CHAPTER 31 – LECTURE NOTES
I.Introduction: American agriculture is economically important for a number of reasons.
A.Learning objectives – In this chapter students will learn:
1.Why agricultural prices and farm income are unstable.
2.Why huge numbers of labor resources have exited U.S. agriculture during the past several decades.
3.The rationale for farm subsidies and the economics and politics of price supports (price floors).
4.Major criticisms of the price-support system in agriculture.
5.The main elements of existing Federal farm policy.
B.Agriculture is a large industry. Consumers allocate about 14 percent of their personal consumption expenditures to food. Gross farm income is about $250 billion per year.
C.Agriculture, in the absence of government farm programs, is a real world example of pure competition (see Chapter 21), many firms selling a virtually standardized product.
D.Agriculture provides evidence of the intended and unintended effects of government policies that interfere with market forces.
E.Farm policies are excellent illustrations of Chapter 29’s special interest effect and rent- seeking behavior.
F.Agriculture reflects the increasing globalization of markets.
G.This chapter examines the economics of agriculture as well as examining the problems with government intervention programs and recent changes in government farm policies.
II.The economics of agriculture
A.The shortrun: Price and income instability result from several factors.
1.There is an inelastic demand for agricultural products. The price elasticity of demand is low since there are few substitutes for agricultural products in general, and diminishing marginal utility occurs rapidly in wealthier societies (Figure 31.1).
2.There are fluctuations in output: Weather is an important factor in production, as is the competitive nature of farming. Both of these result in the individual farmer having little control over the amount of output. Coupled with an inelastic demand this means that relatively small changes in output can lead to relatively large changes in farm prices and incomes. A bumper crop can result in a loss of revenue and income because of the inelasticity of demand (Figure 31.1).
3.Fluctuations in domestic demand can lead to sharp changes in farm incomes (Figure 31.2) but not farm production, due to the fact that farmers’ fixed costs are high when compared with their variable costs.
4.Some of the volatility of demand is caused by unstable foreign demand that is dependent to some extent on weather and crop conditions in the countries that buy U.S. agricultural products. The increased importance of exports has increased the instability of farm incomes (Figure 31.3). (Key Question 1)
5.Figure 31.4 shows the volatility in prices of select agricultural commodities.
6.Consider This … Risky Business
a.Instability of prices creates significant risk in agriculture (e.g. of loan defaults), though farming of some crops is protected by government programs.
b.For crops facing greater risk, farmers have adopted the following techniques to manage risk:
i.Buying and selling farm output in futures markets.
ii.Contracting with processors to lock in farm output prices.
iii.Buying crop revenue insurance to guarantee a certain amount of revenue, even in the event of storm damage, drought, or similar natural events.
iv.Leasing land to other operators for a fixed cash payment.
v.Generating nonfarm income from off-farm employment.
B.The longrun: agriculture is a declining industry.
1.Over time, technology has led to a rapidly increasing supply keeping the pressure on lower prices. Government-sponsored research has been the source of much of the technological advance.
2.Demand has not grown as fast as supply.
3.Demand for agricultural products is relatively income inelastic—the quantity demanded doesn’t rise proportionately as incomes rise.
4.Population growth has not been enough to allow demand to keep pace with increases in supply.
5.Figure 31.5 is a graphical portrayal of the longrun situation. Given the inelastic price and income demand for farm products, an increase in the supply of farm products relative to the demand for them has created persistent tendencies for farm incomes to fall relative to nonfarm incomes. (Key Question 3)
6.Low farm incomes have resulted in an out migration of agricultural workers who worked on small, high-cost farms; a consolidation of smaller farms; and the emergence of huge agribusiness producers. (Table 31.1; Global Perspective 31.1 compares labor force participation in agriculture for selected countries)
C.Historically farm household incomes have been well below nonfarm households. In 2004, average farm household income greatly exceeded the average for all U.S. households ($81,480 v. $60,528).
1.The increase in farm household income has occurred for a number of reasons, including outmigration, consolidation, rising farm productivity, and government subsidies.
2.Nonfarm income has also contributed significantly to farm household income. On average, only 17% of farm household income is derived from farming activities, but this figure is misleading. The average is low because of “residential farms;” “commercial farms” (sales of $250,000 or more) derive most or all of their income from farming.
III.The Economics of Farm Policy
A.The “farm program,” which began in the 1930s, involves six basic policies.
1.Subsidies to support prices, incomes, and output;
2.Soil and water conservation;
3.Agricultural research;
4.Farm credit;
5.Crop insurance;
6.Subsidized sale of farm products in world markets.
B.Farmers and politicians view this primarily as a program to prop up prices and incomes. Global Perspective 31.1 reveals that agricultural subsidies are common.
C.Rationale for farm subsidies: A variety of arguments have been made over the years to justify farm subsidies.
1.Many farmers earn relatively low incomes.
2.The “family farm” is a U.S. institution that should be preserved.
3.Farmers face hazards to production (floods, droughts, insects, etc.) that most industries don’t have to face.
4.Farms are highly competitive, but their suppliers have considerable market power which puts farmers at an unfair advantage.
D.The parity concept was established by the Agricultural Adjustment Act of 1933. Parity suggests that the relationship between the prices received by farmers for their output and the prices they must pay for goods and services should remain constant at the prosperous level of 19101914 base period. The parity ratio is the ratio of prices received by farmers divided by the prices paid by farmers and today is a fraction of the parity concept. This indicates that prices received must rise dramatically for farmers to achieve parity.
Parity ratio = prices received by farmers / prices paid by farmers
E.The concept of parity provides the rationale for government price floors on farm products; these minimum prices are called price supports. Many different price support programs have been tried; they all tend to have similar effects.
1.Support prices tend to cause surplus output because private consumers cut back the quantity purchased at the higher support price, and sellers offer a greater quantity than at the lower market equilibrium price.
2.Farmers gain from price supports as their gross revenues increase (Figure 31.6).
3.Consumers lose because they must pay the higher price and receive less. In some cases the difference between world market prices and support prices can be great. For example the U.S. price of sugar is more than two times the world market price (Last Word)
4.There is an overallocation of resources to agriculture, which represents an efficiency loss. The competitive market would produce less output at a lower price.
5.There are other social losses.
a.Taxpayers pay higher taxes to finance the government’s purchase of the surplus.
b.Government’s intervention entails administrative costs.
c.“Rent-seeking” activity by farm groups involves considerable sums to sustain political support for price supports and other programs to enhance farm incomes.
6.Environmental costs result from the extra production.
a.Greater use of fertilizer and pesticides occurs.
b.More land is cultivated, including “marginal” land that is susceptible to erosion, and wetlands that support wildlife habitat.
7.There are international costs of farm price supports (see Last Word).
a.Inefficient use of resources extends worldwide as U.S. limits imports of foreign products.
b.Governmentcaused surpluses are “dumped” on world markets, depressing world market prices for these products.
F.How do the government and farmers cope with surpluses that occur with price supports?
1.Restricting supply: One policy is called “set aside” or acreage allotment programs that accompany price supports. Farmers agree to limit planting in exchange for the supported prices. “Soil bank” programs pay farmers not to grow any crops, but conserve land for a period of time.
2.Bolstering demand is another way to erase or reduce surpluses.
a.Finding new uses for agricultural products is one way to raise demand—one such use is gasohol, a gasolinegrain alcohol fuel blend. Production of biodiesel is another.
b.Augmenting domestic and foreign demand also is done through programs like food stamps for low-income families to buy more food and the Food for Peace program, a government program for less developed countries to buy our surplus farm products.
IV.Criticism and Politics
A.Decades of experience with government price support programs suggested that the goals and techniques of farm policy needed to be reexamined and revised. In 1996 Congress ended the price support programs for several farm commodities.
B.Economists reject the parity concept because it assumes that relative prices should not change. If that were true we should subsidize producers or high tech goods because of the price declines they have faced since the technology they sell was introduced.
C.Price supports treat symptoms, not causes
1.Agricultural subsidies were designed to treat the symptoms of farm problems, not the causes.
2.The root cause of the problem is a misallocation of resources. There have been too many farmers relative to the rest of the economy.
D.Misguided Subsidies
1.Price support and subsidy programs benefit farmers who need it least. In 1996, 6 percent of farms with $250,000 in sales or more received 46 percent of the payments; the poorest 61 percent of farmers received only 4 percent of direct subsidy payments.
2.Farmers that owned their land benefited from increased land values. Farmers renting land did not benefit, but the wealthy nonfarm landlords, people not actively engaged in farming, did reap the benefits of higher land values.
E.Policy contradictions:
1.Subsidized research is aimed at increasing farm productivity, while farmers take land out of production to reduce supply.
2.Price supports for crops mean increased feed costs for ranchers and higher meat prices for consumers.
3.Tobacco farmers were subsidized while the costs of medical care soar higher.
4.Import quotas on sugar conflict with our free trade policies.
F. Public choice theory can help explain the contradictions in farm policy. (See Chapter 29)
1.Rentseeking behavior occurs when a group (a union, a firm in an industry, or farmers producing a particular crop) uses political means to transfer income or wealth to itself at the expense of another group or society as a whole.
2.The specialinterest effect involves promoting a policy or program whereby a small group of farmers realizes large benefits, and the individual taxpayer’s and consumer’s costs are largely hidden and relatively small.
3.Logrolling occurs to get representatives from rural states to vote on urban issues.
4.Large agribusinesses that sell chemicals and machinery to farms, as well as Department of Agriculture employees, also lobbied for the continuation of the programs.
G.There has been a change in politics of farm subsidies.
1.The farm population continues to decline and is now less than 2 percent of the population (v. 25 percent in the 1930s, when many of these programs were started).
2.Urban congressional representatives have been critically examining the effects of the farm policies on consumers’ grocery bills.
3.More farms resent the Federal government intrusion into their decision-making.
H.World trade consideration
1.The U.S. has taken the lead in reducing trade barriers on agricultural products.
2.Nations of the European Union (EU) and many other nations continue to provide agricultural price support. They then try to rid themselves domestic surpluses on the world markets.
3.These trade barriers hinder American farmers, first because of the trade barriers hinder U.S. farmers from selling in the EU and second because the subsidized exports depress world agricultural prices.
4.These policies distort both world agricultural trade and the international allocation of agricultural resources. Agricultural subsidies shift production away from what would occur based on comparative advantage.
a.Artificially high prices in industrially advanced nations encourage more farm output than would otherwise occur.
b.Farmers in developing countries then face artificially low prices for their exports, discouraging output.
5.In 1994, the world’s trading nations agreed to reduce farm price-support programs and barriers on imported farm products.
V.Recent Reform
A.In 1996, Congress passed the Freedom to farm Act, which:
1.Ended price supports and acreage allotments for wheat, corn, barley, oats sorghum, rye, cotton and rice, thus allowing farmers to respond to changing crop prices;
2.Provided guaranteed annual transition payments to farmers through 2002; these payments are based upon the subsidies formerly received by the farmer and not on crop prices or the farmer’s current income.
B.Economists expect the act will increase the overall agricultural output in the U.S., but also the variability of agricultural prices and farm incomes.
C. To protect themselves against the volatility of prices and income, farmers can be expected to use more tools to manage risk (as described in “Consider This … Risky Business”).
D.During 1998 and 1999 when commodity and pork prices severely declined, the government provided emergency relief in the form of farm-income assistance and crop disaster relief.
E.The Farm Act of 2002 continues the “freedom to plant” and “direct-payment” approaches, but adds an automatic system of “emergency aid,” and extends the direct-payment system to cover peanuts, soybeans, and other oilseeds.
F.The program is for 6 years and is expected to cost $118 billion.
G.The Farm Act provides three forms of commodity subsidies:
1.Direct Payments – Cash payments are fixed and based on past production and prices. Farmers are protected from price and output fluctuations, and also have the choice as to how much to plant in a given season.
2.Countercyclical Payments (CCP) – Payments that protect farmers from crop price fluctuations. If prices fall below a target price, farmers receive an additional payment, essentially implementing another form of price supports.
3.Marketing Loans – Government-provided loans that further protect farmers against price fluctuations. If crop prices equal or exceed the “loan price” (a minimum crop price specified in the loan agreement), the farmer repays the loan with interest. If the price is below the loan price, the farmer can forfeit the crop to the lender to satisfy repayment of the loan.
H.The Farm Act of 2002 stabilizes farm income and demonstrates that the farm lobby still has significant political influence.
VI.LAST WORD: The Sugar Program: A Sweet Deal
A.Price supports for U.S. sugar producers has kept U.S. sugar prices twice the world price for an estimated cost to consumers of $1.5 billion to $1.9 billion per year. The effect is regressive because poor households spend a larger percentage of their income on food than do high-income households. Also, sugar growers receive benefits that are estimated to be twice the nation’s average family income. In one recent year, a single producer received $30 million in benefits while many sugar producers receive more than $1 million each year.
B.Import quotas have been imposed to keep lowpriced foreign sugar out of the U.S. market so that price supports can be maintained. In 1975, 30 percent of U.S. sugar was imported; today imports are about 16 percent comes from abroad.
C.Important foreign markets in less developed countries have been harmed. The decline in potential sugar revenue has hurt the Philippines, Brazil, and a number of Central American countries.
1.Decline in export revenues hurts their ability to repay foreign debt.
2.The sugar that could have been sold in the U.S. is dumped on world markets, where the world price is then further depressed.
3.The U.S. could become an exporting country. This would increase competition for the sugar producers of the developing world.
D.The General Accounting Office estimates that U.S. sugar producers receive a benefit of $1 billion annually while the sugar program costs consumers $1.5 billion to $1.9 billion. This efficiency loss has resulted from an over-allocation of resources to the production and processing of sugar in the U.S.
E.Price supports have caused a shifting of resources to less efficient U.S. producers away from more efficient, low-cost foreign producers.
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