The Impact of Crop Minimum Support Prices on Crop Production and Farmer Welfare

Abstract

In many developing countries, governments often use Minimum support price (MSP) as a subsidy scheme to (i) safeguard farmers' income against vagaries in crop prices, and (ii) ensure sufficient production of different crops. While there are different mechanisms to operationalize the MSP scheme, we focus on the case when the government adopts the credit-based MSP scheme under which the government will not take any possession of the crop; instead, it will credit the farmer should the prevailing price be below the pre-specified MSP. We examine the effectiveness of MSP for achieving these two goals by consider a setting in which the market consists of two types of farmers (with heterogeneous production costs): myopic farmers (who make their crop selection and production decisions based on recent market prices) and strategic farmers (who make their decisions by taking all other farmers' decisions into consideration). By examining the dynamic interactions among these farmers for the case when there are two (complementary or substitutable) crops for each farmer to select to grow, we obtain the following results. First, the total production quantity of a crop is increasing in the MSP of that crop. Second, by setting the MSP of a crop too low, farmers' earnings for growing that crop can be lower than the case of no MSP. Third, relative to the case without MSP, it is possible for the government to choose the MSPs carefully to ensure Pareto improvements for all farmers. Fourth, farmers can attain a higher surplus when the government offers MSPs for complementary instead of substitutable crops.