Transcript Presentation 2B

The Welfare Impact of Government
Funding for Agricultural R&D.
• The the effect of the funding is to rotate the
supply curve downwards to S'.
• The assumption is made that the value of
funding per unit of output increases linearly with
output.
• As land is fixed, increasing output at higher
production levels requires more R&D than to
increase output at lower production levels
(decreasing marginal returns) thus the value of
R&D funding to farmers is greater at higher
production levels.
a. Roughly equal slopes of supply
and demand curves in a closed
economy
S
P
Po
S’
f
a
b
c
Pm
d
g
e
D
Q0
Q1
Q
The government funding results in a fall in the market price from P0 to
Pm, and an increase in output from Q0 to Q1
∆ consumer surplus =
∆ producer surplus =
∆ government revenue =
Total welfare change =
a+b+c
e+g-a
-(f+b+c+e+g)
-f
• Consumers are clearly better off as a result of the fall in price by the
area a+b+c.
• The effect on producers is ambiguous. It is difficult to tell whether the
positive effects for farmers of reduced production costs, e+g, are
greater or less than the negative effects of fall in producer price, a.
• Government revenues have decreased. We can estimate the value
of the R&D funding (and, thus, the cost of the funding to the
taxpayer) as the reduction farmers’ production costs. This is shown
as the area between the two supply curves up to the (new) quantity
produced, f+b+c+e+g.
b. Inelastic demand and elastic
supply in a closed economy
P
S
S’
Po
Pm
D
Q Q
0 1
Producer surplus is no longer ambiguous. Area a is greater than area e+g,
producers experience a net loss.
Q
c. Inelastic supply and elastic
demand in a closed economy
S
P
S’
Po
Pm
D
Q
Q
Q
0
1
In the case of elastic demand producers are clearly better off, here area e+g is greater
than area a. i.e. the reduction in production costs outweighs the effects of the reduction
in producer price.
d. The effect in an open economy
P
S
D
S’
f
Pw
g
d
e
Qs0
Qs0
Qs
1
∆CS = 0
∆ PS = e+g ∆ GR = -(e+g+f)
Total welfare change in an open economy = -f
Qd
Q