Journey in learning economics : 2

The operation of the law of Supply and Demand

First essential lesson is that we must never forget that law of supply and demand ,in any economy where people enjoy even modicum of freedom and choices will always operate. They can not be wished away or ignored as ‘capitalist’ laws. Marxist economy proceeds from labour theory of value and fails to realize the stupendous power of these laws. Thus a correct understanding of these laws is important even for those who are thinking of an alternative revolutionary economics. It is equally significant for those who are interested in understanding the effects of macroeconomic policy decisions.

One of the crucial area of their application is in the sphere of price floors and price ceilings. What is a price floor. A price floor is a minimum price for a commodity(be it in goods,labour or financial market) below which no price is possible. It is a statutory minimum price. It happens in a situation where the equilibrium price of a commodity is perceived to be too ‘low'(please note the value judgement) and a fair price is sought to be fixed for the same. 

Two such examples that we encounter in daily life are the Minimum Support Price and the Minimum Wages. Former is for the farmers and later is for the laborers. These two groups, are often the most marginalized ones in the economy. Political argument is that since there are always more laborers present then needed therefore there is a very real possibility that the equilibrium price of the labor, i.e. the market wages may sink below sustenance levels. Unlike other commodities, this reduction in the wages does not lead to less and less people being willing to supply their labor and thus cost of labor rising and eventually going above sustenance levels. Moreover in the times of economic crisis, the lay offs and slowdown may not only force many families in the pit of unemployment but also may lead to those working thrown to such paltry extremes that they these so called employed individuals may be thrown off the brink of starvation. I wont deny that this is true for India. However, the Minimum wages like any other policy tools have various trade offs. Higher Minimum wages leads to the rise of informal sector. It should be understood that the formal sector is easy to identify and regulate and uses organised labor on large scales. These workers not only get the benefit of a minimum wage but also other benefits like employee insurance, provident fund, safety of work force. When minimum wages are higher than equilibrium price then those willing to supply the labor are many and those willing to buy the labor are few. So those who have to pay a wage above the minimum wage resort to other techniques to increase their profits. First is mechanization of the production which will make the extra labor superfluous. However, profit is also a great driving force of mechanisation and use of newer technology. Higher minimum wage increase this tendency. It adds more workers to the ever increasing pool of unemployed workers. Second is an outsourcing to informal sectors. Third is the tendency to not register or documentise the employment of a worker in the fear that the employees will be forced to pay extra. It also leads to a reduction in labour intensive industries because the labour is costly. Thus it may lead to unemployment. 

Why is a Minimum Support Price Important for India and not that important for U.S.
At the ongoing Geneva talks, India has refused to ratify a trade facilitation protocol which does not provide for permanent exemption of caps from WTO sanctions to programs like MSP and Food Security Bill. What is it that makes these welfare initiatives essential for India.

Minimum Support Price is an example of Price Floors. According of law of supply and demand when you set price of an object more than its equilibrium price then no. of supply of the product will be more than demand. It will lead to less no. of buyers interested in buying the product at given price. Thus this excess unsold agriculture produce will have to be bought by the government. In case of U.S. most of the agriculture production is done mainly by big Agro companies. The subsidies thus benefit mainly these companies which are in fact in no need of such subsidies. Rather the subsidies lead these companies to focus only on intensive farming ignoring the costs of such mechanised and industrialized farming on the environment. It also leads to artificial increase in the price of land. Since production is excess and population is less, this cheap heavily subsidized agriculture produce enters in to government godowns or is exported in poorer countries at nominal rates in the form of aid. It leads to their bankrupting the rural economy of these underdeveloped countries and reducing the laborers to paupers. Thus subsidy in America is merely a political need which can easily be done away with without causing any harm to the economy as such and can easily be replaced with other incentives.

Because of huge population, abject and widespread poverty of India, it stands on a qualitatively different footing than that of America. There is hardly any year, when India does not have to import food. Even the richest of Indian Farmers have farms far less in size and extent as compared to America. Most of the Farmers are middle to small and the land has already been divided in in-numerous small holdings which are barely enough for a family to survive. Any fluctuation in equilibrium i.e. Market Price because of a good monsoon may lead to a hope turning in to a nightmare. Equilibrium prices may go so low, especially in an open economy where challenge is from mechanised farming, that nothing will be left for survival of the farmers after selling their produce. Secondly India needs to support its population by the food it produces on its on land so that it may be able to maintain its independence even in the face of economic sanctions. India can not be reduced to position of a beggar which relies upon other countries for its food. So the incentive and security for the farmers of India comes in the form of MSP. Moreover the subsidies to the agriculture in India do not transform in ruin of Farmers of a non developed country. It is rather used to feed the Millions of families living below poverty line. Thus, giving up MSP or Food Security for that matter, may not just harm some vested interests, but rather prove an economic suicide.

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