Dr.

SHAKUNTALA MISRA NATIONAL REHABILITATION UNIVERSITY

Lucknow

Faculty of Law

“MINIMUM SUPPORT PRICE and

INDIAN AGRICULTURE”

Submitted by

[Ashwani Singh]

Academic Session: 2018-19

X SEMESTER

Under the Guidance of

Mrs. Monisha Thapper

Prof. in Law & Faculty for Economics of Emerging Business
Dr. Shakuntala Misra National Rehabilitation University
 Contents
PRICE FLOOR: A Brief Introduction..............................................................................................................3
Understanding The Principle:......................................................................................................................4
MARKET EQUILIBRIUM................................................................................................................................4
GOVERNMENTS ROLE AND FUNCTION........................................................................................................9
Minimum Support Price............................................................................................................................10
and The Indian Agriculture........................................................................................................................10
Effects of Price Floor..................................................................................................................................12
Short Term Effects:................................................................................................................................12
Long term Effects:..................................................................................................................................13
Review of Literature..................................................................................................................................15
1. Pulse of the nation.....................................................................................................................15
2. Price Floors for Emissions Trading.............................................................................................15
3. An economic analysis of Price dynamics in the presence of a Price floor:.................................16
The case of American Cheese............................................................................................................16
4. Some variance effects of a floor price scheme for wool:...........................................................17
A two period analysis.........................................................................................................................17
5. Managing Quantity, Quality and Timing in Cane Sugar Production: Ex Post Marketing Permits
or Ex Ante Production Contracts?......................................................................................................18
Conclusion.................................................................................................................................................19
Bibliography...............................................................................................................................................20
 3

PRICE FLOOR: A Brief Introduction

What is Price Floor? Price Floor or floor below which prices are not allowed to fall is
nothing but the lowest legal price that a commodity can be sold at. It is an
economic mechanism of price control used by the government of countries to
prevent prices from being too low so that fair prices for goods are available to the
sellers of such goods.

The underlying principle of Price Floor is the concept of Market Equilibrium. For a
price floor to be effective, it must be set above the equilibrium price. If it's not
above equilibrium, then the market won't sell below equilibrium and the price floor
will be irrelevant.. 

In a mixed socialist economy such as ours where the government steps in to

protect the interest of the people such Price flooring is very vital to facilitate the
welfare function of the government.

The most common price floor is the minimum wage--the minimum price that can
be paid for labour. Price floors are also used often in agriculture to try to protect
the farmers and Minimum Support Price (MSP) found throughout our countrys
Public Distribution Shops or ‘Fair Price Shops’.

Thus, through this study we will be able to understand Price Floor as a tool of
welfare economics in India, its uses and the principles on which it works on, in a
comprehensive and systematic manner.

Understanding The Principle:

MARKET EQUILIBRIUM
 4

Broadly speaking, Equilibrium is a state of rest or balance due to the equal action of
opposing forces. In terms of Economics, Equilibrium Price is the price toward which
the invisible hand drives the market. At this point, the upward and downward
pressure on price is equal and the quantity demanded equals the quantity
supplied. The market mechanism naturally present in most markets consists of
these counterbalancing pressures. Equilibrium can occur in all types of markets, but
the commonly assumed model for its occurrence is the perfectly competitive
market. When a market is in equilibrium, there is no excess supply or excess
demand.  Equilibrium quantity is the amount bought and sold at the equilibrium
price. It may be understood by a simple table, known as a schedule (table 1), and a
graph (Fig 1):

Table 1

Price of Commodity Quantity Supplied Quantity Demanded

10 25,000 50,000
16.25 37,500 37,500
20 45,000 30,000

(Fig 1)

Explanation of the Schedule (table 1) and Graph (Fig 1):

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 In economics, we typically use a two-dimensional graph that has the price of the
good or service on the Y-axis (vertical axis) and the quantity that people are willing
and able to buy (or willing and able to sell) on the X-axis (horizontal axis). 

Each point on the graph represents the corresponding price and quantity
demanded. At Rs. 10, the producer produces 25,000 units of the commodity as
opposed to a demanded quantity of 50,000 thus showing a shortage of supply. At
Equilibrium price (which is Rs. 16.25 here), the quantity of goods demanded is
exactly equal to the quantity of goods supplied. While at Rs. 20 the quantity
supplied is 45,000 units as opposed to a lesser quantity demanded f 30,000 units
which leads to an excess in supply.

To understand the Price Floor model, we must understand these two main
concepts regarding Market Equilibrium i.e. the creation of excess supply and excess
demand as explained by Fig 2:

(Fig 2)

Here (Fig 2) it can be seen that any price (P1) above the Equilibrium Price (EP) leads
to the creation of excess supply (the blue shaded region) whereas at price (P2)
below the Equilibrium Price (EP) excess demand is created or there is a shortage in
supply(as seen in the red shaded region).
 6

Here we concern ourselves with the excess supply that is created as a result of
raising the price above the equilibrium price.

It may be noted that if the price is set below the Equilibrium Price it would be
ineffective as the price would be lower than the Equilibrium Price and thus non-
binding on the producers.

(Fig 3)

Here (Fig 3) the Price F is lower than the desired Equilibrium Price which is the price
at which maximum satisfaction to both consumers and producers in a market is
achieved. Therefore to be effective, the price must be set above the Equilibrium
Price. As mentioned earlier, at Equilibrium Price the quantity of goods supplied and
demand are exactly equal. When the price is set above the Equilibrium Price, then
there is a possibility that there will be an excess supply or a surplus. If this happens,
producers who can't foresee trouble ahead will produce the larger quantity where
the new price intersects their supply curve. Unbeknownst to them, consumers will
not buy that many goods at the higher price and so those goods will go unsold.
This is the underlying principle of Price Floor. In this scenario the invisible hand of
market forces here will naturally drive the prices downwards in case of excess
supply to bring it back to the equilibrium price.

An example below showing both the Schedule (table 2) and Graph (Fig 4) of the
Price floor is given below.
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Table 2

Price of Commodity Quantity Supplied Quantity Demanded

10 25,000 50,000
16.25 37,500 37,500
20 45,000 30,000

(Fig 4)

Here the price F (20) is above the equilibrium price (16.25) E because it is supposed
that the price E does not provide incentives to the farmers to produce. Therefore to
promote such production by farmers government keeps the price at Price F. As a
result of such pricing above the Equilibrium Price E there as can be seen from the
diagram (fig 4) is created, a surplus in the market (as shown in the shaded region)
as farmers expand their output and supply.
 8

GOVERNMENTS ROLE AND FUNCTION

The Indian economy is a Mixed Socialist economy i.e. while retaining the free
market feature, the government steps in to regulate and deregulate the prices as
and when it is required for the welfare of the people. The government uses the
economic tool of Price Control to carry out such functions. Price Floors and Price
Ceilings are such Price Controls, examples of government intervention in the free
market which changes the market equilibrium. They each have reasons for using
them. Price Ceilings are maximum prices set by the government for particular
goods and services that they believe are being sold at too high of a price and thus
consumers need some help purchasing them. Price ceilings only become a
problem when they are set below the market equilibrium price. On the other hand,
Price Floors are minimum prices set by the government for certain commodities
and services that it believes are being sold in an unfair market with too low of a
price and thus their producers deserve some assistance. Price floors are only an
issue when they are set above the equilibrium price, since they have no effect if
they are set below market equilibrium price.

Here we discuss how the government in India plays a role in setting such Price
floors which play an important welfare function.
 9

Minimum Support Price

and The Indian Agriculture
 The Minimum Support Price (MSP) Scheme is a scheme of the Government of
India (GOI) to safeguard the interests of the farmers. Under this Scheme the GOI
declares the minimum support Prices of various agricultural produces and assures
the farmers that their agricultural produce will be purchased at the MSP, thereby
preventing its distress sale. The Food Corporation of India (FCI) acts as the Nodal
Agency of the GOI. The Minimum Support Prices were announced by the
government of India for the first time in 1966-67 for Wheat in the wake of the
Green Revolution and extended harvest, to save the farmers from depleting profits.
Since then, the MSP regime has been expanded to many crops.

Currently, the MSP is announced by the Government of India for 25 crops at the
beginning of each season viz. Rabi and Kharif. The following are few of the crops
covered in the two seasons as shown in the following table.

Kharif Crops Rabi Crops

Paddy Wheat
Jowar Barley
Bajra Gram
Maize Masur (lentil)
Cotton Mustard

The market price can sometimes be so low that farmers cannot make enough
money to support themselves. In such cases, the government steps in and sets a
price floor. The rationale is that if there is a fall in the prices of the crops, after a
bumper harvest, the government purchases at the MSP and this is the reason that the
price cannot go below MSP. So this directly helps the farmers.

The government decides the support prices for various agricultural commodities
after taking into account various recommendations of Commission for Agricultural
Costs and Prices, views of ministries and state governments and other relevant
factors.
 10

(Notice that when the price is artificially raised above p*, the quantity supplied
exceeds the quantity demanded. Such a situation is called a surplus: farmers
produce many more crops than buyers want to buy at the new, higher price.)

Effects of Price Floor

The argument for price floors is usually that the government has to protect
suppliers from having to sell their goods at an unfairly low price. They are often
meant to protect suppliers that are considered to be important because they
provide a necessity. However there are various short term and long term effects of
such Price floor which are considered by many as negative effects on the economy.
 11

Short Term Effects:

In the short run, a price floor will have no effect on the supply curve. Due to the
Price floor effect, consumers pay a higher price and decide to reduce their
purchases, while producers find they are guaranteed a higher price than before and
they raise production. This will increase the quantity supplied if the price floor is
binding, that is, the price is higher than the market price. This causes surplus of the
product and a deadweight loss.

Example: Lets say that the price of wheat is falling so the government imposes a
price floor on wheat at Rs 10/kg. If the market were left to itself, wheat would
eventually fall to Rs.8/kg. Once again it is clear that less wheat is going to be
bought at Rs.10 than at Rs.8 which means there will be a chronic surplus of wheat.
The excess would either spoil, be discarded, or be purchased by the government.
Producers who would go bankrupt if the price were allowed to reach equilibrium
would be able to remain in business because of the artificially high price. Those
producers would consider this to be a benefit. 

 The benefit to producers of the price support is equal to the gain in producer
surplus (represented in blue).
 The cost to consumers of the price support is equal to the loss in consumer
surplus (represented in red).
 The cost to the government of the price support is equal to the cost of the
surplus in the market (represented in gray).
 12

However, since the consumers ultimately pay taxes for the government to
purchase the surplus, the total cost to consumers (in the short run) of the price
support is the sum of the loss in consumer surplus and the cost of the
government purchasing the surplus off the market.

Long term Effects:

In the long run, a binding price floor will induce market entrance in perfectly
competitive markets, which will cause supply to increase -- this is represented as an
outward shift of the supply curve -- because firms will be able to sell their product
at above their average total cost, which creates an economic profit. Since prices
cannot fall, this means that economic profits may not fall to normal, inducing
continued firm entrance and ever-larger surpluses, and this may make the price
floor impossible to maintain in the long run.

In the above mentioned example of the government setting a price floor for wheat,
the consumers who are paying more for wheat or buying less wheat than they want
would consider it a penalty. Producers would benefit by not losing their jobs. The
overall economy is penalized because people who would otherwise have to
produce something thats more in demand are able to stay in an inefficient
business. Similarly, when the government imposes a minimum wage to provide a
fair wage to workers the effects include higher wages for some people along with
unemployment (chronic surplus of workers as businesses will hire fewer people due
to the higher cost of labor), bankruptcy of marginal producers, rise in prices. These
are included as some of the negative effects of such Price flooring in the long run.
 13

Review of Literature

1. Pulse of the nation

Editor, The Hindu

The Editor, Business Line in his editorial article dated July 26, 2013 has revealed the
need for MSPs for pulses like gram, chana, etc. in the country. He starts by
emphasizing the fact that India being a chronic importer of pulses has done well in
the recent years in terms of domestic production but highlights the grim fact that
the prices are much lower than required there being no adequate floor price set by
the government for the same. Quoting the recent price crash in Chana prices, he
stresses that the government must incentivise the farmers to grow more pulses as
they have various nutritional values (considering the nutrition deficiency in the
country) and also functions as a nitrogen fixer.

He is of the opinion that if this continues it will discourage farmers from producing
pulses. He urges the government to ensure that farmers get the officially declared
MSPs for the crop to be harvested a couple of months from now. In the absence of
physical procurement support, these MSPs have meaning only on paper and the
new National Food Security legislation may aggravate this, given its sole focus on
guaranteeing a minimum quantity of cereals as a legal entitlement to two-thirds of
the population. This will, in turn, further skew our public resources and
procurement efforts.

2. Price Floors for Emissions Trading

Peter John Wood and Frank Jotzo

Wood Peter and Jotzo Frank (2009) in their article “Price Floors for Emissions
Trading” have revealed the advantages of Price flooring for emission trading and
have given suggestions for the same on how the government can tackle the issue
at hand. They have discussed the advantages of price flooring for emissions trading
and implied that Price floors need to be carefully designed to avoid budgetary
liabilities, and to avoid barriers to international trade in permits. They further argue
that the most direct approach of a government commitment to buy back permits at
a threshold price is unlikely to be viable, especially in the context of international
 14

permit trading, because it implies large contingent budgetary liabilities but that an
alternative approach of a minimum reserve price for auctioned permit, could yield
the desired effect, but could be ineffective if the share of auctioning is small. They
have used various economic tools of research such as graphs, schedule and other
relevant data to support the same.

Concluding, price floors could fulfill an important supporting role in ensuring

effective and efficient climate change mitigation, they can be implemented without
compromising vital aspects of emissions trading, and their budgetary properties
may turn out to be highly attractive to governments.

3. An economic analysis of Price dynamics in the presence of a Price

floor:

The case of American Cheese

Jean-Paul Chavas and Kwansoo Kim

Chavas Jean-Paul and Kim Kwansoo (2005) in their article” An economic analysis
of Price dynamics in the presence of a Price floor: The case of American Cheese”
have provided useful insights on price dynamics in the presence of a government
determined price floor. In the paper they have provided an econometric analysis of
the effects of Price floor on price dynamics and price volatility. Focussing on the
Price floor providing a censoring mechanism to price determination, they have
specified and estimated two competing models with dynamic Tobit specification
under time varying volatility. In their economic analysis they have revealed three
important findings. First, they documented how the price support programme
contributed to reducing price volatility and secondly they uncovered evidence that
such volatility-reducing effects are much stronger in the short run than the long
run. Thirdly they have also found that even under the market regime scenario the
support price can have significant positive side effects on long run expected prices.
They have supported the study with empirical evidence on the dynamics of
American cheese prices and their changing volatility.

Conclusively they have evaluated the welfare effects of changing the price support
level indicating that although lower support prices reduce taxpayer cost and
aggregate welfare loss, they might not improve the relative economic efficiency of
transferring income from consumers and taxpayers to producers.
 15

4. Some variance effects of a floor price scheme for wool:

A two period analysis

J.H. Duloy
Duloy J.H. (1964) in his article “Some variance effects of a floor price scheme
for wool: A two period analysis” has revealed that for complete cycles, a floor
price scheme cannot be expected to have any significant effect upon the mean
level of either growers’ income or of receipts from commercial sales of, in this
study, wool. He gives the reason that because of the absolute magnitude of
changes in both buying and selling periods, a scheme may be expected to have
a more substantial impact upon the variance of both growers income and of
receipts from commercial sales.
Hence concluding, because the variance of the income of the individual wool
grower is likely to be greatly influenced by changes in local conditions leading
to changes in output and by cost changes, any reduction in the variance of the
aggregate is likely to be far less important at individual farm level. Any increase
in the variance of receipts from commercial sales, and hence of export received
of wool sold is likely to lead to an intensification of the severity of periodic
balance of payment crisis. For the income stream of individual woolgrower the
impact of the external effect may predominate, and a fortiori for the rest of the
economy.

5. Managing Quantity, Quality and Timing in Cane Sugar Production:

Ex Post Marketing Permits or Ex Ante Production Contracts?

Sandhyarani Patlolla

In this paper titled “Managing Quantity, Quality and Timing in Cane Sugar
Production: Ex Post Marketing Permits or Ex Ante Production Contracts ?”
Patlolla Sandhyarani (2010) highlights the issue that Sugar processors must comply
with a floor price for cane, but gur and khandsari producers are exempt from the
floor price. Thus, any effect of the sugar processor’s choice of procurement
method on the incentives facing farmers will depend on the expected cane price in
these competing unregulated markets. She has developed a theoretical model of
the Andhra Pradesh cane procurement market that incorporates the government-
mandated floor price policy that applies only to the cane used for sugar processing,
 16

and compared the processors profits under the probabilistic ex post permit system
and ex ante production contracts.

The main conclusion is that ex post permits creates competition among the farmers
to increase cane quality that brings higher profits to the processor at the expense
of higher costs to the farmers. This hypothesis is tested and not rejected using data

from a survey of 205 cane farmers.

Conclusion
It is apparent that instituting a price floor is economically unsound but refraining
from instituting one doesnt mean that everything would work out optimally for
everyone. Price floors have negative long-term economic consequences. The
effects arent always noticeable because the price floor could be set at a level that is
commensurate with the market minimum. In those cases it is as if the floor doesnt
exist. They are still sometimes enacted because of their short-term effect. A price
floor has the immediate effect of increasing the profit of producers. Without a price
floor, some people would lose their jobs and they might not have the skills to
quickly find a new one or they may not get a fair price for their hard earned
produce in the market due to the various exploitations they face in the market by
middlemen etc. The object of setting a Price Floor by the government is driven by
its welfare motive to protect the interest of the class of people who are most
substantially affected by rising and lowering prices of commodities upon which the
very livelihood and life of such people exists. Thus ours being a welfare state, we
take along everyone in our stride to achieve greater economic growth keeping
every individuals own economic goals in mind.
 17

Bibliography
 Internet:
 Wikipedia.com
 Investopedia.com
 economics.fundamentalfinance.com
 Indiabudget.nic.in
 Articles from:
o www.jstor.com
o Econpaper.repec.org
 Books:
 Modern Economic Theory: KK Dewett
 Principles of Micro economics( vol 1): N. Gregory Mankiw