Introduction to Agricultural Economics, 5 th ed Penson, Capps, Rosson, and Woodward © 2010 Pearson Higher Education, Upper Saddle River, NJ 07458. • All Rights Reserved. Government Intervention in Agriculture Chapter 11
Feb 25, 2016
GovernmentIntervention in
Agriculture
Chapter 11
Topics of DiscussionDefining the Farm ProblemForms of government interventionPrice and income support mechanisms Phasing out of supply managementDomestic demand expansionImportance of export demand
2
Net Farm Income With and WithoutDirect Government Payments
Page 212
0
20
40
60
80
100
120
Bil. ($2005)
NFI with Govt. Payments
NFI without Govt. Payments
Pre FAIR ActsFAIR Act
2002Bill
More market driven ag.policy under FAIR Act
(1996 Farm Bill)
3
1.9
65.2
9.8
0
10
20
30
40
50
60
70
Government Payments as a %of Net Farm Income
Page 212
%
4
The Farm ProblemMany agricultural commodities exhibit
inelastic consumer demandIndividual farmers lack market power
In contrast to some input suppliersInterest sensitivity
Capital intensive operationsProduction creditCapital purchases
International trade important marketTends to be more volatile
Asset fixity and excess capacity5
Page 199
Assume we have an inelastic demand for a particular crop
Also assume that due to great weather conditions there is an increase in supply due to record yields→ A shift out of supply
curve at every priceResults in price falling
relatively more than the market clearing quantityQ
$ D S1S2
The Farm Problem
P1
P2
Q1 Q2
ΔP
ΔQ
Market Equilibrium
6
Page 199
What happens to total farm revenue when you have an inelastic demand and an increase in supply?Total revenue under
original equilibrium was area 0P1AQ1
Total revenue under the new equilibrium is 0P2BQ2
We know that total revenue to this sector has ↓, (i.e., 0P2BQ2< 0P1AQ1)How do we know this?
Q
$ D S1S2
The Farm Problem
P1
P2
Q1 Q2
ΔP
ΔQ
0
A
B
7
Page 199
In contrast, with a relatively elastic demand curve, D2 Shift in supply will result in
price P3 instead of P2
Shift in supply will result in quantity Q3 rather than Q2
Compared to inelastic demand, a larger impact on quantity and less of an impact on price
What happens to total revenue?
Q
$ D1 S1 S2
The Farm Problem
P1
P3
Q1 Q2
D2
P2
Q3
8
The Farm ProblemMany agricultural commodities exhibit
inelastic consumer demandIndividual farmers lack market power
In contrast to some input suppliersInterest sensitivity
Capital intensive operationsProduction creditCapital purchases
International trade important marketTends to be more volatile
Asset fixity and excess capacity9
The Farm ProblemFarms and ranchers in the aggregate
exhibit conditions of perfect competitionLarge number of producersProducing a homogenous product (i.e., corn,
soybeans, wheat, etc)No one farmer has sufficient market power
to influence the market equilibrium priceIf a single producer suffers a disastrous year in
terms of yield, he alone will suffer as market price is not impacted
10
The Farm ProblemMany agricultural commodities exhibit
inelastic consumer demandIndividual farmers lack market power
In contrast to some input suppliersInterest sensitivity
Capital intensive operationsProduction creditCapital purchases
International trade important marketTends to be more volatile
Asset fixity and excess capacity11
The Farm ProblemAgricultural sector is one of the most
highly capitalized sector in the U.S. economyMore capital invested per worker
Farmers must obtain short, medium and long-term loans to purchase variable and fixed inputs
→ a change in interest rates will have a significant impact on production costs
12
The Farm ProblemQuarterly Agricultural Interest Rates (%), 7th District
5.0
7.5
10.0
12.5
15.0
17.5
20.0OperatingReal Estate
13
The Farm ProblemMany agricultural commodities exhibit
inelastic consumer demandIndividual farmers lack market power
In contrast to some input suppliersInterest sensitivity
Capital intensive operationsProduction creditCapital purchases
International trade important marketTends to be more volatile
Asset fixity and excess capacity14
The Farm ProblemHigh interest rates in the U.S. economy
increases the value of the dollar in foreign currency marketsMore units of foreign currency per U.S. $Makes U.S. exports more expensive
Many agricultural commodities (i.e., wheat, corn, soybeans, etc) are highly dependent on export marketsFor many agricultural commodities excess
supply relative to domestic marketReduced export demand → Downward
pressure on commodity prices15
0
10
20
30
40
50
60
The Farm Problem
%U.S. Corn and Soybean Exports as a % of Production
Soybeans
Corn
16
The Farm Problem
2.5
4.0
5.5
7.0
8.5
10.0
11.5
13.0
14.5
U.S. Exports and Imports as a Percent of Total U.S. Milk Solids Production
Dairy Exports
Dairy Imports
% of Dairy Solids
Dramatic DropIn Milk Prices
17
The Farm Problem
0
10
20
30
40
50
60
70
80
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q22002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Dairy Exports as % of Production
NFDM
Dry Whey
Butter
%
18
The Farm ProblemMany agricultural commodities exhibit
inelastic consumer demandIndividual farmers lack market power
In contrast to some input suppliersInterest sensitivity
Capital intensive operationsProduction creditCapital purchases
International trade important marketTends to be more volatile
Asset fixity and excess capacity19
The Farm Problem
Asset fixity refers to the difficulty farmers have in disposing of capital equipment when downsizing or shutting down the business Tractors, combines, silos, etc When commodity prices are low and
farmers are downsizing the value of these assets may be quite low relative to purchase price Could owe more on purchase loan than
asset is worth in the used market
20
The Farm ProblemExcess Capacity refers to the fact that the
agricultural sector can produce more than it can sell Can have times with significant stocks of
storable commodities such as corn, wheat and cheese
→Downward pressure on commodity prices
Technological change can shift the supply curve to the right for all prices Leads to excess capacity
21
The Farm Problem
84.4 86.4
0
10
20
30
40
50
60
70
80
90
U.S. Corn and Soybean Stocks as a % of Production
22
The Farm ProblemCombined effect of asset fixity and
excess capacity ↓ in farm asset values when there exists
surplus commodity stocks
23
Government Intervention in Agriculture
There is a history of state and Federal government intervention in agriculture Designed to improve economic conditions Provide appropriate level of environmental
quality as discussed previously
In terms of improving economic conditions a number of intervention types Adjusting production to market demand Price and income support programs Foreign trade enhancements
24
Government Intervention in Agriculture
Adjusting production to market demand ↓ amount of resources employed to
produce a surplus product Primarily land
Example: Pay farmers not to produce by requiring land normally planted to be idled → Supply curve will shift up → Market prices will improve
25
Government Intervention in Agriculture
Every 5 years or so the U.S. Congress enacts legislation known as the Farm Bill Food Security Act of 1985 Food, Agriculture, Conservation and Trade
Act of 1990 Federal Agricultural Improvement and
Reform Act of 1996 Farm Security and Rural Investment Act of
2002 Food, Conservation and Energy Act of 2008 Debate concerning the 2012 Farm Bill is
already starting26
Government Intervention in Agriculture
U.S. Farm Bills The primary agricultural and food policy tool
of the U.S. Federal gov’t. Concerned with both agriculture and all other
programs under control of USDA i.e., Food Stamp and WIC programs
Purpose of Farm Bills Amends/suspends provisions of permanent law Re-authorizes/amends/repeals provisions of
previous temporary agricultural acts Enact new policy initiatives
27
Government Intervention in Agriculture
28
68%
9%
10%
12%
1%
NutritionConservationCrop InsuranceCommoditiesOther
Note: Nutrition includes food stamps, women infants and children (WIC) andother food assistance programs
Allocation of U.S.D.A Expenditures
Government Intervention in Agriculture
S1→original supply curvePolicies restricting
resource use shifts curve to S2
Market equilibrium moves from E1 to E2
Total revenue Original: OP1E1Q1
After move: OP2E2Q2
Does total revenue increase? Depends on demand
elasticity
Q
$ D S2 S1
P2
P1
Q2 Q10
E1
E2
29
Government Intervention in Agriculture
Another strategy to improve economic conditions is to directly support farm prices and income Obtained by gov’t setting a price floor Price floor supported by government
purchasing surplus commodities Dairy product price support program (DPPSP)
Another alternative is to support farm incomes through direct transfers USDA-RMA and subsidization of crop
insurance premiums30
Dairy Product Price Support Program
Program established in 1949CCC offers to purchase nonperishable
dairy products at a specified (intervention) price and in a specified formCheeseButterNon-fat dry milk
No-limit on amount that can be sold to the CCC
31
Dairy Product Price Support Program
Dormant when market prices are above intervention prices
Activated when supply of products exceeds demand at the intervention price
Previous versions set support prices to essentially set a minimum milk priceNow purchase price of products are
explicitly set by newest Farm Bill
32
Dairy Product Price Support Program
Public policy issuesEffectiveness in establishing a realistic and
adequate milk price floorDistortion in allocation of milk and relative
product prices to products not being demanded by the open market
Impact on U.S. dairy trade Keeps the price of some commodities artificially
high and hurts our ability to export these goods.
33
Budget Costs of Dairy Price Supports
Introduction to Agricultural Economics, 5th edPenson, Capps, Rosson, and Woodward
© 2010 Pearson Higher Education,Upper Saddle River, NJ 07458. • All Rights Reserved.
Government Intervention in Agriculture
A third approach to improving economic conditions is to impact foreign trade “rules of the game” Establish tariffs on specific commodities Set commodity quotas
A tariff on a specific imported commodity Essentially a tax Increases it domestic price Could make U.S. sourced commodity more
price competitive → increases demand from foreign customers36
Government Intervention in Agriculture
A quota limits the quantity than can be imported for a particular commodity
By restricting supply you again shift the supply to the left at every price ↑ equilibrium price
Q
$ D S2 S1
P2
P1
Q2 Q10
E1
E2
37
Government Intervention in Agriculture
Another alternative is to ↑ demand for U.S. agricultural products in foreign markets by reducing export priceThe Federal gov’t can subsidize
purchase of U.S. agricultural commodities
Example: The Dairy Export Incentive Program (DEIP)
38
Government Intervention in AgricultureDairy Export Incentive Program
Initiated in 1985 and still in existence Designed to ↑ dairy product demand: butter,
non-fat dry milk and cheese Develop export markets where U.S. products
are not competitively priced
USDA pays cash to exporters to sell U.S. dairy products at prices lower than the exporter's price USDA makes up the difference
39
Government Intervention in Agriculture
Low own-price elasticity and ↑ supply can cause farm incomes to ↓ sharply
Lets review 4 agricultural policies that have been used to soften the effect of ↓ farm incomes Loan rate programs Set-Aside mechanism Establishment of target prices Counter-cyclical payments mechanism
40
The Loan Rate MechanismCommodity Loan
Rate: Sets minimum prices for farmers that participate in the program Commodities such as
wheat, corn and cotton
Lets examine how this program works at the sector or market level for wheat
Q
$ DMKT
SMKT
PF
QF0
E
41
The Loan Rate MechanismWheat market
PF, QF: market clearing price and quantity
USDAwants to support prices at PG > PF Quantity demanded = QD
Quantity supplied = QG
Excess Supply of QG - QD
Q
$ DSMKT
PF
QF0
E
PG
QD QG
ExcessSupply
42
The Loan Rate Mechanism
USDA’s Commodity Credit Corporation (CCC) acts as purchasing agent for the Federal gov’t.CCC makes a loan to participating farms
at the desired fixed price, PG
Loan plus interest must be paid back within 9-12 months
If not profitable to repay the loan due to low wheat price Producer can repay the loan with
collateral (the crop) as payment
43
The Loan Rate MechanismThe goal is to shift
demand from D to D+CCCQ→ ↑ price from PF to
PG Consumer demand ↓
from QF to QD due to higher price
Government purchases QG − QDQ
$ DMKT
SMKT
PF
QF0
E
PG
QD QG
DMKT+CCCQ
44
Gov’t purchase
The Loan Rate MechanismTotal taxpayer cost of
purchases to achieve the target price would be PG x (QG – QD)= Area QDABQG
Q
$ DMKT
SMKT
PF
QF0
E
PG
QD QG
AB
DMKT+CCCQ
45
The Loan Rate Mechanism
The CCC stores the surplus QG-QD at taxpayer expenseThis approach has the unwanted
effect of increasing supply from (QF to QG) in a sector already plagued by surplus production
46
The Loan Rate Mechanism
Q
$ DMKT
SMKT
PF
QF0
E
PG
QD QG
DMKT+CCCQ Consumer surplus declines from area 3+4+6 to area 6 Consumer welfare
decreases by area 3+4Producer surplus
increases from area 1+2 to area 1+2+3+4+5 There is a welfare
gain of area 3+4+5Total economic surplus
increases by area 5
123
45
6
47
The Loan Rate Mechanism
Q
$
SFIRM
PF
qF0
E
PG
qG
The individual firm under free market conditions will produce quantity qF at price PF Profit = area 1
CCC purchases → the price ↑ to PG Participating farmers ↑
production from qF to qG
Profits ↑ by the area 2 Total profit = areas 1 + 2
2
1
48
The Set-Aside MechanismSignificant problem with the loan program
Successive years of low prices → government stocks of grains and other agricultural commodities can become quite large relative to production
→Large expenditures to pay for storage
To control the size of these stocks, the 1990 Farm Bill adopted a set-aside requirement for program participation
49
The Set-Aside MechanismSet-aside requirements
Farmers must remove a certain % of cropland from production
Condition for receiving program benefits Used for a majority for most major food and
feed grains to reduce surplus production such as corn and wheat
Crop-specific %’s determined in part by expected ratio of ending stocks to total use
50
The Set-Aside MechanismMajor Problem
Farmers will set-aside their poorest land first and crop the remaining acres more intensely
Results in larger supply and lower prices than desired by policy-makers
1995 Farm Bill eliminated the ability of USDA to require set-asides
51
The Set-Aside MechanismWhat are the market-level
impacts? SMKT, market supply curve
prior to acreage restrictions E1 is initial equilibrium at
PF,QF
Assume the Federal gov’t wants to support farm price at level PG
Q
$ DSMKT
PF
QF0
PG
QG QS
E1
52
The Set-Aside MechanismAssume that X% of land
must be idled Resulting supply curve,
SMKT*
Achieve desired pointWelfare effects
Farmers give up areas 2 +3 but gain area 6
On net, farmers gain as area 6 > areas (2 + 3)
Consumers lose sum of areas 4, 5 and 6
Net loss to society =sum of areas 3+4
Q
$ DSMKT
PF
QF0
E1
PG
QG QS
SMKT*
12
3
45
6
7E2
Why is SMKT* curved?
53
The Set-Aside MechanismUnlike CCC purchases,
the set-aside program does not encourage production as under loan-rate program
Q
$ DSMKT
PF
QF0
E1
PG
QG QS
SMKT*
12
3
45
6
7E2
54
The Set-Aside Mechanism
Q
$ DSFirm
PF
qF0
PG
qG
SFirm*
12
3
4
At the firm level the set-aside program causes output to be reduced from qF to qG
Welfare Impacts (PS) Before policy = 1 + 2 + 3 After policy = 1 + 4 Gain = 4 – 2 – 3 Whether gain is positive or
negative depends on Supply elasticities Demand elasticities Amount of shift of S
Page 20855
The Target Price MechanismAnother method for assisting with the
maintenance of farm income has been the use of target price deficiency payments
The Federal government sets a predefined target price for particular crops Payment/bushel is based on the difference
between the target price and the market price or loan rate, whichever is higher
Page 20956
Page 209
Target Price Deficiency Payment Mechanism
Deficiency payment = QM x (TP – max(MP, LR)) shown as the blue shaded area TP = Target Price MP = Market price LR = Loan Rate
57
Recent Approachesto Supporting
Farm Prices and Income
58
1996-2002 PolicyThe 1996 FAIR Act many of previously reviewed
mechanismsLoan rate mechanism remainedSet-aside program eliminatedDeficiency mechanisms eliminated
Participating farmers receive fixed contract payments that were phased out over time
Farmers were “free” to plant whatever crops they desire and still receive contract payments.
No longer had a variable safety net should crop prices drop due to weak export demand.
Pages 212-21459
The 2002 Farm BillBegan in 2002 and expired in 2007Retained loan rate mechanism Retained a fixed payment mechanism
introduced under FAIR Act in 1996Added a new counter-cyclical mechanism Updating base acres and program yieldsRisk management tools such as enhanced
crop insurance coverage
Pages 212-21360
Milk Income Loss Contract Program
Milk Income Loss Contract (MILC) ProgramTarget price deficiency payment program but
for dairy (fluid milk)Direct payments to dairy farmers when milk
price falls below a specified levelFirst enacted under the 2002 Farm BillSince 2002, more than $3.9 Bil paid to U.S.
dairy producersIndividual farm payments are limited by an
annual production capProgram unpopular in regions with large herds
61
Milk Income Loss Contract Program
62
Countercyclical PaymentsEstablished via 2002 Farm Bill
Applied to a number of grain cropsCountercyclical Payment: The payment
($/bu) = TP – EPEP = effective price
= max(12 month avg market price, LR + DP) where DP is a direct payment rate
DP is based on commodity base acres not what you plant that year
Page 21064
Countercyclical Payments
DS
LRPF
TP
1
2
34
Q
Payment acres cannot exceed planted acres
The maximum countercyclical payment = sum of areas 3 and 4
Page 21065
Some Demand Side Options
66
Domestic Demand ExpansionIncreased farm income
can be obtained through domestic demand expansion → Shifting out farm
products demand curve in the U.S.
Profits increase by area PFPGE2E1
Page 210
D1S
PF
QF
D2
PG
QG
E1
E2
67
Domestic Demand Expansion
Producer surplus impacts PS before shift = Area 1 PS after shift = Areas (1 + 2 +
3) PS Gain = Areas (2 + 3> > 0
Consumer surplus impacts CS before shift = Areas(2 + 5) CS after shift = Areas (4 + 5 CS Gain = (Areas (4 – 2) > 0?
Societal surplus increase = Area 3 + Area 4 > 0
Page 213
D1S
PF
QF
D2
PG
QG
E1
E2
1
2 3
45
68
Domestic Demand ExpansionHow can domestic demand be shifted out and
therefore result in higher equilibrium prices and quantities?School feeding and other nutrition service
programs (i.e., Food Stamps, WIC)Advertising and promotional programsThe gov’t can subsidize the development of
uses for farm products i.e., state and Federal subsidies in the use
of ethanol as a gasoline extender
Page 21369
Export Demand ExpansionMany agricultural commodities are highly
dependent on foreign markets for purchases For agriculture as whole > 20% of the value of total
production is exported The importance of export market varies by
commodity
Page 213
Commodity 07/08 08/09 09/10 10/11Corn 18.3 15.6 14.7 14.7
Wheat 61.5 40.1 39.1 44.8Soybeans 41.6 43.3 43.5 41.5
Note: Exports originate from both current and stocks. The above gives some sense of importance of foreign markets
Exports as % of Current Production
70
Export Demand ExpansionRemember that
domestic demand for many agricultural products are inelastic
Export Demand tends to be more elastic than domestic demand
At a given price, domestic demand (DD) + export demand = total demand (TD) Page 213
DD
S
QDD
PDD
TD
E1
71
Export Demand ExpansionP0 = price where
export demand = 0E1 represents
equilibrium with no export demand
E2 represents equilibrium with export demand
Price and quantity both increase
Page 213
DD
S
QDD
PDD
TD
Eo
E1
E2
QDD
PTD
Po
72
Export Demand Expansion What the welfare impacts
of having trade? Producer Surplus
Before trade = Area 1 After trade = Areas(1 +
2 + 3) Gain = Areas(2 + 3)
Domestic Consumer Surplus Before trade = Areas( 2
+ 5) After trade = Area(5) Loss = Area(2)
Foreign Consumer Surplus at E2 = Area 4 Page 213
DD
S
QDD
PDD
TD
Eo
E1
E2
QDD
PTD
Po
1
2 3
45
73
SummaryUSDA has tried to support prices and incomes by
acquiring/storing excess supply at desired priceUSDA supply side approaches to supporting farm
prices and incomes included set-aside rates and deficiency payments
FAIR Act decoupled supports from planting decisions; resulted in large supplemental payments during 1999-2001 period. New bill restored safety net with counter-cyclical payments
Demand side approaches designed to promote domestic and/or export demand
74
Chapter 18 focuses on why nations trade ….
75