The Wheat Export Boom and the Strained Port
A regional economy exports 4 million tonnes of wheat annually through a single port with a capacity of 4.2 million tonnes. A new free trade agreement opens a large overseas market, and growers respond: planted area rises 15% and favourable weather lifts yields 10%. Simultaneously, a mining company begins exporting iron ore through the same port, consuming 0.6 million tonnes of capacity. The port authority cannot expand before the next harvest. Domestic wheat consumption is steady at 0.8 million tonnes and is price-inelastic. The central bank observes that the economy is already near full employment and inflation has risen from 2.5% to 4.1% in two years.
1. Calculate the likely export volume next harvest and assess the consequences for the domestic wheat price and the balance of payments. Show your reasoning.
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Volume calculation: New production = 4.0 million × 1.15 × 1.10 = 5.06 million tonnes. Domestic use is 0.8 million, leaving 4.26 million tonnes available for export. But usable port capacity is 4.2 − 0.6 = 3.6 million tonnes. So exports are capped at 3.6 million tonnes, and 0.66 million tonnes of wheat must be stored, discounted, or sold domestically.
Domestic price: Because domestic demand is price-inelastic and supply to the domestic market surges (the surplus that cannot be exported), the domestic price will fall sharply. A small fall in price will not clear the surplus; a large one is needed. Growers face lower domestic returns even while world prices are strong.
Balance of payments: Wheat export receipts rise but are constrained by the port bottleneck, so the current account gain is smaller than the production increase implies. Iron ore exports add to the credit side, partially offsetting the lost wheat revenue. The net effect on the current account is ambiguous and depends on relative world prices; the case illustrates that supply-side capacity, not just demand, determines export outcomes.
2. The government proposes subsidising a second grain terminal. Evaluate this policy using the economic objectives of price stability and external balance.
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Case for the subsidy: The bottleneck is infrastructure, and a second terminal would lift capacity above 5 million tonnes, allowing the full 4.26 million tonnes to be exported. This improves the current account, raises national income, and removes the domestic glut that is depressing local prices. It also reduces the risk of future bottlenecks as iron ore volumes grow.
Case against: The economy is near full employment and inflation is already 4.1%. A large construction program would add to aggregate demand, worsening inflationary pressure and possibly requiring tighter monetary policy. The subsidy also carries an opportunity cost: funds spent on the terminal cannot be spent on other infrastructure. If world wheat prices later fall, the terminal may be underused.
Judgement: The policy addresses a genuine supply constraint and would improve external balance in the medium term. However, its short-run inflationary impact is significant given full employment. A better-timed approach might phase construction, fund it through user charges rather than a subsidy, and coordinate with monetary policy. The subsidy is defensible on external-balance grounds but poorly targeted on price-stability grounds.