McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Politics and Economics: The Case of Agricultural Markets Chapter 19

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Laugher Curve If all economists were laid end to end: a. it would be a good thing. b. they would be more comfortable. c. they would never reach a conclusion. d. they would point in different directions. e. all of the above.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. The Nature of Agricultural Markets n Agricultural markets look like classic perfectly competitively markets: l There are many independent sellers who are generally price takers. l There are many buyers. l Products are interchangeable. l Prices can, and do, vary considerably.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. The Nature of Agricultural Markets n Agricultural markets are far from being perfectly competitive. l Agricultural markets are influenced by government programs. l Whenever the invisible hand pushes prices down, farmers use their political clout to kick them back up.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. The Good/Bad Paradox in Agriculture n Agriculture is characterized by the good/bad paradox – the phenomenon of doing poorly because you are doing well.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. The Long-Run Decline of Farming n The U.S. used to be a highly agricultural economy. n Now just over 2 percent of the labor force works in agriculture.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. The Long-Run Decline of Farming n It used to take a large number of farmers to feed the nation – it now takes relatively few. n Productivity has increased while income has fallen – many farmers have stopped farming altogether.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. The Long-Run Decline of Farming n Due to competition among farmers, most benefits of productivity have gone to consumers in the form of lower prices.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. B A S C S Q0Q0 P0P0 Q1Q1 P1P1 Price Quantity 0 D The Good/Bad Paradox

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. The Short-Run Cyclical Problem Facing Farmers n In the short run, good harvests mean bad times while poor harvest mean good times. n The short-run demand for most agricultural goods is even more inelastic than the long- run demand.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. The Sort-Run Cyclical Problem Facing Farmers n Agricultural production tend to be highly unstable because it depends on weather and luck.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Difficulty Coordinating Farm Production n Farmers are not wild about passing on gains in productivity to consumers instead of keeping them for themselves.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Difficulty Coordinating Farm Production n Limiting production of all farmers would increase their joint income. n It is difficult for them to do so privately because there are so many of them.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Ways Around the Good/Bad Paradox n Farmers organize and get the government to establish programs that limit supply or keep prices high. n These programs include price-stabilization programs and price-support programs.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Ways Around the Good/Bad Paradox n Price-stabilization programs are designed to eliminate short-run fluctuations in prices, while allowing prices to follow their long-run trend line.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Ways Around the Good/Bad Paradox n Price-support programs are designed to maintain prices at levels higher than the market prices.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. The General Rule of Political Economy n Farm programs hurt taxpayers and consumers. l Taxes are higher because government buys up surplus farm output. l Food prices are higher.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. The General Rule of Political Economy n Taxpayers and consumers have not risen up and crushed these programs. n Using the general rule of political economy, public choice economists explain why.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. The General Rule of Political Economy n Government policies tend to reflect a small group’s interests, not the interests of the large group. l The small group is helped and large groups are hurt by the government action. l The small group tends to lobby far more effectively for the policy than the large group against it.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. The General Rule of Political Economy n Farm states with small populations have relatively greater per capita political power in the U.S. Senate. n Farmers’ strong political representation in Congress establishes a core of lawmakers who favor farm supports.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Four Price-Support Options n In a price-support system, the government maintains a higher-than- equilibrium price.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Four Price-Support Options n The government has four price support options: l Regulatory force. l Economic incentives to reduce the supply. l Subsidize the sale of the good. l Buy up and store, give away, or destroy the good.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. S E D QEQE PEPE QSQS QDQD P1P1 Price Quantity0 A Price Support System Some other force must be exerted in order to maintain price. Excess supply exerts downward pressure on price.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Supporting the Price by Regulatory Measures n Government can use regulatory force to prevent anyone from selling or buying at a lower price. n This price floor helps some suppliers and hurts others.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Supporting the Price by Regulatory Measures n How many farmers will be helped or hurt depends on the elasticity of supply and demand. l When supply and demand are inelastic, the number hurt is relatively small. l When the supply and demand are elastic, the number hurt is larger.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. The Need for Rationing n A price floor requires a non-economic method of rationing to distribute the limited demand among the suppliers.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. The Need for Rationing n Keeping new farmers from entering the market limits the quantity supplied. n This method of restriction is to grandfather existing farmers. l Grandfathering – to pass a law affecting a specific group but exempting from the law those in the group before it was passed.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. The Need for Rationing n Most farm subsidy programs are supplemented with tariffs and quotas on foreign imports of the same commodity.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Distributional Consequences n Whenever a market is prevented from operating freely, there is a welfare loss of producer and consumer surplus to society.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. A C D B Demand Supply Q1Q1 Q2Q2 Price Quantity Regulating Price Directly QeQe

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Provide Economic Incentives to Reduce the Supply n Government can provide economic incentives to reduce supply. n One technique is to pay farmers not to grow a crop.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. The Need for Rationing n Supply reductions are combined with regulatory restrictions to prevent entry into the subsidized business. n Existing farmers are grandfathered in. n All others are forbidden to produce.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Distributional Consequences n When economic incentives are supplied, existing farmers do very well. n Consumers pay higher prices n Taxpayers pay more than the regulatory option.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Providing Incentives to Reduce Supply A B Price $ Quantity Q1Q1 QeQe Q2Q2 D S Government payment Consumers pay more

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Subsidizing the Sale of the Good n When the government subsidizes the sale of the good to consumers, suppliers get a higher price and demanders pay a lower price.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Subsidizing the Sale of the Good n Farmers supply at the predetermined price that is higher than the market price. n The government turns around and sells the resulting surplus at whatever price it can get.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Subsidizing the Sale of the Good n No direct transfer takes place from the consumer to the farmer. n Demanders get more goods at a lower price. n This option costs taxpayers the most of the four options.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Subsidizing the Sale of the Good A C B Price Q2Q2 $ Quantity D S 3.50 QeQe

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Buy Up and Store, Give Away, or Destroy the Good n Government can buy up enough of the good so that the total demand increases enough to eliminate downward pressure on price.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Buy Up and Store, Give Away, or Destroy the Good n When the government buys surplus production, it has to decide what to do with it. l One option is to give it to the poor. l Giving food away for free upsets current sellers of food to the poor. l Burning the surplus creates all sorts of image problems for the government.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Buy Up and Store, Give Away, or Destroy the Good n Storing it indefinitely is costly. n Giving the food to foreign governments as humanitarian aid hurts those who are already selling food to their consumers.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. B A Q1Q1 Q2Q2 $5.00 Price Quantity0 QeQe 3.50 D S Buying Up and Storing

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Which Group Prefers Which Option? n Regulation costs the government the least, but it benefits the farmers the least. l Government is least likely to choose this approach because existing farmers are likely to directly push for price supports.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Which Group Prefers Which Option? n Economic incentives costs government more than regulation but less than subsidies or buying up and storing or destroying. l Farmers benefit by not having to grow a crop. l They also benefit if they are allowed to use their land for other purposes.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Which Group Prefers Which Option? n Farmers usually oppose economic incentives if they are not allowed to use their land for other purposes. n They prefer subsidies or buying up and storing or destroying.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Which Group Prefers Which Option? n Subsidies on sales to keep prices down, benefit both consumers (who get low prices) and farmers (who get high prices). n Taxpayers are harmed most by subsidies on sales.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Which Group Prefers Which Option? n Buying up and storing or destroying the goods, costs taxpayers more than regulation and economic incentives but less than subsidies on sales. n However, the government is left with a surplus to dispose of.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Economics, Politics, and Real- World Policies n The two prevalent U.S. farm programs have been: l The land bank program – the government supports prices by giving farmers economic incentives to reduce supply. l The nonrecourse loan program – the government “buys” goods in the form of collateral on defaulting loans.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Interest Groups n The actual policy debate is more complicated than shown here. n Environmentalists have entered the picture with demands that farmers not use certain chemicals and fertilizers.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Interest Groups n Politicians attempt to balance the general good with that of the interest groups they represent or that contribute to their campaigns.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. International Issues n Government’s role in agriculture in the European Union and in Japan is significantly greater than in the U.S. n Our agricultural policy is in part determined by trade negotiations with other nations.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Conclusion n Although the chapter focused on agriculture, in a larger sense, it was concerned with the nexus of economics and politics. n Other subjects could have been considered.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Conclusion n A military draft can be seen as a mechanism for focusing the cost of defense away from the taxpayer and onto a specific group of individuals—young people.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Conclusion n The government’s support of the arts can be seen as a transfer from general taxpayers to a specific group of individuals who like the arts.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Conclusion n Government support for education can be seen as a transfer from general taxpayers to a specific group of individuals: students and teachers.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Conclusion n The role of economists is not to say whether these programs are right or wrong, but to explain the tradeoffs.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Conclusion n The economic framework directs you to look for the self-interest. n Just because some groups may support policies for self-serving reasons, that doesn’t mean that the policies are bad or should not be adopted.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Politics and Economics: The Case of Agricultural Markets End of Chapter 19