Question

Consider two countries, Home and Foreign. Home is a small exporter of wheat. At the world price of $100 per ton, Home growesexport 20 tons. Use the following figure to answer the questions below. Home price 120 100 O 80 Quantity 40 45 15 20

1. Now consider that the government gives subsidy of $20 per ton for production (instead of export).

1. What is the amount of quantity exported after production subsidy?

2. Calculate the effect of the production subsidy on consumers

3. Calculate the effect of the production subsidy on producers

4. Calculate the effect of the production subsidy on the government

5. Calculate the overall net effect of the production subsidy on the Home Welfare.

Answer 1

Domestic post-subsidy Price = $100 + $20 = $120

(i) At Price of $120,

Domestic consumption (QD) = 15

Domestic production (QS) = 45

Export = QS - QD = 45 - 15 = 30

(2) Consumer surplus (CS) will fall since domestic price will increase.

Decrease in CS = (1/2) x Unit Subsidy x (QD before subsidy + QD after subsidy) = (1/2) x $20 x (20 + 15) = $10 x 35 = $350

(3) Producer surplus (PS) will fall since domestic price will increase.

Increase in PS = (1/2) x Unit Subsidy x (QD before subsidy + QD after subsidy) = (1/2) x $20 x (40 + 45) = $10 x 85 = $850

(4) Government's Cost of subsidy = Unit Subsidy x Post-subsidy Exports = $20 x 30 = $600

(5) Overall effect of subsidy will be a net welfare loss.

Welfare loss = Decrease in CS + Government's Cost of subsidy - Increase in PS = $(350 + 600 - 850) = $100