The Welfare Impact of Government Funding for Agricultural R&D. The the effect of the funding is to rotate the supply curve downwards to S'. The assumption is made that the value of funding per unit of output increases linearly with output. As land is fixed, increasing output at higher production levels requires more R&D than to increase output at lower production levels (decreasing marginal returns) thus the value of R&D funding to farmers is greater at higher production levels.

a.Roughly equal slopes of supply and demand curves in a closed economy P Q g f a d bc e S S’ D Po Pm Q0Q1

The government funding results in a fall in the market price from P0 to Pm, and an increase in output from Q0 to Q1 ∆ consumer surplus = a+b+c ∆ producer surplus = e+g-a ∆ government revenue = -(f+b+c+e+g) Total welfare change = -f Consumers are clearly better off as a result of the fall in price by the area a+b+c. The effect on producers is ambiguous. It is difficult to tell whether the positive effects for farmers of reduced production costs, e+g, are greater or less than the negative effects of fall in producer price, a. Government revenues have decreased. We can estimate the value of the R&D funding (and, thus, the cost of the funding to the taxpayer) as the reduction farmers’ production costs. This is shown as the area between the two supply curves up to the (new) quantity produced, f+b+c+e+g.

b. Inelastic demand and elastic supply in a closed economy P Q S S’ D Po Pm Q0Q0 Q1Q1 Producer surplus is no longer ambiguous. Area a is greater than area e+g, producers experience a net loss.

c. Inelastic supply and elastic demand in a closed economy P Q S S’ D Po Pm Q0Q0 Q1Q1 In the case of elastic demand producers are clearly better off, here area e+g is greater than area a. i.e. the reduction in production costs outweighs the effects of the reduction in producer price.

d. The effect in an open economy P Q S S’ D Pw Qs0QdQs0Qs 1 de f g ∆CS = 0∆ PS = e+g∆ GR = -(e+g+f) Total welfare change in an open economy = -f