Saturday, June 18, 2011

Economic Impact of Reducing Ethanol Subsidies

The Daily Iowan has an article on the recent bill in Congress trying to reduce ethanol subsidies, and the reactions by various politicians to the bill. In Prin. of Microeconomics I discuss the economic impact of introducing a per unit subsidy and eliminating a per unit subsidy, such as the 45 cent per gallon subsidy. Economically, we can expect that consumers will pay higher prices (the market price) and thus have a reduction in consumer surplus (i.e. consumer economic well-being), ethanol producers have lower producer surplus, and the government lowers their expenditures. So both consumers and producers are worse off, and the government is better off. Can we make a clear economic conclusion just from the elimination of the per unit subsidy? Yes. Economically, we can expect (all else being equal) that the elimination of the subsidy will increase overall economic well-being, and thus economists as a profession tend to favor the elimination of subsidies.

Not only that, but the proposed amendment also plans to eliminate the tariff (i.e. tax) on importing ethanol. Again, all things being equal, the elimination of this tariff will make US gasoline consumers better off, since this will allow more efficient foreign producers to sell ethanol here in the US, and quite likely make the price of blended ethanol-gasoline cheaper than it currently sells for.

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