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In 1983 the Reagan Administration introduced a new agricultural program called the Payment-in-Kind (PIK) program. Keeping this program in mind assume that the free market price of wheat is $4 per bushel and the free market supply is 20 million bushels. In the past, payment for extra wheat had been made in dollars and the wheat stored.
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Suppose the government wishes to lower the wheat grown by 25% by paying farmers to withdraw land from production. However, in the new program payment is made in wheat TO THE FARMERS rather than in dollars. The wheat comes from the government reserves. The amount of wheat paid is equal to the amount that could have been harvested on the land withdrawn from production. Farmers are free to sell the wheat on the market.
- How much wheat is now produced by the farmers?
- How much wheat is indirectly supplied to the market by the government?
- Will the market price change from free market price of $4? Why or why not?
- Do farmers gain or lose from the program? How?
- Does the government save money in PIK versus the old cash program? How?
- Why was the program very short lived?
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Solution Preview
In 1983, the Reagan Administration introduced a new agricultural program called the Payment-in-Kind Program. To see how the program worked, let’s consider the wheat market.
a. Suppose the demand function is QD = 28 – 2P and the supply function is QS = 4 + 4P, where P is the price of wheat in dollars per bushel and Q is the quantity in billions of bushels. Find the free-market equilibrium price and quantity.
Equating demand and supply, QD = QS,
28 – 2P = 4 + 4P, or P = 4.
To determine the equilibrium quantity, substitute P = 4 into either the supply equation or the demand equation:
QS = 4 + 4(4) = 20
and
QD = 28 – 2(4) = 20.
b. Now suppose the government wants to lower the supply of wheat by 25 percent from …
