Home > Microeconomics, Tax Policy > How Subsidies Create Economic Distortions

How Subsidies Create Economic Distortions

If ever there was a “textbook” case, it’s ethanol subsidies in the U.S.:

To ease the pain, Congress threw in a 45-cents-a-gallon subsidy ($6 billion a year); to add another layer of protection, it imposed a tariff on imported ethanol of 54 cents a gallon. That successfully shut off cheap imports, produced more efficiently from sugar cane, principally from Brazil.

Here is perhaps the most incredible part: Because of the subsidy, ethanol became cheaper than gasoline, and so we sent 397 million gallons of ethanol overseas last year. America is simultaneously importing costly foreign oil and subsidizing the export of its equivalent.

So many real-life examples here of what we studied in class:
1) Subsidies create different internal and external prices.
2) Tariffs create different internal and external prices.
3) Distortions in the market create inefficient resource allocation.

In sum, U.S. policy on ethanol is both reducing potential gains from trade that could be realized beyond the U.S. PPF, and moving production further away from the U.S. production possibilities frontier, into less efficient territory.

Categories: Microeconomics, Tax Policy
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  1. July 6, 2011 at 8:57 am

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