Lecture 3

Policy analysis of
agricultural support

Goytom A. Kahsay
Department of Food and
Resource Economics

Email: goytom@ifro.ku.dk
Plan for today

 Lecture

 Discussion on sample term paper proposals from

previous students

 Group exercises

 Checking group formation

Today’s Reading materials

Alston, J. M., & James, J. S. (2002). The incidence of

agricultural policy. Handbook of agricultural economics,
2, 1689-1749. (section 1-3)
Why do we study policy incidence?

1. To measure welfare effects

• Consumer surplus

• Producer surplus

• Tax payers’ surplus

2. To identify and measure distribution effects among different

economic agents
 Analytical framework
• Focus on farm commodity markets or input markets, although many
policies affect agriculture

• Focus on individual commodities and thus not constrained by inelastic

supply and land

• Important assumptions
• Static supply and demand. So, we focus on comparative-static analysis
excluding dynamism and uncertainty of policies

• Implied changes in producer and consumer surplus are appropriate measures

of welfare change

• Perfect knowledge, perfect competition, and perfect and costless

enforcement of policies.

• Harberger's (1971) "Three Postulates" of applied welfare economics

• What are these postulates?

Basic model

• Consider Wallace’s (1962) comparison of two policies in a

competitive market for a non-traded commodity
• A marketing quota

• A target price and deficiency payments (subsidy)

• Distribution implications
• Quota: benefits producers, hurts consumers, no effect on tax
payers

• Why doesn’t a quota policy instrument affect tax

payers?

• Subsidy: benefits both producers and consumers, hurts tax

payers
Welfare effects of a quota and a subsidy
Welfare effects of a quota and a subsidy
Dead weight loss (1)

• What is the reason behind this hypothesis

Dead weight loss (2)

• Is the assumption of constant producer price effect

realistic?

• An alternative to comparing social cost of changes in price is

to look at redistribution of transfer efficiency
• Use graphical comparison using surplus transformation
curves (STCs)

• STC: combinations of welfare of producers versus consumers

and taxpayers that can be achieved using a policy instrument.

• Several STCs, one for each policy instrument under

consideration, may be drawn in a single graph

• Compare policies for a given some target (level of producer

benefits or some acceptable cost to consumers and taxpayers)
Efficiency measures
Redistribution using an output quota

Key points

• DWL of a quota is a vertical or

horizontal distance from STC to the
45° line

• As one moves to the left of point E

(quota get stricter), DWL increases
• ATE and MTE decreases as we move
away from point E, but ATE>MTE.
Why is ATE>MTE as we move to
the left of E?
Comparing quotas and subsidies

• Why does STC quota lie above STC subsidy

Surplus transformation curves: quota versus
subsidy
Multiple instruments

• STC could also be used to analyse a combination of

instruments.

• For instance, combining quota and subsidy to achieve the

45° line

• However, issues remain when it comes to the number of

policy instruments and sub-optimal combinations
The marginal social opportunity cost of funds

• Could you suggest an example of such distortion?

 Beyond the basic model: Implications of
international trade for incidence

• Not explicitly accounting for international markets is misleading. Why?

• Most agricultural products are traded internationally

• This affects both supply and demand and thus elasticities which are important
for welfare as well as domestic and international distribution of the effects

• Trade expands the number of potential policy instruments as well as possible

combinations

• For instance, a country may use a combination of targeted prices,

deficiency payments, export subsidies, food aid, and government stocks
policies

• Consideration of policies such as export subsidies and price discrimination and

revenue-pooling schemes.
 Market power in trade

• Monopoly and monopsony power large countries

 Output quotas for traded goods

• Import barriers have been extensively used by countries to support

domestic agriculture irrespective of their market power.

• Output quotas are often accompanied by trade-restricting policy,

e.g., import tariff or import quota
• What do you think about the welfare consequences of such
combined policy for a small country?

• For a large-country exporter, an output quota offers similar benefits

to an export quota (or export tax), but is less efficient since the
output quota distorts domestic consumption. Why?
• An exception if the output quota on US tobacco
Comparing subsidies on output versus exports (1)

Why?
Comparing subsidies on output versus exports (2)

. Why?
 Price discrimination and pooling schemes

• Marketing boards or state trading enterprises

• E.g., Australian and Canadian wheat boards

• Regulated pricing and revenue

pooling is equivalent to

1. Output subsidy Pp – Pe
financed by Pd - Pe per unit
domestic consumption tax

2. Export subsidy Pp – Pe
financed by per unit
domestic consumption Pd –
Pp