Government Target Price Intervention in Economies With Incomplete Markets

Abstract

The target price/deficiency payment program is among economists' favorite examples of costly government intervention in competitive markets. Dubbed the after President Truman's Secretary of Agriculture, this program pays producers any positive difference between a given target price and the prevailing market price for their output. In a world of certainty and perfect competition, such an intervention benefits producers, hurts consumers (as taxpayers) and causes a net (Harberger triangle) welfare loss. These implications are not only standard fare in economics lecture halls; they have become conventional wisdom in contemporary policy discussions. For example, the 1986 Economic Report of the President states: Income support programs by inhibiting the efficient operation of agricultural markets can impose extra costs on consumers and taxpayers that exceed the amount of income transferred to farmers. When such losses occur, the programs are doing more than redistributing income, they are wasting valuable economic resources that could be used to make everyone better The object of this paper is to show that these conclusions do not extend to a stochastic production economy with incomplete contingent claim markets. In the latter setting, the distributional and welfare implications of a Brannan Plan can be reversed: producers can be made worse off, consumers can be made better off and, with nonstochastic compensation, all agents can be made better off. The conditions under which these outcomes occur include producer risk aversion and low price and income elasticities of demand, all well-known characteristics of staple food markets in which target price programs are actually employed (e.g., markets for wheat, corn, and rice). Like many other equilibrium analyses of resource allocation