Reference no: EM132200717

Question: Gandhi and the leftover principle (from 8th edition, chapter 6)

In 1917, Mahatma Gandhi settled a dispute between Indian farmers and British landowners. Under a share-cropping arrangement, each indigo farmer gave 15% of the harvest to the landowner. When landowners heard about the development of synthetic indigo, they quickly sold the land to the farmers, who at the time didn't know about synthetic indigo and the upcoming collapse of indigo prices. When the price of indigo dropped, the farmers who had purchased land demanded their money back. Gandhi negotiated a partial refund of the payments. Imagine that you are Gandhi's research assistant and must compute the appropriate refund for the typical landowner.

The initial price of indigo is $10.

The annual output is 100 units per hectare.

To purchase land, farmers borrow money at an interest rate of 10 percent per year.

The alternative crop is rice, which has a price of $8.

The annual output of rice is 110 units per hectare.

The non-land costs of production per hectare (including the opportunity cost of the farmer) are equal for both commodities (rice and indigo).

a. Under the original share-cropping arrangement, the effective annual rent on land is $ ______ per hectare which implies that the non-land cost per hectare is $ ________

b. Before farmers find out about synthetic indigo (while they are assuming that the price will be $10), the anticipated annual profit from indigo is $ _____________ per hectare and a farmer's willingness to pay for a hectare, which is the present value of the stream of profit per acre, is $ _______________

c. Suppose that the development of synthetic indigo decreases the price of indigo to $5. The new annual profit from a hectare of land is $ ____________

d. A farmer's willingness to pay is $ ________ The appropriate refund, to be paid by the old landowners tot eh new landowners is $ ___________ per hectare.