Applied Welfare Economics
and Agricultural Policy
MSc Course, Humboldt-Universität zu Berlin
by
Dieter Kirschke
in cooperation with
Franz Heidhues and Jerzy Wilkin
supported by
Nana Künkel
Ch1: 2/42
Applied Welfare Economics and
Agricultural Policy
Introduction
1
2
3
Principles of applied welfare economics
Price policy I
Price policy II
4
EU agricultural policy and international framework
© Dieter Kirschke, HU Berlin
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Applied Welfare Economics and
Agricultural Policy
5
6
7
8
Agricultural policy in transition countries (Wilkin)
EU enlargement and accession (Wilkin)
Rural finance in development (Heidhues)
Structural adjustment policies (Heidhues)
9 Structural policy
10 Multiobjective policy analysis
© Dieter Kirschke, HU Berlin
Applied Welfare Economics
and Agricultural Policy
MSc Course, Humboldt-Universität zu Berlin
Chapter 1
Principles of Applied Welfare
Economics
Ch1: 5/42
What is Benefit in Applied Welfare Economics?
Price
Benefit
Demand curve
p
q
Quantity
Benefit:
The benefit from consumption of a good is equal to the willingness
to pay for this good.
Assumptions:
people count, consumer sovereignty, irrelevance of distribution
© Dieter Kirschke, HU Berlin
Ch1: 6/42
What is Welfare Cost?
Price
Supply curve
Cost
Cost:
q
Quantity
The cost to produce a certain amount of a good is equal to the
foregone consumption of other goods measured as foregone
willingness to pay.
© Dieter Kirschke, HU Berlin
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Welfare Measurement under Autarky:
1. Approach: economic activities
Price
Benefit
S
p
D
q
© Dieter Kirschke, HU Berlin
Quantity
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Welfare Measurement under Autarky:
1. Approach: economic activities
Price
S
p
Cost
q
© Dieter Kirschke, HU Berlin
D
Quantity
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Welfare Measurement under Autarky:
1. Approach: economic activities
Price
Welfare
S
p
D
q
Quantity
Welfare:
Welfare describes the level of satisfaction that people obtain from the
consumption of a good.
Note:
Welfare (W) = Benefit (B) - Cost (C)
© Dieter Kirschke, HU Berlin
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What is Consumer Surplus?
Price
Benefit
Demand curve
p
Expenditure
q
© Dieter Kirschke, HU Berlin
Quantity
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What is Consumer Surplus?
Price
Consumer surplus
Demand curve
p
q
Quantity
Consumer surplus:
The consumer surplus describes the satisfaction for a group of
consumers to consume a certain amount of a good. It is equal to the
willingness to pay for this amount of the good (benefit), minus
foregone willingness to pay on other markets.
Note: Consumer surplus = Benefit - Expenditure
© Dieter Kirschke, HU Berlin
Ch1: 12/42
What is Producer Surplus?
Price
Revenue
Supply curve
p
Cost
q
© Dieter Kirschke, HU Berlin
Quantity
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What is Producer Surplus?
Price
Producer
surplus
Supply curve
p
q
Quantity
Producer surplus:
The producer surplus describes the satisfaction for a group of
producers to produce a certain amount of a good. It is equal to the
potential willingness to pay for the production of a certain amount of
this good (revenue), minus foregone willingness to pay (cost). The
producer surplus has the gross margin as its equivalent on firm level.
Note: Producer surplus = Revenue - Cost
© Dieter Kirschke, HU Berlin
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Welfare Measurement under Autarky:
2. Approach: economic groups
Price
Consumer
surplus
S
p
D
q
© Dieter Kirschke, HU Berlin
Quantity
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Welfare Measurement under Autarky:
2. Approach: economic groups
Price
Producer
surplus
S
p
D
q
© Dieter Kirschke, HU Berlin
Quantity
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Welfare Measurement under Autarky:
2. Approach: economic groups
Price
Welfare
S
p
D
q
Quantity
Welfare:
Welfare describes the level of satisfaction that people obtain from the
consumption of a good.
Note:
Welfare (W) = Consumer surplus (CS) + Producer surplus (PS)
© Dieter Kirschke, HU Berlin
Ch1: 17/42
Welfare Measurement under Autarky:
Summary
Price
Welfare
S
p
D
q
Quantity
Note:
1. Approach: economic activities
Welfare (W) = Benefit (B) - Cost (C)
2. Approach: economic groups
Welfare (W) = Consumer surplus (CS) + Producer surplus (PS)
© Dieter Kirschke, HU Berlin
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Welfare Measurement with Trade
Price
Benefit
S
p
D
qd
© Dieter Kirschke, HU Berlin
qs
Quantity
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Welfare Measurement with Trade
S
Price
p
Cost
D
qd
© Dieter Kirschke, HU Berlin
qs
Quantity
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Welfare Measurement with Trade
Price
Foreign exchange
S
p
D
Foreign exchange:
qd
qs
Quantity
Foreign exchange describes the potential satisfaction that an economy
can achieve from the consumption of goods produced in other
countries. Foreign exchange results from the potential willingness to
pay from export goods (foreign exchange earning), minus foregone
willingness to pay for import goods.
© Dieter Kirschke, HU Berlin
Ch1: 21/42
Welfare Measurement with Trade
Price
Welfare
S
p
D
qd
qs
Quantity
Note:
Welfare (W) = Benefit (B) - Cost (C) + Foreign exchange (FE)
© Dieter Kirschke, HU Berlin
Ch1: 22/42
Welfare Measurement with
Government Intervention
Price
Consumer surplus
S
pc
pp
D
q
© Dieter Kirschke, HU Berlin
Quantity
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Welfare Measurement with
Government Intervention
Price
Producer surplus
S
pc
pp
D
q
© Dieter Kirschke, HU Berlin
Quantity
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Welfare Measurement with
Government Intervention
Price
pc
Tax = Government
budget
S
pp
D
q
Quantity
Government budget:
Government budget describes the potential satisfaction that an
economy can achieve from this source. It is equal to the potential
willingness to pay (government revenue), minus the foregone
willingness to pay (government expense).
© Dieter Kirschke, HU Berlin
Ch1: 25/42
Welfare Measurement with
Government Intervention
Welfare
Price
S
pc
pp
D
q
Quantity
Note:
Welfare (W) = Consumer surplus (CS) + Producer surplus (PS)
+ Government budget (B)
© Dieter Kirschke, HU Berlin
Ch1: 26/42
Welfare Effects of Import Substitution
S
Price
pi
D
pw
qs
qs‘
q d‘
qd Quantity
i denotes a situation under current price policy to
increase foreign exchange earning
w denotes a free trade situation
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Welfare Effects of Import Substitution
S
Price
pi
D
Decrease
in benefit
pw
qs
© Dieter Kirschke, HU Berlin
qs‘
q d‘
qd Quantity
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Welfare Effects of Import Substitution
S
Price
pi
D
Increase
in cost
pw
qs
© Dieter Kirschke, HU Berlin
qs‘
q d‘
qd Quantity
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Welfare Effects of Import Substitution
S
Price
pi
D
Increase in
foreign exchange
pw
qs
© Dieter Kirschke, HU Berlin
qs‘
q d‘
qd Quantity
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Welfare Effects of Import Substitution
S
Price
pi
D
Decrease in
welfare
pw
qs
qs‘
q d‘
qd Quantity
Note:
dWelfare (dW) = dBenefit (dB) - dCost (dC) +dForeign exchange (dFE)
(-)
(-)
(-)
© Dieter Kirschke, HU Berlin
(+)
(+)
(+)
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Does Government Revenue
Increase Welfare?
Export country
Price
pw
D
S
pi
qd
q d‘
qs‘
qs Quantity
i denotes a situation under current price policy to
increase government revenue
w denotes a free trade situation
© Dieter Kirschke, HU Berlin
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Does Government Revenue
Increase Welfare?
Export country
Price
pw
D
S
Increase in
consumer surplus
pi
qd
© Dieter Kirschke, HU Berlin
q d‘
qs‘
qs Quantity
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Does Government Revenue
Increase Welfare?
Export country
Price
pw
D
S
Decrease in
producer surplus
pi
qd
© Dieter Kirschke, HU Berlin
q d‘
qs‘
qs Quantity
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Does Government Revenue
Increase Welfare?
Export country
Price
pw
D
S
Increase in
government budget
pi
qd
© Dieter Kirschke, HU Berlin
q d‘
qs‘
qs Quantity
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Does Government Revenue
Increase Welfare?
Export country
Price
pw
D
S
Decrease in
welfare
pi
qd
q d‘
qs‘
qs Quantity
Note:
dW
(-) (-)
=
© Dieter Kirschke, HU Berlin
dPS
(-)
+
dCS
(+)
+
G
(+)
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Welfare Effects of Producer Incentive Prices
and Cheap Food Prices for Consumers
Import subsidy
P
D
Increase in
government
expense (G)
S
P
D
Increase in
consumer
surplus (CS)
S
pi = pw
pi = pw
pi ‘
pi ‘
qs‘ qs
P
qd
D
qd‘
Q
Decrease in
producer
surplus (PS)
S
pi = pw
qs‘
qd
qs
P
D
qd‘
Q
Loss of
welfare (W)
S
pi = pw
pi ‘
pi ‘
qs‘ qs
© Dieter Kirschke, HU Berlin
qd
qd‘ Q
qs‘
qs
qd
qd‘
Q
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Welfare Effects of Producer Incentive Prices
and Cheap Food Prices for Consumers
Consumption subsidy
P
D
Increase in
government
expense (G)
S
P
pis=pid=pw
pis=pid=pw
pid‘
pid‘
qd
qs
P
D
qd‘
Q
Producer
surplus (PS)
is constant!
S
P
pis=pid=pw
pid‘
pid‘
© Dieter Kirschke, HU Berlin
qd
qd‘
Q
qd
D
qs
Increase in
consumer
surplus (CS)
S
qs
pis=pid=pw
qs
D
qd‘
Q
Loss of
welfare (W)
S
qd
qd‘ Q
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Welfare Effects of Producer Incentive Prices
and Cheap Food Prices for Consumers
Consumption and production subsidy
P
D
Increase in
government
expense (G)
S
pis‘
P
pis=pid=pw
pid‘
pid‘
qs‘
P
D
qd
qd‘
Q
Increase in
consumer
surplus (CS)
S
pis‘
P
pid‘
pid‘
© Dieter Kirschke, HU Berlin
qd
qd‘
Q
D
qd
qd‘
Q
Loss of
welfare (W)
S
pis‘
pis=pid=pw
qs‘
qs‘
qs
pis=pid=pw
qs
Increase in
producer
surplus (PS)
S
pis‘
pis=pid=pw
qs
D
qs
qs‘
qd
qd‘
Q
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Welfare Effects of Producer Incentive Prices
and Cheap Food Prices for Consumers
“Social food policy”
P
pis‘
D
S
Increase in
government
expense (G)
pis=pid=pw
pid‘
D
S
pis=pid=pw
pid‘
qs
P
pis‘
P
pis‘
Increase in
producer
surplus (PS)
qd qd‘=qs‘
D
S
Q
Increase in
consumer
surplus (CS)
pis=pid=pw
pid‘
qs
P
pis‘
D
qd qd‘=qs‘
S
Q
Loss of
welfare (W)
pis=pid=pw
pid‘
qs
qd qd‘=qs‘
© Dieter Kirschke, HU Berlin
Q
qs
qd qd‘=qs‘
Q
Ch1: 40/42
Discussion
• Should everything be
counted in money?
• Do Markets impose a
„dollar democracy“?
© Dieter Kirschke, HU Berlin
Ch1: 41/42
Literature
* Houck, J.P. (1986): Elements of Agricultural Trade Policies. New York:
Macmillan, pp. 45-60, 87-93
* Pindyck, R.S.; Rubinfeld, D.L. (1998): Microeconomics. 4th. ed. Upper
Saddle River: Prentice-Hall, pp. 289-329
Buckwell, A. (1997): Some Microeconomic Analysis of CAP Market Regimes.
In: Ritson, C.; Harvey, D.R. (Ed.): The Common Agricultural Policy.
Wallingford: CAB International, pp.139-162
Helmberger, P.G.; Chavas, J.-P. (1996): The Economics of Agricultural Prices.
New Jersey: Prentice-Hall, pp. 203-221
Just, R.E.; Hueth, D.L.; Schmitz, A. (2004): The Welfare Economics of Public
Policy. Northampton, MA: Edward Elgar, pp. 49-182
Sadoulet, E.; de Janvry, A. (1995): Quantitative Development Policy Analysis.
Baltimore: The Johns Hopkins University Press, pp. 176-213
© Dieter Kirschke, HU Berlin
Ch1: 42/42
Questions
1. How can welfare be measured with supply and demand curves?
2. Explain the two different approaches to welfare measurement based on
economic activities and economic groups!
3. What are the economic consequences of policies to increase foreign
exchange earning? Give an example!
4. What are the economic consequences of policies to increase government
revenue? Give an example!
5. Explain the budgetary consequences of various policies to provide producers
with incentive prices and consumers with cheap food prices!
© Dieter Kirschke, HU Berlin