:(7) Y = Ε Zwhere Ε = Π-1 Γ is a 1 x 5 matrix containing the model’s full set of reduced-form coefficients orelasticities. To compute Ε numerical values have to be assigned to the model’s parameters.Parameterization Demand ElasticitiesNumerical values for the domestic demand elasticities were assigned based on theory and areview of econometric estimates provided by Rickertsen. Rickertsen found the own-priceelasticity estimate for fish in Norway to be -0.64, evaluated at its mean value.Since no estimates exist for the World elasticity, we examine the literature to see what6estimates exist for different products and markets. Cheng and Capps report a own-price elasticityestimate for finfish in the US to be -0.6746, evaluated at its mean value. In this study, they alsorefer to other studies of the US market. Some of these estimates are, Cod (-.405), Shrimp (-0.63)and Total seafood (-0.465). Salvanes and DeVoretz found own-price elasticity estimates forCanadian households to be in the range of -0.9149 (Fresh fish), -0.9635 (Cured fish), -0.9836(Canned fish) and -0.9450 (Other fish).Unfortunately, these estimates are not directly applicable to this study since they are toonarrowly defined, i.e., they are either product or country specific. What is needed is an estimatesof the World excess demand, that pertain to all product forms from all supply sources. Given thatsuch an estimate is not available, an elasticity was derived using equation (8), namely:(8) ήW = [(1 - mW)/mW] εW + (1/mW) ηWwhere mW = (DW - SW)/DW > 0 is the world’s import share (where DW - is world demand, whileSW - is world supply of seafood). The UN organization FAO estimated the world’s import shareto be about 60% in 1999. The εW is the worlds “domestic” supply elasticity for seafood, and ηW isthe corresponding world “domestic” demand elasticity in absolute value.  We assume that theworld’s domestic supply and demand responses to price are similar across deficit regions and setεW = 0.5 and ηW =0.67.The estimates of ήW obtained in this fashion are interpreted as world importers’ long-runresponses to price; to obtain the corresponding short-run responses we set εW = 0.  This procedureyield a short-run world import demand elasticity of 1.11; the corresponding long-run elasticity is1.45.  Thus, demand responses to price in this model are elastic both in the short and the longrun.7International Price Transmission ElasticitiesNo empirical evidence exists to indicate the extent to which changes in the domestic seafoodprice, exchange rates, and shipping costs are passed on to foreign consumers. A study done onsalmon by Kinnucan and Myrland (2001) found a price transmission elasticity of 0.94 and acorresponding exchange rate transmission elasticity of 0.74. We know from theory that both ofthese transmission elasticities has to be less than one. Bredahl, Meyers, and Collins state (p. 59):A free-trade model with nonzero transportation costs will have price transmission elasticitiesacross countries that are less than one.  If the foreign price is differentiated by transportationcosts or subject to a constant tariff (PF = Pus + C), then Epi [the elasticity that expresses theresponse of the ith country’s price to a change in the U.S. price] will be less than one.  If theforeign price is less than the U.S. price, the case if imports are subsidized (PF = Pus - C), Epi willbe greater than one.When discussing the effects of a domestic currency depreciation on foreign prices, Dutton andGrennes state (pp. 104-05):The percentage change in the foreign currency price of exports (PX*) associated with a givenchange in the exchange rate (E) can be expressed asdPX*/PX* = [1/(1 - ηX/εX)] dE/Ewhere ηX and εX are the elasticities of demand and supply for exports.  Unless the supply ofexports is infinitely elastic, the depreciation will be incompletely passed through to foreignconsumers.With these caveats in mind, we use the values from Kinnucan and Myrland (2001) in thesubsequent analysis.8Norwegian Supply ElasticitiesThe Norwegian supply elasticity corresponding to the aggregate supply curve for Norwegianseafood has not been estimated by an empirical study.  However, the elasticity for farmed salmonwas estimated by Steen, Asche, and Salvanes using annual data for the period 1984-95.  Thisstudy indicated a “intermediate-run” (two year) elasticity of 1.00, and a “long-run” (four year)elasticity of 1.54.  However, Norway has a feed quota arrangement that makes the supply ofsalmon more inelastic.  Kinnucan and Myrland (2002) show that the feed quota biases the supplyelasticity downwards, and their adjusted supply elasticity is 0.39. Gordon, Hannesson and Bibbestimate supply elasticities for Norwegian Frozen and Salted fish. These were reported to be0.425 for Frozen fish, and 1.07 for Salted fish, evaluated at mean values.  Given these estimateswe use the value εN = 0 for the short run calculations, and εN = 0.3 for the long run evaluation.We have seen that all reported elasticities used in this study are highly uncertain. Toevaluate how this uncertainty affect our conclusions a stochastic simulation in a Monte Carloframework was used.  All parameter values were given distributions (see table 1), and the modelwas recalculated 10.000 times using the software @Risk to give a confidence interval of thefindings.Reduced-Form ElasticitiesThat exchange-rate effects can swamp sector-specific policies is clear from a comparison of thereduced-form elasticity (table 2).  Focusing first on short-run impacts, pN*/ZW* = -0.78, whichmeans a 10% increase in kroner’s value against the export currency reduces the Norwegian price9by 7.8%.  As for long-run impacts, pN*/ZW* = -0.64, which means a 10% strengthening of thekroner against the export currency reduces the Norwegian price some 6.4%.In assessing relative impacts, elasticity estimates alone are not sufficient.  The actualpercentage changes in the Norwegian currency against the major currencies during the first eightmonths of 2002 is used.  The mean appreciation of the krona during this period was 8%. Combining this information with the reduced-form elasticities provides a basis for determiningthe relative impact of this appreciation.Welfare AnalysisA key issue from the Norwegian perspective is an estimate of the loss in producer surplus due tothe appreciation of the Norwegian krona.  To determine this, we measured producer welfareeffects using the formula:(9) ∆PS = [pN*/ZW*] ZW* v (1 + ½ [qN*/ZW*] ZW*)where ∆PS is change in producer surplus due to the exchange rate.  Equation (8) is anapproximation formula.  It is based on the assumption that demand curves shift in a parallelfashion, which may not be the case.  However, if equilibrium displacements are small (say 10%or less), as is the case in this study, (9) provide a good approximation to the true welfare changeseven if shifts are not parallel (see Alston, Norton, and Pardey and references cited therein).To apply (9) we set v = 19.005 million kroner, the export value of seafood during the firsteight months of 2001.  The bracketed terms in (9) are set equal to the corresponding reduced-form elasticities calculated earlier.  ZR* in (9) is set to -8.0% since the Norwegian krona hasappreciated this amount against the European euro and an average of the main export market1A 90% confidence interval on this value is in the range of 1.045 - 1.275 million kroners.2A 90% confidence interval on this value is in the range of 790 - 1.119 million kroners.10currencies during the first eight months of 2002.Scenario 1 represents our “best-guess” estimate of the short-run currency effect, whereas scenario 2 includes a more long-run perspective since it allows for supply response.Results based on scenario 1 indicate that the exchange caused an initial (short-term)reduction on Norwegian producer surplus equal to 1.158 million kroner1.  In the long run(scenario 2)  producer surplus dissipate due to supply response to 954 million kroner2.  Concluding CommentsOverall, market prices are very sensitive to exchange rates changes.  Currencyrealignments, therefore, can easily swamp or obscure other positive demand effects such asadvertising and increased income, as Houck suggests. The actual reduction in export value was1.520 million kroner during the first eight months of 2002. Using the numbers from the short runsimulations (scenario 1), this indicates that the exchange rate contributed to 76% of thisreduction.  Still, caveats are necessary to bear in mind in that results are conditional on modelassumptions, and on the accuracy of parameter values.  International price transmission andexchange-rate elasticities are based on values from a study done on salmon, and on theassumption that prices are determined in a free market. In this note we look at a simple structural model from the Norwegian perspective. What isimportant to bear in mind when looking at exchange rates and trade policy effects in an export11market setting is that our international competitors currencies also comes into play. Consider thecase when our currency appreciates against a major export market currency, whereas one of ourinternational competitors see a depreciation of its currency.  This change in our competitorscurrency also has a spillover effect into our equilibrium prices.  This type of spillover effectscould potentially be large and might reinforce the negative effects a currency appreciation alreadyhas on exports.  However this type of spillovers are not considered in this study.12Table 1.  Parameter Definitions and ValuesItem Definition ValueηN Domestic demand elasticity -0.64 aήW Demand elasticity for the world - Short Run -1.11 bήW Demand elasticity for the world - Long Run -1.45 bψN Price transmission elasticity 0.94 cξW Exchange rate transmission elasticity 0.74 cεN Norwegian supply elasticity 0  or 0.3da Rickertsen (1996). For the stochastic simulations the parameter values is assumed to follow a triangulardistribution with minimum, most-likely, and maximum values as follows: (-.32,-.64,-.96).b Excess demand elasticities based on formula (8); see text for details. For the short run stochastic simulations theparameter values is assumed to follow a triangular distribution with minimum, most-likely, and maximum values asfollows: (-.555,-1.11,-1.655). The corresponding values for the long run simulations were: (-.725, -1.45, -2.175).c Kinnucan and Myrland (2001). For the stochastic simulations the parameter values of the price transmission isassumed to follow a triangular distribution with minimum, most-likely, and maximum values as follows: (.88, .94,1). The corresponding values for the exchange rate transmission were: (.64, .74, .84).d See text for details. For the long run stochastic simulations the parameter values is assumed to follow a triangulardistribution with minimum, most-likely, and maximum values as follows: (0, .3, .6).13Table 2.   Reduced-Form Elasticities for Exchange RateTime Horizon/Exogenous VariableEndogenous VariablePN* PW* qN* qW* XS*Short run (εN = 0):    ZW* -0.7775 0.0091 0.4976 -0.0102 0.0000Long run (εN = 0.3):    ZW* -0.6378 0.1404 0.4082 -0.2035 -0.191314ReferencesAlston, J. M., G. W. Norton, and P. G. Pardey.  Science Under Scarcity: Principles and Practicesfor Agricultural Research Evaluation and Priority Setting.  Ithaca and London: CornellUniversity Press, 1995.  Bredahl, M. E., W. H. Meyers, and K. J. Collins.  “The Elasticity of Foreign Demand for U.S.Agricultural Products: The Importance of the Price Transmission Elasticity.”  AmericanJournal of Agricultural Economics.  61 (1979): 58-63.Cheng H-T, Capps., O. Jr. (1988). “Demand Analysis of Fresh and Frozen Finfish and Shellfishin the United States.” American Journal of Agricultural Economics, 70(3), 533-542.Davis, G. C. and M. C. Espinoza.  “A Unified Approach to Sensitivity Analysis in EquilibriumDisplacement Models.”  Amer. J. Agr. Econ.  80 (1998): 868-79.Dutton, J. and T. Grennes.  “The Role of Exchange Rates in Trade Models.” In Elasticities inInternational Agricultural Trade.  (C. A. Carter and W. H. Gardiner, editors.)  Boulderand London: Westview Press, 1988, Chapter 4, pp. 87-135.Gordon, D. V., Hannesson, R., and Bibb, S. (1993). “Testing for Output Substitution Possibilitiesin Cod Fish Processing in Norway.” Marine Resource Economics, 8, 17-30.Houck, J. P. Elements of Agricultural Trade Policies.  Prospect Heights, Illinois: WavelandPress, Inc., 1986 (reissued 1992).Kinnucan, H. W., and Myrland, Ø. (2001). “Optimal promotion expenditures for salmon: theimportance of international price linkages.” Aquaculture Economics & Management,5(5/6), 319-335.15Kinnucan, H. W., and Myrland, Ø. (2002). “The Relative Impact of the Norway-EU SalmonAgreement: A Midterm Assessment.” Journal of Agricultural Economics, 53(2).Piggott, R. R. (1992). Some Old Truths Revisited. Australian Journal of Agricultural Economics36: 117-40.Rickertsen, K. (1996). “Structural change and the demand for meat and fish in Norway.”European Journal of Agricultural Economics, 23(3), 316-330.Salvanes, K. G., DeVoretz, D. J. (1997). “Household demand for Fish and Meat Products:Seperability and Demographic Effects.” Marine Resource Economics, 12(1), 37-55.Steen, F., F. Asche, and K. G. Salvanes.  “The Supply of Salmon in EU: A NorwegianAggregated Supply Curve.”  SNF Working Paper 53/97.  Centre for Fisheries Economics,Norwegian School of Economics and Business Administration.  Bergen, Norway.December 1997.

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A note on measuring the effects of exchange rate changes on Norwegian exports of seafood

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