Question

Consider the market for any agricultural commodity for which there exists a binding output quota and demand is inelastic. One outcome of this situation is that

Select one:

A. producers leave this industry because total revenues fall as a result of the the quota.

B. producers who were in this industry before the introduction of the quota are harmed.

C. producers who enter this industry after the introduction of the quota benefit.

D. it is difficult for new producers to enter this industry because the quotas are very expensive.

E. the price and quantity adjust back to the free-market equilibrium levels.

Answer 1

figure 1

Let S and D denote the demand and supply of agricultural commodity respectively. When a binding output quota is imposed, then the quantity supplied cannot be higher than Q2. The new supply curve is shown as the curve highlighted in green. For quantity supplied less than Q2, the new supply curve coincides with the previous supply curve but at Q2, new supply curve becomes vertical. As a result of which, the price paid by the consumers rises to P2.

Demand is inelastic, which means even if there is an increase in price of the commodity, consumers would still buy it at a higher price.

Producer surplus before quota = area below Pe and above the supply curve S1 = B+C

Producer surplus after quota = area below P2 and above the supply curve S2 = A+B

Clearly, C>A so the producers have been well off after quota because they can charge high prices still the quantity demanded would not fall by as much (because demand is inelastic). Total revenue (P*Q) would rise because P has increased by much larger value than the fall in Q, pushing the revenue upwards.

A. Total revenue increases after quota. Hence the statement that producers leave this industry because total revenues fall as a result of the the quota is FALSE.

B. Since the producers now have a higher revenue, they are better off after quota. Therefore, the statement that the producers who were in this industry before the introduction of the quota are harmed is FALSE.

C. Any new producer that enters this industry would be able to sell his produce at a higher price, this would mean that they are better off. Therefore, the statement that producers who enter this industry after the introduction of the quota benefit is TRUE.

D. New producers can enter the industry and receive higher price for their produce. Therefore, the statement that it is difficult for new producers to enter this industry because the quotas are very expensive is FALSE.

E. The new price after quota becomes P2 and the new quantity becomes equal to the quota, Q2. It does not fall to the earlier levels. Therefore, the statement that the price and quantity adjust back to the free-market equilibrium levels is FALSE.

Hence, the correct answer is option C. producers who enter this industry after the introduction of the quota benefit.

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