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Chapter 9: Problem 3

Japanese rice producers have extremely high production costs, due in part to the high opportunity cost of land and to their inability to take advantage of economies of large-scale production. Analyze two policies intended to maintain Japanese rice production: (1) a per-pound subsidy to farmers for each pound of rice produced, or (2) a per-pound tariff on imported rice. Illustrate with supply-and-demand diagrams the equilibrium price and quantity, domestic rice production, government revenue or deficit, and deadweight loss from each policy. Which policy is the Japanese government likely to prefer? Which policy are Japanese farmers likely to prefer?

Short Answer

Expert verified
Both policies have their pros and cons. A subsidy leads to lower prices and higher quantity produced but comes at a cost to the government and can lead to overproduction. A tariff, meanwhile, leads to higher prices and quantity, benefits the government in terms of revenue, but could potentially lead to deadweight losses due to reduced trade. The government would likely prefer the tariff because of the revenue it generates, while farmers could potentially prefer the subsidy since it directly reduces their costs and enables them to produce more.

Step by step solution

01

Policy Analysis - Subsidy

A subsidy to farmers shifts the rice supply to the right (it increases). This happens because the subsidy effectively reduces the production costs for the farmers, allowing them to supply more at every given price. As a result, the equilibrium price decreases, and the equilibrium quantity increases. However, this policy results in a fiscal deficit for the government, because it must pay the subsidy to the farmers. Depending on the subsidy amount, this can lead to a significant financial burden for the government. Moreover, the subsidy encourages overproduction, causing a deadweight loss: resources that could have been used more efficiently elsewhere are drawn into the rice production sector.
02

Policy Analysis - Tariff

A tariff on imported rice, on the other hand, effectively shifts the domestic demand curve to the right (increases). This is because the tariff makes imported rice more expensive, which increases the demand for domestic rice. Due to this, both the equilibrium price and quantity increase. This policy results in tariff revenue for the government, but it can also lead to deadweight losses due to reduced trade and inefficiencies in distribution of resources.
03

Policy Preference Analysis

As for preferences, the Japanese government is likely to prefer the tariff policy. It raises equilibrium prices (beneficial for domestic producers), increases demand for domestic rice, and brings revenue to the government through tariffs. On the other hand, Japanese farmers could prefer the subsidy policy, which would directly decrease their costs and allow them to produce more. However, they could also potentially benefit from the tariff policy if the increase in local demand compensates for the absence of a subsidy.

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