When the government enhanced minimum support price for wheat, it involved government’s commitment to purchase the surplus produce to maintain minimum price level as announced. Otherwise, the surplus in the market can decrease price below the market price equilibrium. This increased government stocks of wheat on the one hand and discourages market price mechanism on the other hand.
In an open market situation, the supply and demand are such that equilibrium price and quantity are P৹ and Q৹ respectively. Both, consumer and the producer share the surplus (Fig 3) equally. However, this ideal equilibrium does not often exist for wheat in Pakistan as the governments have continuously been announcing minimum support price. The enhancement of 2008 has been a more significant jump by all means.
If we see the impact of support price on demand of consumers and supply line, a situation as in graph emerges.
Price of wheat increases, so demand for wheat decreases from Q৹ to Q1. It reduces consumer surplus and hence the cost of grain is increased. On the other hand, due to increase in profits, the farmers try to produce more. They ignore other crops, use more fertilizers and use the best technology available to produce Q2 which is much more than the demand of the consumers. It increases producer surplus and more profits to the farmers.
Hence, the government had announced support price with a commitment that if the farmers do not get the advertised price in the market, the government shall procure the surplus wheat on the announced price. So the government has to purchase surplus quantity from Q1 to Q2.
An increase in minimum support price of wheat results in substitution effect on the farmers as well as the consumers. The farmers start cultivating more wheat by substituting vegetables, fodder, etc. Though they get a better price for their wheat but have to pay more for vegetables, fruit, and fodder as consumers.
Similarly, when consumers have to pay more for the wheat, their real income levels decline. They can’t purchase the same quantity of wheat with their household income. You can see the consumer’s initial equilibrium at point "A." You can also see the budget line and higher indifference curve. The consumer is using more wheat and less rice. However, with the increase of support price of wheat, the budget constraint line shifts downward and the consumer’s equilibrium shifts to point E on the lower indifference curve where he is forced to use more rice than wheat. Consequently, the price of rice also soars and its consumption goes down.
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