Abstract: In many developing countries, crop Minimum support price (MSP) is a subsidy scheme to (i) improve farmer welfare by safeguarding farmers' incomes against vagaries in crop price, and (ii) improve consumer surplus by ensuring sufficient crop production. Among different mechanisms to operationalize an MSP scheme, we focus on credit-based MSPs under which government will credit farmers should the prevailing market price be below the pre-specified MSP. By accounting for the implementation cost of MSP we examine the effectiveness of MSP in terms of net benefit (i.e., farmer's surplus minus the implementation cost) and net social value (i.e., sum of farmer's and consumer's surpluses minus the implementation cost) in a market that consists of risk-averse farmers with heterogeneous production costs. Also, farmers face two types of uncertainties: (1) market uncertainty and (2) production yield uncertainty. We find that a credit-based MSP can induce crop production, which is intuitive. However, we find some more interesting results: (i) offering a higher MSP may not improve farmer's surplus, (ii) the {net benefit of MSP can be negative: the cost of offering MSP can exceed farmer's surplus, and (iii) there exists an MSP that maximizes the {net social value. We extend our single crop model to the case of two crops to capture the inter-crop MSP interaction. We show that when one crop is more rewarding but riskier than the other crop, then it is sufficient to offer an appropriate MSP for one of the two crops, while offering no MSP to the other crop.

Author Name: Prashant Chintapalli
Journal Name:  Management Science
URL: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3681588