Suppose the US government instituted a policy of subsidizing the use of corn to produce ethanol in an effort to lower US domestic gas prices. Assume that the subsidy makes the use of corn for ethanol more valuable than the use of the corn for food so that farmers would rather sell their corn to ethanol producers than food producers.
a. Explain how this will affect the market for food made from corn (e.g. cornflakes)? What side of the market (supply or demand) is affected? How is it affected (explain)? What do you predict will happen to equilibrium price and quantity in this market? Depict your answer in a supply and demand graph - label all curves, axis, points.
b. Given your answer to (a) how will this policy affect the market for food made from wheat (e.g. Wheaties)? What side of the market is affected and how? Explain. What do you predict will happen to equilibrium price and quantity in this market? Depict your answer in a supply and demand graph - label all curves, axis, points.
c. Assume that world prices (of food made from corn and wheat) follow the US price. Comment on the effect of this policy in the developing world. How is the welfare of the poor impacted by this policy? Does this policy make sense? Is it good policy?