McGraw-Hill/Irwin ©2008 The McGraw-Hill Companies, All Rights Reserved The Farm Problem Chapter 29

2 Destabilizing Forces The agriculture industry is one of the most competitive of all U.S. industries.

3 Competition in Agriculture Individual farmers have no market power. Market power – The ability to alter the market price of a good or service.

4 Competition in Agriculture Competition in agriculture is maintained by low barriers to entry. Barriers to entry – Obstacles that make it difficult or impossible for would-be producers to enter a particular market.

5 Competition in Agriculture Because of low barriers to entry, economic profits don’t last long in agriculture. Economic profit – The difference between total revenues and total economic costs.

6 Technological Advance Since 1929, the farm labor force has shrunk by two-thirds, yet farm output has increased by 70 percent. Farm output per labor hour has grown even faster, increasing nearly ten times since the early 1950s. LO1

7 Inelastic Demand Neither lower prices nor higher incomes significantly increase the quantity of food demanded. The price elasticity of food demand is low. The income elasticity of food demand is also low. LO1

8 Inelastic Demand Price elasticity of demand – The percentage change in quantity demanded divided by the percentage change in price. Income elasticity of demand – The percentage change in quantity demanded divided by the percentage change in income. LO1

9 Inelastic Demand With low price elasticity of demand, abrupt changes in farm output have a magnified effect on market prices. demand of elasticity price quantity in change percentage price in change percentage Required  LO1

10 Inelastic Demand Prices and farm income have fallen over time because U.S. food production has grown faster than the U.S. demand for food. In the absence of government price- support programs and foreign demand, farm prices would have fallen still further. LO1

11 Abrupt Shifts of Supply Short-term swings in weather generate large supply shifts in both directions. LO1

12 Short-Term Instability 0 Price (dollars per bushel) Quantity (bushels per year) Weather-reduced supply Normal supply Abundant harvest supply Demand p2p2 p1p1 p3p3 LO1

13 Response Lags Time lags between the production decision and the resultant harvest also contribute to price instability. If prices are high one year, farmers have an incentive to increase their rate of output. LO1

14 Unstable Corn Prices LO1

15 The First Farm Depression The first farm depression occurred in two major steps: World War I ended and exports to Europe dropped drastically. The Great Depression. LO1

16 Farm Prices, LO1

17 U.S. Farm Policy The U.S. Congress has responded to these agricultural problems with a variety of programs. LO2

18 Price Supports As early as 1926, Congress decreed that farm products should sell at a fair price. By fair, Congress meant higher than the market equilibrium. LO2

19 Price Supports A price floor creates a market surplus. Market surplus – The amount by which the quantity supplied exceeds the quantity demanded at a given price; excess supply. LO2

20 Price Supports The farm-nonfarm price relationships of were regarded by Congress as fair and came to be known as parity prices. Parity – The relative price of farm products in the period LO2

21 0 Quantity of Food (bushels per year) Price of Food (dollars per bushel) Fair Prices and Market Surplus Market demand Market supply Surplus pfpf pepe qdqd qsqs LO3

22 Supply Restrictions The goal of parity pricing couldn’t be attained without altering market supply or demand. LO2

23 Set-Asides Congress raised farm prices without creating a surplus by reducing the production of food. Congress did this by paying farmers for voluntary reductions in crop acreage. LO2

24 Set-Asides These acreage set-asides shift the food supply curve to the left. Acreage set-aside – Land withdrawn from production as part of policy to increase crop prices. LO2

25 Dairy Termination Program Between 1985 and 1987, the government paid dairy farmers to kill or export dairy cows to boost dairy prices. LO2

26 Marketing Orders The federal government permits farm groups to limit output to keep farm prices artificially high. LO2

27 Import Quotas The market supply of farm products is also limited by import restrictions. Import taxes limit the foreign supply of other farm products. LO2

28 Demand Distortions While trying to limit the supply of farm products, the government also inflates the demand for selected farm products. LO2

29 Government Stockpiles President Franklin Roosevelt created the Commodity Credit Corporation (CCC) in Farmers can borrow money from the CCC at loan rates set by Congress. Loan rate – The implicit price paid by the government for surplus crops taken as collateral for loans to farmers. LO2

30 Government Stockpiles Whenever market prices are below CCC loan rates, the government ends up buying surplus crops. LO2

31 Government Stockpiles The market surplus induced by price supports must be eliminated in one of three ways: Government purchases. Export sales. Restrictions on supply. LO2

32 0 Price (per unit) Quantity (units per period) 0 Price or Cost (per unit) Quantity (units per period) The Impact of Price Supports MC p2p2 p1p1 q1q1 q2q2 Impact of price supports on the individual farmer Q1Q1 p2p2 p1p1 Supply Surplus CCC loan rate Equilibrium price Market demand Impact of price supports on the agricultural market LO3

33 Cost Subsidies The market surplus induced by price supports is exacerbated by cost subsidies. For example, irrigation water is delivered to many farmers at substantially below the cost of delivering it. This difference amounts to a subsidy. LO2

34 0 Price or Cost (dollars per bushel) Quantity (bushels per year) The Impact of Cost Subsidies Initial marginal cost Subsidized marginal cost p2p2 p1p1 q1q1 q2q2 q3q3 LO3

35 Direct Income Support The advantage of direct income supports is that they achieve the goal of income security without distortions of market prices and output. LO2

36 Direct Income Support The principal form of direct income support are so-called deficiency payments. A deficiency payment is an income transfer paid to farmers for difference between target and support prices. LO2

37 Direct Income Support In principle, direct income payments are a more efficient mechanism for subsidizing farm incomes. But many farmers would rather have price supports – “parity, not charity.” LO2

38 The Second Farm Depression, Despite price supports, supply restrictions, cost subsidies, and income transfers, farm incomes have remained low and unstable, especially for small farms. LO2

39 Net Farm Income, LO2

40 The Cost Squeeze The cost squeeze was not due to abrupt price declines, but rather to steeply rising production costs. As a result, the profit of farmers fell abruptly. LO2

41 The Cost Squeeze Fuel costs – the cost squeeze on farm incomes started with an abrupt increase in fuel prices in Fertilizer costs – being mostly manufactured from a petroleum base, fertilizer went up in price along with fuel. LO2

42 The Cost Squeeze Interest rates – when interest rates skyrocketed, the debt burden of farmers mounted. Declining land values – high interest rates and declining incomes reduced the value of farmers’ most important asset – their land. LO2

43 Declining Exports In 1980, President Carter imposed an embargo on grain sales to the Soviet Union. Between 1980 and 1984, the international value of the dollar rose a staggering 50 percent. LO2

44 Steps Toward Deregulation U.S. government farm policy was changed during the 1980s and 1990s. LO2

45 The 1985 Farm Act Deregulation began with the Farm Security Act of The core feature of the act was a gradual reduction in government price supports. It also limited government purchases of surpluses. LO2

46 The 1990 Act By 1990, crop prices, farm incomes, and the farmland prices had all risen. Declining oil and fertilizer costs, and strong foreign demand for U.S. Farm products increased profits. LO2

47 The 1990 Act The 1990 farm act continued the basic structure of farm subsidies. It increased the loan rates, effectively raising the price floor for farm products. Nevertheless it moved farming a small step closer to market realities. LO2

48 The 1996 Freedom to Farm Act In 1996, the Federal Agricultural Improvement and Reform Act made two radical changes in farm policy: Target prices and their associated deficiency payments were terminated. Many restrictions on acreage set-asides were eliminated. LO2

49 The 1996 Freedom to Farm Act In the place of deficiency payments, farmers were offered market transition payments. Transition payments were targeted to stabilizing farm incomes rather than farm prices. LO2

50 The 1996 Freedom to Farm Act Farmers no longer have to keep set- aside acreage completely idle or grow only specific commodities. LO2

51 The Asian Crisis The Asian crisis that began in July 1997 was the principal cause of the farm economy turning sour again. U.S. farm exports fell sharply when the currencies of Thailand, Korea, Indonesia and Malaysia, and other Asian nations tumbled. LO2

52 Renewed Subsidies When farm prices and incomes plunged during 1997 and 1998, farmers again demanded federal aid. Because it was an election year, they got a fast response. LO2

53 The 2001 Farm Act The intent of the 1996 Farm Act was to wean farmers off the dole, making them more reliant on market forces. That isn’t how it worked out, however. LO2

54 The 2001 Farm Act When the market for farm products went bad, farmers expected more aid not more freedom to farm. Farmers got more permanent aid with the Farm Security Act of LO2

55 The 2007 Farm Act Rising commodity prices in created another opportunity to wean farmers off the dole. With an election looming in 2008 there was little enthusiasm for reducing farm subsidies. LO2

McGraw-Hill/Irwin ©2008 The McGraw-Hill Companies, All Rights Reserved The Farm Problem End of Chapter 29