The Price and Welfare Effects of Biofuel Mandates and Subsidies

The coordination of agricultural, environmental and energy policies requires a thorough understanding of the interactions between crop, food and energy markets. This paper develops a general equilibrium model to analyze the interactions and to evaluate the price and welfare effect of biofuel mandates and subsidies. Results suggest that biofuel mandates are a primary cause of some of the major concerns associated with crop-based biofuel production, including higher food prices and lower consumer welfare. The price and welfare effects of biofuel subsidies depend on the level of the biofuel mandate. When the mandate is weak or not binding, a biofuel subsidy becomes a transfer from consumers to biofuel producers, which tends to reduce food and fuel prices because of the negative income effect. However, with a strong mandate, a biofuel subsidy will increase the prices of crops, food, and fuel when crops account for a large share of production cost and when the supply of crops is inelastic. Using parameter values consistent with empirical evidence found in the U.S., we calculated the price and welfare effects of the biofuel mandates and subsidies specified in the Energy Independence and Security Act of 2007. Results suggest that the biofuel mandates and subsidies increased the price of corn by 25-40 %, increased the price of food by 1.5-2.5 %, and lowered the price of gasoline by 5-10 %. Overall, the biofuel policies had only a small effect on consumer utility.