Suppose Home is a small exporter of wheat, engaged in free trade. Now suppose th

Question

Suppose Home is a small exporter of wheat, engaged in free trade. Now suppose the Home government decides to support its domestic producers with an export subsidy s (and a matching import tariff on wheat).

(a) Illustrate and decribe the effects of the export subsidy on the price received by domestic producers from selling the good on the domestic and export market, respectively.

(b) (How) Do consumer and producer surplus change? And what is the net welfare effect of the export subsidy on the Home country?

(c) Answer the questions above for the case where the goverment instead uses a production subsidy only.

Explanation / Answer

a. Since an export subsidy s has been given by the government, exports will increase because of the subsidy. The price in the domestic market will increase and the price in the foreign market will decrease due to more supply in the foreign market.

b. Consumer surplus will decrease and Producer Surplus will increase.The net welfare effect of the export subsidy on the home country will decrease.

c. Under the production subsidy, the quantity produced at the home country will increase. The production subsidy does not affect the price at the domestic market, the higher production in quanitity will have to be exported, thus price in the export market will increase.

Consumer surplus remain unaffected as price is unaffected and excess quantity produced due to production subsidy is used only in the export market.

Producer Surplus will increase. The net welfare effect of the export subsidy on the Home country will decrease as net effect is the sum of consumer surplus. producer surplus and government revenue. The subsidy reduces the government revenue by a lot hence the net effect decreases.

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