Import Demand When Domestically Produced and Imported Goods Are Perfect Substitutes

Inorganic fertilizer production is only to meet the increasing domestic food production. In contrast, countries in the Middle East, due to abundant and cheap gas supply, have expanded the development of inorganic fertilizer production industry, although the consumption markets are relatively far away.

The political changes in CEE & CIS countries and the transition of these economies to market mechanisms have caused a sharp decline in domestic fertilizer consumption in these countries; massive exports to the EU15 have significantly damaged the EU15 nitrogen fertilizer industry.

While most countries are trying to build their own fertilizer industry to ensure national food security, no country's fertilizer industry has a competitive advantage.

b. Current world demand for urea

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Biogas technology has been strongly developed in many countries. The environmental impact of nitrogen has caused much controversy and received special attention from international public opinion. At the Third International Conference on Nitrogen, countries issued the "Nanking Declaration" calling on governments to have policies and solutions to maximize the benefits of nitrogen use and minimize nitrogen leakage into the environment.

Agricultural prices and bad weather affected the cultivation and consumption of inorganic fertilizers in 2005, especially in South America. In general, the demand for nitrogen fertilizers continued to increase. In 2003/04, the global demand for N was 85.8 million tons, up 1.1% over the previous year, and in 2004/05 it was about 88.3 million tons, up 2.8% over 2003/04.

In 2003/04, the agriculture of South America and South Asia grew strongly, especially in Brazil and India, so the demand for nitrogen fertilizer in these regions also increased (South America increased by 2 million tons, or about 18.7%, and South Asia increased by 0.9 million tons). Meanwhile, in East Asia, the demand for nitrogen fertilizer decreased sharply (-1.1 million tons) due to crop failure in China due to severe weather.

In 2004/05, agriculture in China and India grew strongly, with demand for nitrogen fertilizers in East Asia increasing by about 2.3 million tons and South Asia by about 1.0 million tons. The largest increase in demand for nitrogen fertilizers in 2004/05 was in Southeast Asia, about

6.8%, followed by Northeast Africa with an increase of about 6.3%. The region with a sharp decrease in nitrogen fertilizer demand is North America, about -0.4 million tons, due to the loss of food prices there.

c. Current world urea supply

According to the International Monetary Fund, nitrogen fertilizer consumption began to recover from late 2001 and increased rapidly until 2004. In 2005, the growth rate will tend to decrease. Due to the high prices of oil and natural gas, nitrogen fertilizer prices also increased continuously from 2001 to 2005.

To meet the demand for fertilizers, average urea production in 2004 increased by 4% compared to 2003. However, world urea production was close to record levels, with most producers operating at between 75% and 95% of their capacity. Tight markets led to high prices for most fertilizers, intermediates and raw materials since the beginning of 2004. Urea trade increased steadily by 3%. Urea exports increased mainly from China, Qatar and Russia, while urea exports from Egypt and Indonesia declined sharply. Imports from major consumers remained relatively stable and decreased compared to the previous year. World ammonia production capacity expanded to 159.1 million tonnes in 2004. World urea capacity also increased by about 6 million tons to 137.4 million tons, of which half of the increase was in China. In 2005, world ammonia capacity increased by about 2.8 million tons and urea capacity increased by about 5.2 million tons. In 2005/06, demand for nitrogen fertilizer increased by only less than 1.5%. If in 2004 urea supply exceeded demand by 9 million tons, in 2005 supply exceeded demand by about 11 million tons, including unused capacity.

According to the International Fertilizer Association (IFA), in the next 5 years, fertilizer consumption is expected to reach 171.9 million tons of nutrients, an increase of 11.6% compared to 2005/06, corresponding to an average increase of 2.2%/year, of which nitrogen fertilizer will increase by 99.4 million tons, an average increase of 1.8%/year. Most of this increase will come from the Asian region, with South Asia and East Asia accounting for more than half of this total increase, increasing by an average of 3.3% and 2% respectively. Specific regions in the world where IFA predicts average fertilizer consumption increases are as follows: North America 2.1%; Southeast Asia 3.3%; Eastern Europe and Central Asia 3%; Oceania 2.1%; West Asia and Northeast Africa 1.9%; Africa 4.2%; Western Europe stagnates, Central Europe increases 1.2%.

Unlike the above regions, Northeast Asia is likely to see a 1.4% reduction in nitrogen fertilizer demand per year. IFA also notes that factors such as oil prices, the development of bioenergy and avian influenza could have a direct impact on global fertilizer prices and demand in the coming years (Appendix PL-2.13 to PL-2.16).

2.4 Leamer's import demand model

2.4.1 The problem of aggregate demand

Demand theory is based on the assumption that consumers always choose a set of consumption goods to maximize their utility on a limited budget. The optimal consumption problem can be written as:

v(p, I) = Max x u(x) such that p T x = I. (2-3)

In which: x = (x 1 , x 2 , … , x n ) is the set of consumption goods, u(x) is the utility function, p is the price vector of that set of goods, p T x is the expenditure on the set of consumption goods and I is the budget for consumption.

In many situations, when necessary, we need to use the consumer choice model with local utility maximization problems; for example, we want to model the consumption choice of "meat" without distinguishing how much of it is beef, pork, or lamb... We can divide the set of consumer goods into two sets of goods denoted by (x,z). In which x is the consumption vector of different types of meat and z is the consumption vector of the remaining goods. The price vector is also divided similarly into (p,q); with p being the price vector of meat and q being the price vector of the remaining goods. The consumer utility maximization problem then has the form.

Max x u(x) such that p T x + q T z = I. (2-4)

The question now is under what conditions can we study the demand problem for a commodity x without knowing how that demand is divided among the components of the commodity x. To solve this problem, we construct an index of the scalar quantity X, and a scalar price index P. P is then viewed as a kind of "price index" that gives the average price of the commodity x.

the above, and X is a quantity index indicating the average consumption of meat. The new utility function now has the form U(X,z) which depends only on the quantity index of consumption of group of goods x, and the problem:

Max x U(X, z) such that PX + q T z = I. (2-5)

Gives us the same solution as solving the utility maximization problem (2-4)

In empirical studies of the demand for a particular good, people often use the two-goods model. In that case, z is a single good with price q, and the remaining goods belong to the group of goods X. The model (2-5) now has the form:

Max x U(X, z) so that PX + qz = I (2-6)

The demand function for good z now depends on its price, the price index P of the group of goods X and the consumption budget I: z = z(q, P, I). Since this demand function is homogeneous of degree 0, we can write: z = z(q/P, I/P). In practice, the price index P of other groups of goods is often taken as the consumer price index CPI, [64].

2.4.2 Import demand function according to Leamer's theory

a. Select variables

Regarding the dependent variable. Demand theory suggests that quantity is the appropriate dependent variable, so we must divide the time series of import values by the corresponding prices to obtain the dependent variable in terms of quantity. The dependent variable is then given by:

M = V M /P M (2-7)

In which: M is the import quantity of one or a group of goods, P M is the price of imported goods or the price index of the group of imported goods, V M is the import value. It is obvious that with goods that are homogeneous in quality, M is an accurate measure of the quantity of imported goods.

Regarding the explanatory variables. The quantity of imports demanded by consumers will depend on their income, the price of imported goods, and the prices of other consumer goods. That proposal for an economy we can write the aggregate import demand function as:

M = V M /P M = f(P M , P Y , Y) (2-8)

Where: Y is nominal domestic income, P M is the price of imported goods and P Y is the price of other domestically produced goods. In fact, the demand relationship for individual consumers can be aggregated by individual and by goods to obtain formula (2-8) by the aggregation theorem. According to demand theory, equation (2-8) can be rewritten as (2-9)

M = f(P M /P Y , Y/P Y ) (2-9)

The import demand theory discussed above is based on the assumption that imported goods and domestically produced goods are substitutes but not perfect substitutes. However, suppose that imported goods and domestically produced goods are perfect substitutes, or that their price elasticities are very large, as in Figure 2-2: DD is the domestic demand for a good, SS is the domestic supply. The difference between the demand and supply diagrams MM represents the excess demand—the demand for imported goods—for the same imported good as the domestically produced good. From an empirical point of view, the very important difference between the two cases, which is related to equation (2-8) and illustrated in Figure 2-2, is that in the former case, domestic supply affects imported goods only indirectly through its impact on domestic prices, whereas in the latter case, domestic supply affects import demand directly. Thus, the import demand function needs to include domestic supply variables.

The basic import demand function suggested in this second case is: M = f(S, Y, P, P A ) (2-10)

In which: S is a variable that shifts the domestic supply function, Y is revenue.

Nominal import, P is the general price of domestically produced and imported goods, and PA is the price of domestic goods that are imperfect substitutes for the good under consideration, [53].

There has been little effort to explore the relationship (2-10) except to point out that there is a variable related to S. The variable S should represent the factors affecting the supply of import-competing goods. It should be noted here that the ability of the import-competing industry can be reflected in current investment. Other factors that could be considered include the cost of inputs such as labor and raw materials.

Supply

D Bridge

S Overpass

O Q

Figure 2-2: Import demand when domestically produced and imported goods are perfect substitutes

To capture complex demand phenomena requires more than two variables, depending on the specific case, other necessary explanatory variables may be considered.

b. Function form

The most commonly used forms are linear and log-linear functions as

after:

M = a + bY/P Y + cP M /P Y + u (2-11)

log M = log a 1 + b 1 log(Y/P Y ) + c 1 log(P M /P Y ) + log u (2-12)

In equation (2-11), a is the intercept, b is the marginal propensity to import, c is the import coefficient of relative prices, and u is a random error term reflecting other secondary effects, which are assumed to be uncorrelated with the variables.

Explanation. In the log-linear form the price and income elasticities are measured by the coefficients b 1 and c 1 read directly from the regression results (2-12)

The disadvantage of the linear form is that the price elasticity decreases as income increases. Therefore, the log-linear form is preferred because it controls the elasticity by a constant. According to Khan, MS and KZ Ross (1977), Dilip Dutta and Nasiruddin Ahmed, the log-linear form should be used rather than the linear form when modeling the aggregate import demand function. Goldstein and Khan argue that the price elasticity of a country's aggregate import demand usually falls in the range (-1;-0.5) and in the range (1;2) for real income. [37], [46]

In theory, import demand should be differentiated according to whether it is consumption demand or production demand. Each economic phenomenon requires a suitable set of explanatory variables. We can eliminate aggregation within each group of goods according to the nature of domestic substitutes by special treatment when there is a nearly perfect substitute available domestically, [53].

2.4.3 Some empirical studies of India and Mexico

a. India 's aggregate import demand function ( Dilip Dutta, 2001) [37]

In his study of India 's aggregate import demand function for the period 1971-1995, Dilip Dutta of the University of Sydney used the import demand model:

Ln(RIMPORT t ) = a 0 + a 1 ln(RIMPRICE t ) + a 2 ln(RGDP t ) + a 3 D t + u t (2-13)

In which, RIMPORT: actual quantity of imported goods; RIMPRICE: relative price of imported goods; RGDP: GDP of India; D: dummy variable, taking value 0 for the period 1971-1991, value 1 for the period 1992-1995, u: random error. The model is built under the assumption: imported goods are imperfect substitutes for domestically produced goods and the world's supply of imported goods to India is perfectly elastic.

The objectives of this study are: First, to find the long-run relationship between India's aggregate import demand and the major factors influencing import demand based on annual data for the period 1971-1995. Second, to study the impact

of India's import liberalization policy on import demand. The model uses dummy variables to assess the impact of liberalization policy on import demand. The regression model shows that all these three explanatory variables prove to be important determinants of India's import demand function.

The results show that: India's aggregate import demand is inelastic to price; the income elasticity is greater than 1, reflecting the increase in import demand at a rate greater than the increase in real GDP; with coefficients a 1 = - 0.47 and a 2 = 1.48 relatively consistent with the ranges of import demand elasticity to price and income proposed by Goldstein and Khan. And India's trade liberalization policy has a certain impact on import demand with a significance level of 0.14. [37].

b. Forecasting Mexico's demand for imported dairy products (Aysen Tanyeri-Abur and Parr Rosson, 2002) [31]

In this study, the authors estimated domestic and import demand functions for four dairy products, namely, fresh milk, non-fat condensed milk, cheese, and butter, to find out how the consumption of dairy products changes with changes in income, prices, and policies. The results show that the demand for fresh milk is relatively elastic and most sensitive to changes in price, the demand for non-fat condensed milk is inelastic to its price, but there is still no evidence of a strong substitution relationship between the two products; this raises the question of whether other substitutes for fresh milk exist. The income elasticities show that fresh milk, butter, and cheese are consumed more than non-fat condensed milk at higher income levels. The estimates of import demand equations show that the income elasticity of import demand for fresh milk is the largest and that Mexico is likely to import more fresh milk than condensed milk as per capita income increases. This is an important result indicating that as the country becomes richer, the import of fresh milk is much larger than the import of condensed milk. The fact that the elasticity of both import and domestic demand for fresh milk is very high suggests that there are substitutes, leading to the hypothesis that there are other drinks, such as Coca Cola or other soft drinks, that are stronger substitutes for fresh milk than for condensed milk.

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