Question

After experimenting with an export subsidy for a couple of years, the Government of Home country realizes that the Government revenue annual decrease of $1,600 is not sustainable in the long run. Assume that Home still faces a world price of $100 per ton an Home growers of wheat still export 20 tons (see Fig. 4). However, starting year 3, the Government replaces the Export subsidy with a Production Subsidy. Using Fig. 4, answer the following questions:

Home price 140 100 10 20 40 50 Quantity Figure 3: Export subsidy for small home country

1. What is the quantity exported with the production subsidy?

2. Calculate the effect of the production subsidy on consumer surplus, production surplus and Government revenue.

3. Calculate the overall net effect of the production subsidy on Home welfare. Is the cost of a production subsidy more or less than the cost of an export subsidy for a small country?

Required:

Modify and rename Fig 3 as Fig. 4, and label all relevant curves and areas.

Confine your calculations and answers to a table identifying each impact, area, calculations of the Production Subsidy and net gains/losses. Show all your computations.

Answer 1

1. Exports = Quantity supplied - Quantity demanded = 50 - 10 = 40 units

2. Consumer surplus decreases by 10(140 - 100) + 1/2 x (140 - 100)(20 - 10) = 400 + 200 = $ 600

Production surplus increases by 40(140 - 100) + 1/2 x (140 - 100)(50 - 40) = 1600 + 200 = $ 1800

Government revenue = Decreases by (140 - 100)(40 - 20) = 40 x 20 = $ 800

3.

Home price Increase in P.S After subsidy 140 Fall in C.S 100 Before subsid Quantity 10 20 40 50

Overall net effect of the production subsidy on Home Welfare is positive. It costs less than the cost of export subsidy. Production subsidy increases welfare as it increase P.S by greater amount.