Government failure: welfare loss in the EU

One example where there may be welfare loss to society through government intervention can be seen through the European Union's Common Agricultural Policy CAP. In this case, government intervention results in a welfare loss, and we're going to see this in the following slide, where we do some analysis using client demand. In the case of the Common Agricultural Policy, the CAP, there are two objectives. One is to distribute fluctuations in farmers income to ensure that farmers receive a consistent income every year and that this income doesn't change because the size of the crop farmers produces is changing due to volatility in the climate. Also secondly, to ensure that farmers experience an increase in income and therefore have an incentive to stay in farming because obviously producing food is very important for society. One of the side effects of the European Union's Common Agricultural policy is an increase in agricultural surplus. This simply means that because the European Union places a higher price than the world price on crops grown by European farmers, it means that European farmers have a greater incentive to produce more crops, and the result is that there is a surplus of crops.

So the effects of the common agricultural policy in practice can be seen from this diagram, where we have the price of crops on the vertical y-axis and the quantity of crops on the x-axis, we have the upward sloping supply of crops, S-curve and the downward sloping demand for crops, D-curve. If the world price for crops is represented by a WP, the horizontal line, then we can also represent the new price of the European Union places a tariff or a tax on crops coming from countries outside the European Union, the price increases to EUp. So in this case, we say that is an increase costs along the supply curve represented by the areas abc plus cS_W EU_Sb. So in this case, farmer's gain, an area EU_pacW_p, which is equivalent to a gain in producer surplus. In other words, a gain for farmers, however, taxpayers pay an area equivalent to EU_p acW_p plus abc. In this case, it's clear to see from the diagram that taxpayers loss is greater than the farmer's gain. So the result is overall welfare loss due to the Common Agricultural Policy of setting a tariff on agricultural imports coming into the European Union from countries outside.