The Value and Cost of Crop Minimum Support Price: Farmer and Consumer Welfare and Implementation Cost

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 the government credits farmers should the prevailing market price be below the prespecified MSP. By accounting for the implementation cost of the MSP, we examine the effectiveness of the 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 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 an MSP can be negative—the cost of offering an MSP can exceed the 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 intercrop 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. This paper was accepted by Vishal Gaur, operations management.