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Paddy sector has always been given special treatments by successive governments of Sri Lanka and among the treatments, provision of subsidized fertilizer to smallscale paddy farmers has been recorded as the most expensive program. It has been argued that provision of subsidies had led to the sub-optimum application of fertilizers. This study examined the pattern of chemical fertilizer application by the farmers and paddy yields during the period 2005-2015 where a price subsidy on fertilizer was implemented. During this period, the chemical fertilizer levels recommended by the Department of Agriculture were provided at a rate of Rs. 350 per 50 kg bag to the paddy farmers by the Agrarian Service Centres. A production function was estimated in quadratic form using data extracted from cost of cultivation reports of the Department of Agriculture to determine the effects of application of fertilizer on paddy yields. The results of econometric estimation revealed that the effect of urea application on yield was positive and statistically (p<0.05) significant. A simulation exercise was performed to compare potential urea application levels under alternative fertilizer price levels for a profit maximizing farmer. The results indicated a potential over application of fertilizers beyond the recommended levels under the subsidized price levels. However, in practice, farmers could not purchase quantities that would have given them the maximum possible profit as only the recommended levels were provided under the subsidy scheme. The results further indicated that profit maximizing farmers may continue to use urea fertilizers even if the price subsidy is removed.

Do price subsidies lead to over application of fertilizers? an analysis of <em>Kethata-Aruna</em> Program of Sri Lanka