PA 403 Economics for Management and Policy Case #1
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PA 403
Economics for Management and Policy
Case #1
Straussland is a small island nation in the Pacific Ocean. It is a relatively low income country, with a per capita income of $8,000. Agriculture is its main industry and rice, which is a staple of the local diet, is one of its primary crops. Because it is a small country, Straussland ’s agricultural production has no influence over global prices.
In order to protect its farmers from world competition, Straussland currently bans imports of rice. All rice consumed on the island is grown by local farmers. This policy is of great benefit to farmers. A bag of rice in Straussland sells for $8.00. 500,000 bags or rice are consumed per year. If consumers were allowed to purchase rice grown abroad, they could purchase bags of rice for just $5.00.
A local legislator is concerned about the impact the import ban has on low-income families. This legislator proposes removing the import ban.
Concerned about the fate of farmers, a second legislator argues that rice production should instead be subsidized. Since the world price of rice is $3 less than the local price, he proposes a subsidy of $3 per bag of rice. To make the policy easier to implement, this payment would initially go to farmers.1 Under this plan, rice imports would still be banned.
Finally, a third legislator argues in favor of free trade, but suggests that the $3 per bag subsidy proposed by the second legislator would help to soften the cost to farmers of lifting the import ban.
You have been asked to evaluate the economic impact of each proposal. For each, please find:
1. The total quantity of rice purchased by consumers
2. The total quantity of rice produced by local farmers
3. The total quantity of rice imported (if any)
4. The change in consumer surplus
5. The change in producer surplus
6. The cost to taxpayers of the subsidy (if any)
7. The net welfare gained or lost for the economy as a whole
To carry out this analysis, you have been given the following information about rice markets in
Straussland:
price elasticity of demand: -0.5
price elasticity of supply: 0.75
price paid by consumers with subsidy (under import ban): $6.2
To simplify your calculations, you may assume that all supply and demand curves for rice markets in Straussland are linear.
You have been asked to prepare a brief memo for a legislator in Straussland analyzing these three policy options. Your memo should address each of the impacts requested above, and should include a recommendation as to which policy (if any) the legislator should support. As the contents of your memo will be used to prepare the legislator for debate, it is important that this information be presented in a direct, non-technical manner that is accessible to non- economists. As such, the legislator has asked that you limit your analysis to two pages and to limit the use of economic jargon. Be sure to include a table summarizing your results. Since the legislator does have economic training, it is allowable to supplement your two-page memo with figures that illustrate your analysis. However, any explanations provided in the memo itself must be presented in a way that allows the legislator to convey the information to others in a non- technical manner.
Case 1 Instructions
Legislator A proposed removing the import ban and allowing Straussland to trade on the world market.
Legislator B proposed a subsidy for rice production, equal to the difference between the local price and the world price of rice, $3.00, while retaining the current ban on imports.
Lastly, Legislator C proposed removing the import ban and allowing free trade, yet continuing to subsidize the price of rice to aid local farmers.
P su
8
6.2 5
Domestic supply
Domestic supply
Domestic demand
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Legislator A – Removing the import ban
• The big winners from allowing imports are consumers. Instead of paying $8 per bag of rice, consumers would pay $5 per bag. On the other hand, the losers would be local farmers. They will not be able to compete well with cheap rice imports on the world market.
• With no import ban, consumers purchase 593,750 bags of rice. Local farmers supply 359,375 bags. However, since consumers would like to purchase more rice than what local farmers are able to supply, 234,375 bags of rice are imported. Please calculate the change in consumer surplus, which is the difference between the consumer surplus with the import ban and the consumer surplus without the ban.
• The concern with this option is that it would hurt local farmers by decreasing the price they receive per bag while also decreasing the total amount ofrice sold from domestic farms. Please calculate the change in producer surplus which is the difference between the producer surplus with the import ban and the producer surplus without the ban.
Legislator B – Providing subsidy and retaining the import ban
• After the $3 subsidy is provided to local farmers, consumers will pay $6.2 per bag, and local farmers will receive $9.2 per bag ($6.2 plus $3 subsidy). The new equilibrium quantity is 556,250 bags.
• Both consumers and local farmers benefit from this proposal. Please calculate the change of consumer surplus and the change of producer surplus as compared with the original situation.
• However, the subsidy will cost the government, and thus the taxpayers. Please calculate the total subsidy, and compare the subsidy with the sum of the increase in consumer surplus and the increase in producer surplus. This policy proposal could actually result in what is called a “net welfare loss,” meaning that even though the demand for and production ofrice has increased, there are not enough benefits being added to the economy to cover the cost of the subsidy, and the economy as a whole will still experience a loss.
Legislator C – Providing subsidy and removing the import ban
• The final proposal is a combination of the other two. It lifts the ban on imported rice and gives farmers the $3 subsidy. The price of rice and increase in the amount of rice consumers are able to purchase is the same as the first proposal. However, the $3 subsidy eases the cost for local farmers. They would be able to produce the same amount of rice as they currently do with the import ban.
Avoid technical terms
• The net benefits gained by consumers are what economists call consumer surplus.
• The net benefits gained by local farmers are what economists call producer surplus.
2022-10-08