The government in control of the closed economy would impose a restriction on foreign trade in a closed economic scheme. This restriction often reflects upon the mental state of the country’s head and could be described as a protective measure for the country to have. The government will instruct the populace that they are self-sufficient and do not require outside aid in order to produce all that is necessary for a good life in an effort to raise the morale of the entire country’s population. To sway public perception of a closed economy, propagandistic imagery is often employed as this is not always the most attractive economic ideal. The Democratic People’s Republic of North Korea (although some exceptions have been made) and the former Union of Soviet Socialist Republics are notable examples of closed economies.
Closed economy policy interventions
Introduction of a consumer subsidy
Let us say flour when the figure above shows the market for a food commodity. The market price is P0 and the quantity supplied and demanded is Q0 and they are given by the intersection of the supply curve SS and the demand curve D at the original equilibrium. Supposing, the effect of the government which introduces a specific consumer subsidy is to shift the demand curve upwards. Because the new demand curve is sometimes called the subsidy-laden demand curve. Measured by the vertical distance Pp – Pc, the subsidy drives a wedge between the price received the producer – the producer price Pp – and the price paid by the consumer – the consumer price Pc-.
The market price (including the subsidy) rises to Pp and the quantity supplied rises to Q1 in order to restore market equilibrium following the introduction of the subsidy. This market price is the price the consumer actually pays, the market price less the subsidy, which is Pc. The fact that when the market price rises, some of the benefit of the subsidy. They can leak out to benefit producers. By looking at the changes in consumer and producer surplus, we can evaluate the benefits to consumers and producers.
The area a+b is the increase in producer surplus. The area c+d+f is the increase in consumer surplus. Taxpayers pay these benefits to producers and consumers. The value of expenditure on the consumer subsidy is the welfare loss to the taxpayer. It is given by the entire rectangular area a+b+c+d+e+f, i.e. And given by the difference between Pp and Pc, it means the volume of the product consumed at the new equilibrium, multiplied by the value of the unit subsidy, or the price wedge.
Note that the cost of the taxpayer does not entirely match the gains to producers and consumers. The difference, the area e involved in making these transfers. And it represents the economic cost or the deadweight cost to society, or the loss of real income.
|Change in consumer surplus||c+d+f|
|Change in producer surplus||a+b|
|Change in taxpayer expenditure||-(a+b+c+d+e+f)|
|Total welfare change||-e|
For producers and consumers, the supply and demand curves decide the relative benefits . The more the consumer subsidy will actually benefit producers when the more inelastic supply is relative to demand. The entire expenditure on the consumer subsidy would benefit producers in the extreme case of perfectly inelastic supply. Conversely, the more the consumer subsidy will benefit consumers if the more inelastic demand is relative to supply. The entire expenditure on the consumer subsidy actually benefit consumers In the extreme case of perfectly inelastic demand, and only in this case.
The subsidy-laden demand curve rotates rather than shifts if the consumer subsidy is a proportional or ad valorem one (i.e., expressed as a percentage of the price of flour).
Fixed payment to producers
Suppose, to improve the income of wheat producers, the government introduces a fixed payment per tonne of wheat produced. The producers are now willing to produce the same amount at a lower market price than before when there have represented a downward shift in the producers’ supply curve as, taking the subsidy into account. However, some of the benefits of the subsidy leak away to consumers if the greater willingness of producers to supply wheat drives down the market price (in a closed economy).