Price Subsidies With or Without Physical Procurement: Impact on Quality, Profits, and Welfare

Abstract

Newly introduced price subsidy programs without physical procurement have resulted in an increased (vis-à-vis the subsidy programs with physical procurement) preponderance of deliberate quality degradation for certain crops by Indian farmers. The physical procurement of the crop from farmers provides an alternate sales channel to farmers enabling the government to subdue the competition between the farmers in the open market. The farmers' deliberate quality degradation may moderate the benefits of the altered competitive structure. The viability of such programs has been questioned, and policymakers are looking for guidance. Using a multi-stage incomplete information-based (Bayesian) game-theoretic model, we comprehensively characterize the farmers’ strategic production and selling decisions. We demonstrate that the government price support with multiple sales channels created by physically procuring the crop improves the producer surplus when the farmers' landholdings are highly disparate and the quality-based competition is lower. A higher minimum support price (MSP), a higher landholding for a farmer producing a high-quality crop, and a lower high-quality crop price premium in the open market improve the consumer surplus, the social surplus, and the average quality of the crops supplied by farmers when the government does not procure the crop physically v/s when it does. To eliminate farmers' deliberate crop quality degradation, when MSP is moderate, if not lower, the government should (should not) procure the crop physically if the high-quality crop price premium in the open market is higher (lower). We provide guidance to the government exercising caution in selecting MSP and the farmer subsidy program.

Keywords: Minimum support price; farmer subsidies; agriculture; crop quality; quality degradation