Price Supports and Production Quotes

9. 4 Price Supports and Production Quotes

Apart from putting fewer prices, the government has the best option to raise the price of goods in different ways. American agriculture policy is totally based upon the price supports system. In which the government has the full right in setting the market price of the goods which is above the market level which is one free basis. They are also entitled to purchase the output which is required to maintain that rate which has been set by them. The other ways, by which government can raise the prices by way of restricting production, which can be done directly or by controlling the excess profit that is given to sellers. In this part, we will come across with such types of policies as how they work and what their effect on buyers along with producers and federal budget.

Price supports

In United States, the main aim of price supports is to increase the cost of daily products along with corn, tobacco and peanuts which will directly increases the higher income of the producers. Under this program, the government is responsible for setting support cost Ps and then it is purchased up as whatever output is required in order to keep the value of market cost at this level. Let us examine the losses and gains which have come from results to consumers along with producers and government.

Consumers

For the price Ps, whatever quantity which is demanded by the consumers declines to Q1, but there is an increase in the quantity which has been supplied to Q2. In order to maintain the price along with avoiding the inventories which piled up in producers warehouses, the government have to purchase amount Qg=Q2-Q1.

This is done because, the government has adds its demands to Q8 to the consumers demand where sellers can sell all their goods at price Ps. This is done since those buyers who want to purchase the goods will pay high cost Ps in place of Po, consumers will suffer consumer surplus loss provided by rectangle A. This is because of high price thenbuyers will not buy goods nor buy less where this loss of surplus will be provided by triangle B. So at less price that we have examine above, the consumer will have to suffer loss.

Producers

On the other side, producer’s gain (that is why this policy is in implementation). Producers are now able to sell large quantity Q2 at high price Ps.

The Government

There is cost to the government also (which can be easily paid by way of a tax which is directly cost to the consumers. Cost is (Q2 − Q1) Ps which is paid by the government compulsorily for the output which is purchased by them. In below figure, the amount is shown by large sparkled rectangle. This cost is decreased if the government may dump some purchases i.e. that they should sell them beyond country at lower prices. By doing this, domestic ability of the producers will be hurt as they have to sold the things in foreign market, and government places these domestic producers in the first place.

To find total welfare cost, change the consumer surplus by adding it to variation in producer surplus and then deduct it from the cost to government. So, the total changes in welfare can be seen as

Production Quotas

Apart from coming into this market and purchasing up the output- which indicates an increase in the total demand- the government can raise the price of good by reducing supply. They can do this by decree which indicates by simply setting the quotas as how many products are being produced by each firm. With the help of these quotas, the cost can easily be pushed up to any level.

We will come across with examples where you will come across with different city government who are maintaining high taxi fares. They limit the total supply by having each taxi cab where they will have medallion and then they will limit the supply of total numbers of medallion. Next example is to control the licenses of liquor by state government. It is necessary to have this license before serving beer and alcohol in restaurants and then they should limit the supply of licenses’ where new restaurants will not avail their benefits on one side and it allows to gain more profit to such people who are having licenses’ and earning good profit margins.

In practice, the price supports for agricultural commodities are also affectedby loans. The loan rate will give effect to a price floor. If in loan period if the market prices are insufficient or low, farmers can easily forfeit grain to the respective government (which is specifically because of Commodity Credit Corporation) and this is the full payment for loan. Farmers have the right to do this till the market price increases above the support price.

The effects of the welfare are shown by plotting a graph. The government has the right to restrict the quantity provided to Q1. Then the supply curve will becomes vertical line S, at Q1. You will come across with reduction of consumer surplus by rectangle A (which is for those consumers who buys the goods at higher price+ triangle B( which will show the consumers who will not buy the goods at high price) Producers will gain rectangle A( where they sell the products at higher price) but they will suffer lossfrom triangle C( which is due to production and selling to Q1 instead of Qo. You will come across with dead weight loss which is given by the triangles B and C.

Incentive Programs–

In agricultural policy of U.S there will be reduction in the output by the incentives instead by outright quotas. Farmers will receive financial incentives by Acreage limitation programs which will leave some acreage idle. Fig 9.11 shows about the effects of the welfare by reduction in supply in this way. The supply curve will becomes inelastic  completely to such quantity Q1,when the farmers agrees to have such kind of limitation in  planted acreage, which will lead to an increased of market price from P0 to Ps. With direct production quotas, there will be change in buyer excess.

Now Farmers will go to receive the high price for production Q1 which is corresponding to the surplus gain in rectangle A. There will be loss in producer surplus which is corresponding to C due to the production which is reduced from the Qo to Q1. At last government will pays money to the farmers in the form of incentive in order to reduce the production. There will be full change in buyer’s surplus which is now at

Government cost is in a form of payment which is sufficient to give to the farmers which is in form of an incentive in order to reduce the output to Q1. The incentive here must be at least more than B+C+D because it represents the profit which is additional one and is made by planting at greater price Ps (Ps is high price, which gives farmersan incentive in order to produce greater quantity.

The values will be the same what has come forvariation in producer surplus as the price support maintained by government at the purchase of the output. Farmers should be different in two policies because they both end by gaining same amount. Like consumers have lose same amount of money.

Which of these policies will costs more to the government? Answer is totally depends on sum of triangles that is B+C+D in below figure is more or smaller than (Q2 − Q1) Ps which is the large speckled triangle.  It will at smaller point so that the acreage-limitation program which is costs to the government (and society) is lesser than price supports which are maintained by the government on purchases part.

If acreage-limitation program remains more costly to the society, in that case they are handling the farmer’s money. Total changes in the welfare part can be-

Society will be better in efficiency part if the government will give farmers A +B + D along leaving price and output. Farmers will then at gaining part A +B + D and on the other side government will be on losing part A +B + D for change in total welfare that is zero instead of loss in terms of B+C. In context, the main aim of government policy is not always in economic efficiency.

9.5 Import quotas and Tariffs

Many companies are using import quotas and tariffs in order to keep the domestic price of the products above the world levels which help the domestic industry to enjoy the higher profit which would be under free trade. We will see the cost to taxpayers will be high from this type of protection and loss to the consumers who are exceeding their gain to domestic producers.

 Without quotas and tariffs, the country will be able to import good when the price of them is below the price which would prevail in domestic field when there are no chances of import. It is stated above that this principal where S and Dare domestic supply along with demand curves. Domestic price and quantity is P0 and Q0, if there were no chances of imports where supply and demand is equal. If the world price will come below, then the domestic consumers will have the best option in form of an incentive where they can easily get from abroad and they will do this till imports are not restricted.  Now the next question is how much amount will be bought from abroad? The answer to this simple question can be given by- The domestic price of the products will fall down to the global price at lower price, domestic manufacture will also results in fall, and on the  other  side domestic consumption will  give rise.

Now if the government is having pressure from within the country, it eliminates imports by way of imposing quota of zero— which is forbidding the importation of goods. Now what will be the gain and loss from such policy?

 When no imports were allowed, there will be rise in domestic price to Po. Consumers who are still buying the goods (in quantity Qo) will have to pay more prices and will suffer the loss of an amount of surplus which was given. And, some consumers will not buy the goods at higher price which results in additional loss of consumer surplus which is given by the triangle C.

9.6 The Impact of a Tax or Subsidy

If the government will impose 50 cent per gallon tax and only considering the two methods of collection they will include under method 1 each gas station owner will have to deposit the tax money which is 50 cents per gallons sold in a box which has been locked and that will be collected by the government’s agent.In second method, the buyers will have to pay the tax 50 cents per gallons purchased to government. Which method will help buyer more? Most people will go for method 2 which is wrong.

Burden of tax falls both on buyers and sellers side partly in nature. We see that the share of the tax is borne by the consumers which depend on the shapes of demand and supply curve which is related to elasticity of supply and demand.

Subsidy’s effects

Just in the way we understand the principles related to tax, in the same manner we can easily analyze subsidy. One can also call subsidy a kind of facility that offers negative tax implications. When there is a subsidy under consideration the price incurred by the seller will exaggerate what is actually paid by the buyer and variation between both amounts is the exact value of subsidy. The effect that is created due to subsidy is simply opposite of the taxation procedures. The quantity that is being produced and the quantity that is being consumed will increase because of the provided subsidy.

This entire process is clearly demonstrated with the help of diagram 9.19. When the market price is at P0 level it indicates the pre – subsidy case. At this point the demand elasticity and the supply elasticity are almost at par. Due to this effect the advantage arising from the subsidy is available in equal proportion to the sellers as well as the buyers. This does not always happen in the case related to tax. Talking about the general scenario if the ES/ED is small then most of the benefit of the subsidy goes to the buyer and if the ED/ES is large then benefits of subsidy will be availed mostly by the sellers.

In the questions associated with tax, the supply curve is there, along with the demand curve and the exact amount of subsidy under consideration. Taking all these things into account the aspects related to the quantity and the price can be easily solved. The 4 main conditions those are required for market clearing as in the case of demand are same for the case of subsidy also. The difference that is on the account of variation in the price of buyer and seller is equal to the exact amount of subsidy. These conditions can be written very easily in the form of algebraic equations.

In order to make clear in your mind, the exact impact that occurs because of a subsidy or due to tax and its comprehensive analysis you can get some extensive knowledge by working on some of the examples given at the exercises no. 2 and no. 14 that you will find at the last section of this chapter.

Summary

• Figures of supply and demand can be used in simple form in order to analyze government policies in different way including price controls along with minimum prices and price support programs with production quotas or in the form of incentive programs in order to limit output and importing tariffs and quotas, with other subsidies and taxes.

• In every case, consumer along with producer surplus is used for evaluation of gains along with losses to producers and consumers. When there is application of methodology how natural gas price could be controlled, airline regulation then in this case the cost supports for wheat and sugar quota will shows these gains and losses at higher scale.

• The intervention of the government leads to a loss; in such case when the consumer and producer surplus weigh equally, the net loss from govt. policies occur is able to shift surplus from one to another group. Economic inefficiency is in the form of dead weight loss that must be considered while designing and implementation of the policies.

Review questions

1. What is the meaning of Dead Weight Loss? Why it is generally seen that due to the effect of price ceiling there is always the resultant in the form of Dead Weight Loss?

2. Given a condition that the supply curve related to a particular good is totally inelastic in nature. If the government has planned that the effective level of price ceiling below the desired level for market clearing purpose then whether it would lead to Dead Weight Loss or not? Please explain in your own words.

3. How can the consumers become better off when the price ceiling is implemented? State the circumstances under which price ceiling can make the consumers worse off?

4. Given the condition that the government is regulating the price of a particular good such that it cannot go down beyond the minimal level. If such a minimum price is applied can this situation result in the producers becoming worse off as a whole? Explain the situation in your words.

5. What are the ways by which the limits associated with production are taken into practice to increase the price level of the given services and goods-
   A. Rides of taxi
   B. Drinks in the bars and restaurants
   C. Corn or wheat?

6. If there is a situation that the government is planning to raise the income level of the farmers. Then in such a case why do the programs related acreage limitation and the ones associated with price support system cost much more to the society than normally giving the farmers money just in a simple way?

7. If the government wishes that the imports of specific goods should be limited, then in such a case is it the correct way that tariff or an import quota is applied? If so or so not please explain the reasons behind it?

8. The ultimate burden of tax is borne by the consumers as well as the producers. What are the situations under which the consumers will be paying majority of the taxes? Which are those conditions in which the producers will be paying most of the taxes? What are the aspects that help in determination the exact share of the subsidy that will be availed by the consumers as benefit?

9. Why it is always seen that the tax leads to Dead Weight Loss? Explain that what is the way by which the size of this loss is determined?

 

Links of Previous Main Topic:-

• Introduction Markets and Prices Preliminaries
• The Basics of Supply And Demand
• Consumer Behavior
• Appendix to Chapter 4 Demand Theory a Mathematical Treatment
• Uncertainty and Consumer Behavior
• Production
• The Cost of Production
• Production and Cost Theory   A Mathematical Treatment
• Cost in the Long Run
• The Cost of Production Production with Two Outputs
• Profit Maximization and Competitive Supply

Links of Next Microeconomics Topics:-

• Market Power Monopoly and Monopsony
• Monopolistic Competition and Oligopoly
• Game Theory and Competitive Strategy