Artificial Shortage in Agricultural Supply Chains

Problem definition: Price surge of essential commodities despite inventory availability, due to artificial shortage, presents a serious threat to food security in many countries. To protect consumers’ welfare, governments intervene reactively with either (i) cash subsidy, to increase consumers’ purchasing power by directly transferring cash; or (ii) supply allocation, to increase product availability by importing the commodity from foreign markets and selling it at subsidized rates. Academic/practical relevance: This paper develops a new behavioral game-theoretic model to examine the supply chain and market dynamics that engender artificial shortage as well as to analyze the effectiveness of various government interventions in improving consumer welfare. Methodology: We analyze a three-stage dynamic game between the government and the trader. We fully characterize the market equilibrium and the resulting consumer welfare under the base scenario of no government intervention as well as under each of the interventions being studied. Results: The analysis demonstrates the disparate effects of different interventions on artificial shortage; whereas supply allocation schemes often mitigate shortage, cash subsidy can inadvertently aggravate shortage in the market. Furthermore, empirical analysis with actual data on onion prices in India shows that the proposed model explains the data well and provides specific estimates on the implied artificial shortage. A counterfactual analysis quantifies the potential impacts of government interventions on market outcomes. Managerial implications: The analysis shows that reactive government interventions with supply allocation schemes can have a preemptive effect to reduce the trader’s incentive to create artificial shortage. Although cash subsidy schemes have recently gained wide popularity in many countries, we caution governments to carefully consider the strategic responses of different stakeholders in the supply chain when implementing cash subsidy schemes.