Suppose that peanuts are produced by a large number of small farmers in a perfec

Question

Suppose that peanuts are produced by a large number of small farmers in a perfectly competitive industry with identical technologies. The industry is currently in long run equilibrium at a price of $.37 per pound of peanuts. As we discussed in class, there are large numbers of additional farms who could enter the industry under the right conditions; in other words, there is easy entry and exit. A congressional investigating committee holds hearings on the peanut industry and comes away appalled at the low level of profits on a typical peanut farm. It proposes two alternative remedial plans. Discuss each plan's effects on farm incomes, the price of peanuts, the number of firms in the industry, etc. Which plan do you favor? Why?

Plan A: The government stands ready to buy as many peanuts as farmers want to sell at $.42 per pound.

Plan B. Every year, the government will pay every active peanut farmer an annual subsidy of $10,000.

Plan A

Plan A

Explanation / Answer

Plan B is definitely better. Under Plan A too many resources will be devoted to peanut production and there will be a surplus that the government will have to purchase and store. Plan B will ensure that the peanuts are produced with a more efficient allocation of resources.

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