Minimum Support Price, Storage Limits and Wheat Farmers
A state government fixes a minimum support price (MSP) of ₹100 per kg for wheat, above the market-clearing price. In a small mandi, demand for wheat is estimated as Qd = 500 − 2P and supply as Qs = 100 + 3P, where Q is kg per day and P is ₹ per kg. The government promises to buy any unsold wheat at ₹100 per kg and store it. Before the MSP, the market clears freely. Traders argue that the policy will not raise farmers' total receipts because consumers will buy less; farmer unions argue that the government purchase makes the policy a pure gain. There is no foreign trade, transport cost is zero, and government storage capacity is only 80 kg per day. You must work out the free-market outcome, the effect of the MSP, and whether the storage limit changes the policy's credibility.
1. Calculate the free-market equilibrium price and quantity before the MSP.
Read the worked answer
Set demand equal to supply:
500 − 2P = 100 + 3P
400 = 5P
P = 80.
Substitute P = 80 into demand: Qd = 500 − 160 = 340.
Check supply: Qs = 100 + 240 = 340.
The free-market equilibrium is ₹80 per kg and 340 kg per day. Farmers' total receipts are 80 × 340 = ₹27,200 per day.
2. At the MSP of ₹100, calculate quantity demanded, quantity supplied, the surplus, and the government's purchase cost if it buys the entire surplus. How does the 80 kg storage limit affect the outcome?
Read the worked answer
At P = 100:
Qd = 500 − 200 = 300 kg.
Qs = 100 + 300 = 400 kg.
Surplus = 400 − 300 = 100 kg per day.
If the government buys all 100 kg, its cost is 100 × 100 = ₹10,000 per day, before storage costs.
But storage capacity is only 80 kg. The government cannot credibly absorb the entire surplus. If it buys only 80 kg, total offtake is 300 kg by consumers plus 80 kg by government = 380 kg. That leaves 20 kg unsold. Those 20 kg may be sold at a distress price below ₹100 or go to waste.
So the effective support is incomplete. Farmers receive ₹30,000 from consumers plus ₹8,000 from government = ₹38,000 for 380 kg, and the remaining 20 kg has little or no market. The announced MSP is not fully credible because the government has not provided enough storage to buy the surplus it has promised to buy.
3. Evaluate the traders' claim that farmers' total receipts will not rise, and the unions' claim that the policy is a pure gain.
Read the worked answer
The traders are wrong about total receipts if the support is implemented. Free-market receipts are ₹27,200. With full government purchase at ₹100, receipts would be 100 × 400 = ₹40,000. Even with the storage limit, receipts are at least ₹38,000 from the 380 kg absorbed, before any distress sale of the last 20 kg. Farmers as a group therefore gain.
But the unions are also wrong to call it a pure gain. Taxpayers bear ₹8,000–₹10,000 per day plus storage and wastage. Consumers pay ₹100 instead of ₹80 for the 300 kg they buy, so consumer surplus falls. Production rises to 400 kg although only 340 kg is efficient at the free-market price, using extra resources.
The gain is also unevenly distributed. Farmers with access to procurement centres and storage benefit; small farmers who cannot sell to government may be left with unsold wheat. The policy is therefore a transfer with real costs, not a free lunch.