Why intervene?
- Agricultural prices are subject to considerable fluctuation (risk and uncertainty, lack of lone term investment plan, cobweb theory of supply, etc.).
- Farm incomes rise less likely over time than other incomes.
- The lack of economic power of farmers.
- Traditional rural ways of live may be destroyed.
- Completion from abroad (cheap food imports from abroad).
Objectives of the government intervention:
1) To reduce price and income instability
2) To improve resource allocation pattern
3) To make the nation self sufficient in food and fibers and ultimately in export of goods
4) To raise the general economic standard of people
5) To provide guide for the producers of goods and services
Mechanism of intervention
A) Price control mechanism:
– Under perfect competition market, price is determined by the market equilibrium.
– In some context, equilibrium price may not be desirable in that condition, government prefer to set the price either higher or lower than the equilibrium.
B) Floor price:
– It is that type of price setting when government prefer to fix price above equilibrium which at least cover the cost of production and then not to allow market price below that price.
– It is also known as minimum support price.
Impact of floor price
– As the floor price will be favorable to producer they are enhanced to produce more product creating surplus supply into industry.
– It causes reduction in quantity demands.
– The surplus quantity of good is known as buffer stock.
– If there will not be governmental regulation, price will fall.
Solution for buffer stock
– Government should purchase at raised price which can be stored for future supply when in shortage condition.
– Government should control the production level by imposing tax, reducing subsidies or fixing quota.
– Government can play significant role to increase the demand for the goods through various means such as advertisement and diversification of the product, increasing the level of income, decreasing the supply of close substitute goods.
C) Ceiling price:
– If the price is set below the equilibrium and don’t allowed the price higher than that level is known as ceiling price.
– It is also known as maximum price.
– It is in favor to the consumers.
Impact of ceiling price
– If the price is set below the equilibrium, there will be certainly reduction in quantity supply.
– The goods being shortage, consumer will have to pay higher price than the ceiling price from back door, which is considered as illegal market.
– This type of illegal supply at higher price is known as black market.
Control measures of black market/ ceiling price
– Government should supply goods itself.
– Government should produce goods itself and supply at reasonable price.
– Provide subsidies for producer
– Encourage the production of substitute goods to cope the shortage of related goods.
D) Effect of tax:
– When the government imposes tax on any goods, it will cause the shift in supply curve upward that means quantities of supply decreases.
– In case of specific tax, it will be parallel shift since the amount of tax is same at all the prices.
– In case of ad valorem tax (according to value or price), this will cause swing upward. That means at zero price, there will no tax and hence no shifts in supply curve.
Effect of tax on market equilibrium:
– If the government imposes tax on good, price of goods also increases.
– Demand will decrease as price increase.
– Hence market equilibrium will disturb and new marketing equilibrium exists. Thus burden with the incidence of such taxes which is distributed between consumer and producer.
– Consumer pay to the extent the price rises due to tax, is known as consumer share of tax on good/consumer burden.
– Similarly, producer has to pay some portion of the price rise due to tax is known as producer share/producer burden.
Types of taxes:
- Specific Tax: levied on a good at a rate fixed in money terms per unit quantity, regardless of their price.
- Ad valorem: Value added tax (VAT) is levied on the value added of a business.
- Lump Sum Tax: is levied on a particular activity, regardless of its extent or the income of the taxpayers. For example, UK Television licenses.
- Expenditure Tax: would be levied on income less net savings.
E) Subsidies:
– If the government feels market price for the farmers is too low then one of the method of supporting farmers income is to pay subsidy (per unit production basis) which will be received by the farmers in addition to the market price.
– This will encourage the farmers to produce more which in turn will decrease the market price.
– Thus subsidies will be given to improve the income of both the producer and consumers.
– The certain portion of cost of production of the firm shared directly or indirectly by government is known as subsidies.
– If the producer get subsidies, he will produce more and more until marginal product equals to zero.
Effect of subsidies on market equilibrium:
– If the subsidy is provided to the producer then he go for maximum production.
– Hence the quantity supply will increase, which cause downward movement of the supply curve. Then the price of the goods goes on decreasing due to increase in supply.
