CASE STUDY:- RICE SUBSIDY IN PARAVIA

(submitted by Ankur Gupta and Pradeep Yadav)

 Current price of Rice in Paravia is 600 pesos/kg which is very high.

 Therefore, Domestic demand (Do) and supply (So) curves will make equilibrium at
600 pesos/kg of rice and Equilibrium quantity is Qo.
 Even after unrestricted international trading permitted in Paravian rice market, price
will reduced upto 400 pesos/kg only which is not inclined with prices mentioned in
election manifesto of ruling party (i.e. 300 pesos/kg).
 Due to unrestricted international trading permitted in Paravian rice market, domestic
consumers will have access to rice quantity at 400 pesos/kg as depicted by supply
curve S1.
 The supply curve (S1) to the domestic consumers will bend at 400 pesos. At this
price, consumers will consume Q2 quantity and Q1 quantity (<Qo) will be supplied
by the domestic producers and for meeting the consumer demand of rice additional
quantity of Q2–Q1 will be supplied through imports.
 As mentioned in assignment “Under the current estimates of demand and supply for
rice, it is expected that free trade will lead to 200 million Kgs. of rice imports”. It
signifies that import quantity after free trade is 200 Million Kgs and shown as Q2-Q1
in below figure.
 To reduce the price further to 300 pesos/kg (as promised in the election manifesto),
the government will have to give subsidy of 100 pesos/kg of rice. The supply curve
for the domestic consumers will bend at Price P1=300 pesos. At this price, the
consumers will consume Q4 (point-H) (>Q2) quantity and suppliers will be willing to
supply Q3 (point-G) (<Q1), therefore imports will increase to Q4-Q3 which will be
definitely more than Q2-Q1 which is 200 million kgs. So government is under wrong
presumption that 20 Billion pesos is to be given in subsidy.
 By giving subsidy, government has to give more than 20 billion pesos as subsidy,
which was not picturized by the government. Increased subsidy about will also drain
the foreign reserves of the country. Thus, giving subsidy will not be good for the
country. So the promises made by ruling party in election manifesto are detrimental to
the Paravian economy.

.
 Table-A
Surplus Before Subsidy After Subsidy Change

Consumer AEPw AHP1 (+)PwEHP1

Producer PwFC P1GC (-)PwFGP1
Govt. 0 (-)IJHG (-)IJHG
Societal Gain/Loss (-) (IFG+EJH)

Figure-
a)Is the economic reasoning behind the arguments mentioned above sound?
The economic reasoning given in the Policy paper which concluded that, “this price is
worth the benefits of political stability in terms of higher productivity and better
climate for investment” is not correct. There is loss of quantity produced of rice by the
domestic producers from Q1 to Q3, and hence the labour & land resources will get
freed causing unemployment and lack of productivity.

b) Who will benefit and who will lose as a result of import subsidy?
Only Consumers will be benefitted and Producers and Government will be at loss as
depicted in Table-A above.

c) What will be the overall impact of proposed subsidy on welfare of Paravia? Will
Paravia be better-off or worse-off? By How much?
As depicted in Table-A, consumers are gained but Producers and Govt are at loss and
Overall dead-weight loss is also there (IFG+EJH) this is not going to pass either to
consumer-producer or to government.

d) Besides rigorous analysis (using graphs), could you also describe in simple words
the welfare impact of the proposed import subsidy? The leader of the opposition
wishes to use it for his speech during debate in Paravian Parliament.

1. Simply by giving subsidy of 100 pesos/kg to rice imports, government has to

release more than 20 billion pesos for subsidizing the rice. Therefore, claim of
government that only 20 billion pesos subsidy is to be given is wrong and this lead
to drain of foreign reserves of paravian economy.
2. Due to import subsidy, producer’s surplus got reduced. Producers will start
mobilizing their resources to other activities/agri production. This will lead to
generation of unemployment in Paravia.