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Principles of Microeconomics: Econ102

Price & Income instability results from:

An inelastic demand for agricultural products Very low price elasticity of demand Biological factors Rapidly diminishing marginal utility

Very large price cuts are needed to induce small increases in food consumption

Fluctuations in farm output Natural events are beyond farmers’ control Small changes in output result in relatively

larger changes in prices & incomes

Shifts of the demand curve for farm products Dependence on world markets Weather & crop production abroad Cyclical fluctuations International politics, foreign exchange, etc.

19-2

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Source: Derived from the authors from Foreign Agricultural Trade of the United States, http://www.ers.usda.gov/Data/FATUS; and Bureau of Economic Analysis, http://www.bea.gov

19-3

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Source: Author calculations using nominal values from Global Financial Data, globalfinancialdata.com, adjusted for inflation with the GDP deflator published by the Bureau of Economic Analysis, bea.gov

19-4

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Technological ProgressSignificantly increased the supply of agricultural products

Amount of capital increased 15 times between 1930 and 1980, permitting a fivefold increase in land cultivated per farmer

One unit of farm labor / units of farm output

1950: 14; 1970: 43; 1980: 60; 1990: 91; 2000: 128; 2008: 154

Productivity in agriculture has advanced 2x as fast as in the nonfarm economy

Lagging DemandIncome-Inelastic

Increases in consumer incomes produce less-than-proportionate increases in spending on farm products

Population Growth

19-5

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Long-run decline of agricultural prices and farm income

D1

P1

Q0

P

P2

Q1

b

a

D2

S1 S2

Q2

c

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Major consequences

Increased minimum efficient scale (MES)

Consolidation

Agribusiness

Massive exit of workers

Farm labor 2% of labor force

Farm-Household Income

19-7

Year

In Millions

Of People

As %Of Total

Employment

#Of

Farms,(000)

1950 9.3 15.8 5388

1960 6.2 9.4 3962

1970 4.0 5.0 2954

1980 3.5 3.5 2440

1990 2.5 2.1 2146

2000 2.2 1.6 2172

2008 1.8 1.2 2200

*Includes self-employed farmers, unpaid farmworkers, and hired farmworkers

Source: derived by the authors from Economic Report of the President, 2010, Table B-100; U.S. Bureau of Labor Statistics, http://www.bls.gov, and Department of Agriculture, Economic Research Services, http://www.ers.usda.gov

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Subsidized since 1930s

Support for agricultural prices, income, and output

Soil and water conservation

Agricultural research

Farm credit

Crop insurance

Subsidized sale of farm products in world markets

19-9

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Necessities of lifeMany farmers have relatively low incomes so they

should receive higher prices & incomes through public help.

“Family farm” institutionIt is a fundamental U.S. institution and should be

nurtured as a way of life.

Extraordinary hazardsDroughts, floods, insects and other disasters not

faced by other industries

Competitive markets for output while inputs have significant market powerThe Parity Concept: Rationale for price supports

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Effective price floor

Generates surplus output

Gain to farmers

Loss to consumersHigher burden on the poor

Efficiency lossesOver-allocation of resources

Other social losses

Environmental costs

International costs

19-12

Q0

P

b

a

S

S

D

D

Pe

Qe

Ps

Tax BurdenOf Surplus

Qc Qs

Surplus

c

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Restricting supply Acreage allotments

Bolstering demandGasoholBiodieselCorn-based ethanol

The ethanol programHigher food pricesSecondary effects

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Criticisms of parity concept

Criticisms of price supports

Symptoms not causes

Misallocation of resources between agriculture and the rest of the economy

Too many farmers……low prices……..low incomes

Supports encourage much of the same

Misguided subsidies

Policy contradictions

Free-trade policies

Wildlife habitats

Health problems

19-14

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Public choice theory revisited

Rent-seeking behaviorSpecial-interest effectPolitical logrolling

Changing politics

Declining political supportWorld trade considerations

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Recent farm policy

Freedom to Farm Act of 1996Ended price supports and acreage allotments“Freedom to Plant” approach; Markets……...not governmentTransition payments

Declining annual payments through 2002Based on a farmer’s previous production levelsNo regard to current prices or output

In 1999, reduced export demand & strong crop productionResulted in larger subsidies than before Act

Food, Conservation, and Energy Act of 2008Direct payments (do not decline year to year; permanent transfers

Countercyclical paymentsMarketing loans

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Price supports

Import Quotas

Domestic Costs32 percent above world price

Developing countriesExclusion Increased world supplyU.S. ….from a sugar-importing nation to a

sugar-exporting nation

U.S. efficiency loss

Global resource misallocation19-17

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