Question

4. The market for corn is currently perfectly competitive. The government wants to increase corn consumption and production so they decide to subsidize farmers. The subsidy is a constant amount given to farmers for every unit of corn they produce. Determine how the welfare of consumers, producers, the government and total welfare are affected (increase, decrease or unchanged) by the subsidy to farmers. Use a graph to show the effect of the subsidy and identify where welfare for the consumers, producers and the government are before and after the subsidy. Also identify the deadweight loss if any.

Answer 1

If the market for corn is perfectly competitive then equilibruim in the market is determined through demand and supply forces. As shown in the above diagram intial equilibrium is determined where market demand and market supply curve intersect which is at point E and equilibrium price is OP and equilibrium quantity is OQ.

、e.cv.t n Subsiclt

Now, if the government has decided to privide subsidy to the farmers in production. This will decrease their production cost and as a result supply curve shift rightwards.The new equilibrium point is now point E1. This will create a gap between price paid by the producer and price paid by the buyer. Price paid by the buyer reduces and for producer it will increase.

This gap between the price is subsidy rate.Now, due to subsidy there will be deadweight loss as effect of subsidy is mot realized completely.

Before subsidy the Consumer Surplus is the area DPE i.e., ( Area below the demand curve and above the price line).

Producer surplus will be the area PES i.e.,( Area belos price line and above supply curve). and there will be no deadweight loss.

After Subsidy:

Consumer surplus will be DP_bE1

Producer surplus will be P_saS.

Therefore increase in consumer surplus will be : PP_bEE_1.

_{Increase in producer surplus will be : PEaPs.}

_{Hence dead weight loss will be the triangle EaE1}