Intermediate Microeconomics and Its Application 12th Edition by Walter Nicholson,Christopher Snyder

Exercise 8

Ethanol Subsidies in the United States and Brazil
Ethanol is another term for ethyl alcohol. In addition to its role as an intoxicant, the chemical also has potentially desirable properties as a fuel for automobiles because it burns cleanly and can be made from renewable resources such as sugar cane or corn. Ethanol can also be used as an additive to gasoline, and some claim that this oxygenated product reduces air pollution. Indeed, several governments have adopted subsidies for producers of ethanol.
A Diagrammatic Treatment
One way to show the effect of a subsidy in a supply-demand graph is to treat it as a shift in the short-run supply curve.1 In the United States, for example, producers of ethanol get what amounts to a 54-cents-a-gallon tax credit. As shown in Figure 1, this shifts the supply curve (which is the sum of ethanol producers' marginal cost curves) downward by 54 cents. This leads to an expansion of demand from its presubsidy level of Q 1 to Q 2. The total cost of the subsidy
then depends not only on its per-gallon amount but also on the extent of this increase in quantity demanded.
Ethanol and U.S. Politics
Whether subsidizing ethanol production makes sense in either economic or environmental terms is open to question. But the politics of the ethanol subsidy are clear. The largest corn-producing state, Iowa, is also the site of one of the earliest presidential primaries. And ethanol producers are major donors to many political campaigns. So, for many years, politicians gave overwhelming support to the ethanol subsidy program. In 2013, however, the program was allowed to expire, in part because of its costs. But, because government mandates to use increasing amounts of ethanol in gasoline production remained in effect, things continued as if the subsidy remained by artificially increasing the demand for the additive (how would you show this in Figure 1?). U.S. politicians are probably still happy with this result.
Ethanol and Brazilian Politics
In Brazil, ethanol is made from sugar cane. Although this process is less costly than the corn-based process used in the United States, the urge to subsidize production remains a powerful political force. Although ethanol mandates were reduced in 2000 in response to rising sugar prices, ethanol producers continued to press for additional support. Eventually, in 2013, the Brazilian government announced a new and very large subsidy to all ethanol producers that will last for many years. Brazilian politicians (at least those from sugargrowing regions) are also still happy.
Supporters of ethanol subsidies argue that they meet two important goals: (1) using a renewable source of fuel that is more "environmentally friendly" than oil; and (2) developing a domestic source of fuel that can be substituted for foreign oil imports. How would you assess these arguments? What sort of evidence would support or refute them? Even if the facts tended to support one or both arguments, would a subsidy be the best way to achieve the desired results?