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'farmers would get 100% subsidy for installing micro irrigation gadgets like dripper, sprinkler etc. the farmers should make use of this opportunity to have better yield in sugarcane, coconut, oil palm, groundnut, grams, cotton etc. while saving a lot of water.'

I am very confused how the graph will look like for this situation where farers are given subsidies , which give them a better yield thus increasing supply and helping them save water.

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First of, you would not be able to infer actual data on marginal measures of social benefit or social cost from this prompt alone, as they do not indicate any such information (if they are constant or variable). You'd instead have to conjecture the explicit effects of the saving of water. In doing so, we can, more safely than not, assume that conserving water is a positive externality of this subsidy, and this marginal benefit is ..clears throat.. constant.

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The subsidy being imposed, we notice that Supply (MPC) curve moves to the right; that is, for every same level of price, producers now supply more to the market.

Furthermore, we notice that the Demand (MPB) curve remains constant, as no measure that takes place should change the needs of the consumers for agricultural products.

On this we will add a constant Marginal Social Benefit; that is the positive externality of rationing on water usage. Mechanisms at work, classical economic theory suggests, would imply that the consumption of these subsidized products, saves more water; so people naturally want to purchase more of them. This being the case, the Marginal Social Benefit curve is established further to the right than the Demand curve.

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One final point of equilibrium is that where $Q=Q_2$, and producers receive price $P_0$ as part of their subsidy, while costumers pay an actual price of $P_2$.

The cost of this subsidy is $Q_2 * (P_0-P_2)$.

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  • $\begingroup$ Hello, Thank you so much for replying. I have some questions (sorry for bothering). 1.) would there be a market failure here and if so where?. 2.) wont the MSC graph maybe lie below MPB to show the positive externality of production. THANK YOU. $\endgroup$
    – coda
    Dec 5, 2020 at 19:49
  • $\begingroup$ 1) Insofar as producers are receiving handouts for producing, they are not thought by fundamental economics to not do so. There are, however, inefficiencies that can arrive and can be exhibited by comparing costs and benefits. Bear in mind how this model is really simplistic. 2) The MSC and the MPB curves are not subject to each other's movement. Perhaps you mean to compare some other two curves? $\endgroup$
    – S. Iason Koutsoulis
    Dec 5, 2020 at 20:25
  • $\begingroup$ So is the new equilibrium the optimal quantity produced $\endgroup$
    – coda
    Dec 6, 2020 at 12:07
  • $\begingroup$ Yes. Perhaps you'd want to open another query for your remaining questions? $\endgroup$
    – S. Iason Koutsoulis
    Dec 6, 2020 at 14:29

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