Effects of Market Power on the Size and Distribution of Subsidy Benefits: The Case of Ethanol Promotion

The subject of market power is discussed frequently in debates about subsidies for ethanol production, and structural conditions in the industry create a prima-facie case for concerns about market power. This paper develops a prototype model for determining the production and price impacts and distribution of benefits from the U.S. ethanol subsidy when upstream sellers in the seed sector and downstream buyers in the processing sector may exercise market power. The impact of the subsidy is analyzed within a simulation framework for alternative levels of market power. Results demonstrate that the impacts on prices and output are limited for modest departures from competition. Distributional impacts are much greater. Seed producers and corn processors with market power are able to capture relatively large shares of the benefits from the subsidy. A perhaps surprising result is that upstream oligopoly power exercised by seed producers is prospectively as important in influencing the positive and distributional impacts of the subsidy as the much more frequently discussed and debated prospect that downstream corn processors may exercise buyer power.