Annex 2A


a purchase of (effective demand for) weapons counts as a increase in welfare while the food
needs of poor with insufficient purchasing power are left out of consideration.

The clear distinction between tradable and non-tradable goods on which the model is
based with the implied assumptions concerning price levels and price formation
processes does not comply with reality. While there are certain sectors whose outputs
largely fall under one of these categories (e.g. cash crops for export under tradables, most
government and many other services under non-tradables), there is a wide range of goods,
including most food commodities, which fall somewhere in between the pure categories. This
means, in effect, that the prices of such goods are neither exclusively wrid
market prices (as assumed to apply to tradables) nor exclusively by domestic supply and
demand farctr (as assumed to apply to non-tradables). Some of the factors which imply
diversions from the model assumptions are as follows:

* The degree of tradability of a good varies between different regions, due to transport
 costs and depending on the existing marketing and physical infrastructure. Generally it
 can be assumed that the number of tradable goods is much greater in border areas and
 close to major cities than in remote rural areas. Many goods belonging to the tradable)
 category in the first instance may be non-tradables in the latter case. /

* The degree of tradability varies over time, depending on changing price differentials
 between different areas. If, for example due to a currency devaluation, the price for
 imported food rises substantially in the major consumption centres, a good produced in a
 remote area and belonging to the non-tradable category before may start to be sold to the
 cities, hence to developing into an importable or import substitute.

 Although some local food products are non-tradables, they function as imperfect or
 quasi- substitutes for importable food commodities. This applies to inferior low-cost
 food commodities such as cassava and millet. If, due to a currency devaluation, the prices
 of imported foods increase, the demand for cheaper import substitutes expands. The
 increased demand will, contrary to the model assumptions, probably lead to price
 increases in this category of non-tradables, too.

 Many imported goods have some local value-added components in their final consumer
 price (e.g. transport, storage and marketing costs) which are non-tradable. On the other
 side, many non-tradable goods have some imported components (e.g. production inputs).

 The existence of market monopolies in export and import sectors implies particular
 price formation processes. In order to remain competitive, a trader dealing with imported
 food may be prepared to reduce his monopoly margin and increase the price less than
 would be expected from a currency devaluation. On the other hand, an exporter may
 retain a percentage of the extra profit incurring from a currency devaluation and not pass
 it on to the producers.

 There are further reasons why the prices of tradables and non-tradables do not behave
 as assumed in the model, e.g. economies of scale in export and import marketing,
 trade barriers, depressing effects of simultaneous adjustment in a number of


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