Price Volatility, Price Subsidy, Supply Response, Error Correction Model
The development of small developing states has long been influenced by foreign aid. Apart from the macro benefits of bridging the savings and investment gap and building the foreign exchange gap, it is also said to stabilise output price, provide price certainty and affect output price positively. In this paper I examine these three aspects in detail with respect to the price subsidy that Fiji’s sugar industry has been receiving over the last three decades. Price stability is measured by examining the conditional variance by estimating a GARCH (1,1) model and price certainty aspect is examined by testing if the forecast price is an unbiased and efficient predictor of the actual price. The price effect on supply response is examined by estimating the long and short run response equations. The price certainty analysis reveals that the forecast price is an unbiased and efficient predictor of actual price. The price stability test reveals that the world free market price is not volatile and therefore price stability is not a reason for preferential prices. Lastly, the supply response analysis reveals that in the long run, the price effect on output supply is transmitted via acreage change under sugarcane crop. In the short run, price has lagged effect on both sugarcane supply and acreage response. The inelastic price elasticities of output supply have important policy ramifications.
Key words: Price Volatility, Price Subsidy, Supply Response, Error Correction Model