1. Government Intervention in Agriculture
Chapter 11

2. Topics of Discussion Defining the Farm Problem
Forms of government intervention
Price and income support mechanisms
Phasing out of supply management
Domestic demand expansion
Importance of export demand 2

3. Net Farm Income With and Without Direct Government Payments
More market driven ag.
policy under FAIR Act
(1996 Farm Bill)
Bil. ($2005)
FAIR Act
Pre FAIR Acts
NFI with Govt. Payments
2002
Bill
NFI without Govt. Payments 3
Page 212

4. Government Payments as a %
of Net Farm Income % 4
Page 212

5. The Farm Problem
Many agricultural commodities exhibit inelastic consumer demand
Individual farmers lack market power
In contrast to some input suppliers
Interest sensitivity
Capital intensive operations
Production credit
Capital purchases
International trade important market
Tends to be more volatile
Asset fixity and excess capacity 5

6. The Farm Problem
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 price
Results in price falling relatively more than the market clearing quantity
Market Equilibrium $ D S1 S2 P1 P2 ΔP Q Q1 Q2
Page 199 ΔQ 6

7. The Farm Problem
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? $ D S1 S2 A P1 P2 B ΔP Q Q1 Q2 ΔQ 7
Page 199

8. The Farm Problem
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? $ D1 S1 S2 P1 P3 P2 D2 Q Q1 Q2 Q3
Page 199 8

9. The Farm Problem
Many agricultural commodities exhibit inelastic consumer demand
Individual farmers lack market power
In contrast to some input suppliers
Interest sensitivity
Capital intensive operations
Production credit
Capital purchases
International trade important market
Tends to be more volatile
Asset fixity and excess capacity 9

10. The Farm Problem
Farms and ranchers in the aggregate exhibit conditions of perfect competition
Large number of producers
Producing a homogenous product (i.e., corn, soybeans, wheat, etc)
No one farmer has sufficient market power to influence the market equilibrium price
If a single producer suffers a disastrous year in terms of yield, he alone will suffer as market price is not impacted 10

11. The Farm Problem
Many agricultural commodities exhibit inelastic consumer demand
Individual farmers lack market power
In contrast to some input suppliers
Interest sensitivity
Capital intensive operations
Production credit
Capital purchases
International trade important market
Tends to be more volatile
Asset fixity and excess capacity 11

12. The Farm Problem
Agricultural sector is one of the most highly capitalized sector in the U.S. economy
More 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

13. The Farm Problem 13

14. The Farm Problem
Many agricultural commodities exhibit inelastic consumer demand
Individual farmers lack market power
In contrast to some input suppliers
Interest sensitivity
Capital intensive operations
Production credit
Capital purchases
International trade important market
Tends to be more volatile
Asset fixity and excess capacity 14

15. The Farm Problem
High interest rates in the U.S. economy increases the value of the dollar in foreign currency markets
More 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 markets
For many agricultural commodities excess supply relative to domestic market
Reduced export demand → Downward pressure on commodity prices 15

16. The Farm Problem U.S. Corn and Soybean Exports as a % of Production %
Soybeans
Corn 16

17. The Farm Problem Dairy Exports Dairy Imports % of Dairy Solids
Dramatic Drop
In Milk Prices
Dairy Exports
Dairy Imports 17

18. The Farm Problem % 18

19. The Farm Problem
Many agricultural commodities exhibit inelastic consumer demand
Individual farmers lack market power
In contrast to some input suppliers
Interest sensitivity
Capital intensive operations
Production credit
Capital purchases
International trade important market
Tends to be more volatile
Asset fixity and excess capacity 19

20. 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

21. The Farm Problem
Excess 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

22. U.S. Corn and Soybean Stocks as a % of Production
The Farm Problem
U.S. Corn and Soybean Stocks as a % of Production 22

23. The Farm Problem Combined effect of asset fixity and excess capacity
↓ in farm asset values when there exists surplus commodity stocks 23

24. 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

25. 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

26. 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 starting 26

27. 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

28. Government Intervention in Agriculture
Allocation of U.S.D.A Expenditures 28

29. Government Intervention in Agriculture
S1→original supply curve
Policies 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 $ D S2 S1 P2 E2 P1 E1 Q Q2 Q1 29

30. 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 premiums 30

31. Dairy Product Price Support Program
Program established in 1949
CCC offers to purchase nonperishable dairy products at a specified (intervention) price and in a specified form
Cheese
Butter
Non-fat dry milk
No-limit on amount that can be sold to the CCC 31

32. 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 price
Now purchase price of products are explicitly set by newest Farm Bill 32

33. Dairy Product Price Support Program
Public policy issues
Effectiveness in establishing a realistic and adequate milk price floor
Distortion 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

34. Budget Costs of Dairy Price Supports

36. 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 customers 36

37. 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 $ D S2 S1 P2 E2 P1 E1 Q Q2 Q1 37

38. Government Intervention in Agriculture
Another alternative is to ↑ demand for U.S. agricultural products in foreign markets by reducing export price
The Federal gov’t can subsidize purchase of U.S. agricultural commodities
Example: The Dairy Export Incentive Program (DEIP) 38

39. Government Intervention in Agriculture
Dairy 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

40. 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

41. The Loan Rate Mechanism
Commodity 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 $
DMKT
SMKT PF E Q QF 41

42. The Loan Rate Mechanism
Wheat 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 $ D
SMKT
Excess
Supply PG PF E Q QD QF QG 42

43. 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

44. The Loan Rate Mechanism
DMKT+CCCQ
The 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 − QD $
Gov’t purchase
DMKT
SMKT PG PF E Q QD QF QG 44

45. The Loan Rate Mechanism
DMKT+CCCQ
Total taxpayer cost of purchases to achieve the target price would be PG x (QG – QD)
= Area QDABQG $
DMKT
SMKT PG A B PF E Q QD QF QG 45

46. The Loan Rate Mechanism
The CCC stores the surplus QG-QD at taxpayer expense
This approach has the unwanted effect of increasing supply from (QF to QG) in a sector already plagued by surplus production 46

47. The Loan Rate Mechanism
DMKT+CCCQ
Consumer surplus declines from area to area 6
Consumer welfare decreases by area 3+4
Producer surplus increases from area 1+2 to area
There is a welfare gain of area 3+4+5
Total economic surplus increases by area 5 $
DMKT
SMKT 6 PG 5 4 3 PF E 2 1 Q QD QF QG 47

48. The Loan Rate Mechanism
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 $
SFIRM PG 2 PF E 1 Q qF qG 48

49. The Set-Aside Mechanism
Significant 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

50. The Set-Aside Mechanism
Set-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

51. The Set-Aside Mechanism
Major 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

52. The Set-Aside Mechanism
What 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 $ D
SMKT PG PF E1 Q QG QF QS 52

53. The Set-Aside Mechanism
Why is SMKT* curved?
Assume that X% of land must be idled
Resulting supply curve, SMKT*
Achieve desired point
Welfare 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 $ D
SMKT*
SMKT 7 E2 PG 6 4 5 E1 3 PF 2 1 Q QG QF QS 53

54. The Set-Aside Mechanism
Unlike CCC purchases, the set-aside program does not encourage production as under loan-rate program $ D
SMKT*
SMKT 7 E2 PG 6 4 5 E1 3 PF 2 1 Q QG QF QS 54

55. The Set-Aside Mechanism
At the firm level the set-aside program causes output to be reduced from qF to qG
Welfare Impacts (PS)
Before policy =
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 $ D
SFirm*
SFirm PG 4 3 PF 2 1 Q qG qF 55
Page 208

56. The Target Price Mechanism
Another 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 209 56

57. 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
Page 209 57

58. Recent Approaches to Supporting Farm Prices and Income58

59. Policy
The 1996 FAIR Act many of previously reviewed mechanisms
Loan rate mechanism remained
Set-aside program eliminated
Deficiency 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. 59
Pages

60. The 2002 Farm Bill Began in 2002 and expired in 2007
Retained loan rate mechanism
Retained a fixed payment mechanism introduced under FAIR Act in 1996
Added a new counter-cyclical mechanism
Updating base acres and program yields
Risk management tools such as enhanced crop insurance coverage
Pages 60

61. Milk Income Loss Contract Program
Milk Income Loss Contract (MILC) Program
Target price deficiency payment program but for dairy (fluid milk)
Direct payments to dairy farmers when milk price falls below a specified level
First enacted under the 2002 Farm Bill
Since 2002, more than $3.9 Bil paid to U.S. dairy producers
Individual farm payments are limited by an annual production cap
Program unpopular in regions with large herds 61

62. Milk Income Loss Contract Program62

64. Countercyclical Payments
Established via 2002 Farm Bill
Applied to a number of grain crops
Countercyclical Payment: The payment ($/bu) = TP – EP
EP = 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 64
Page 210

65. Countercyclical PaymentsD S
Payment acres cannot exceed planted acres
The maximum countercyclical payment = sum of areas 3 and 4 TP 4 3 PF 1 LR 2 Q 65
Page 210

66. Some Demand Side Options66

67. Domestic Demand Expansion
Increased farm income can be obtained through domestic demand expansion
→ Shifting out farm products demand curve in the U.S.
Profits increase by area PFPGE2E1 D2 D1 S PG E2 PF E1 QF QG 67
Page 210

68. Domestic Demand Expansion
Producer surplus impacts
PS before shift = Area 1
PS after shift = Areas ( )
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 D2 D1 S 5 4 PG E2 3 2 PF E1 1 QF QG 68
Page 213

69. Domestic Demand Expansion
How 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 programs
The 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 69
Page 213

70. Export Demand Expansion
Many 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
Exports as % of Current Production
Commodity
07/08
08/09
09/10
10/11
Corn
18.3
15.6
14.7
Wheat
61.5
40.1
39.1
44.8
Soybeans
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
Page 213 70

71. Export Demand Expansion
Remember 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) S
PDD E1 TD DD
QDD
Page 213 71

72. Export Demand Expansion
P0 = price where export demand = 0
E1 represents equilibrium with no export demand
E2 represents equilibrium with export demand
Price and quantity both increase Eo Po S
PTD E2
PDD E1 TD DD
QDD
QDD
Page 213 72

73. Export Demand Expansion
What the welfare impacts of having trade?
Producer Surplus
Before trade = Area 1
After trade = Areas( )
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 Eo Po S 5 4
PTD E2 2 3
PDD E1 1 TD DD
QDD
QDD
Page 213 73

74. Summary
USDA has tried to support prices and incomes by acquiring/storing excess supply at desired price
USDA 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 period. New bill restored safety net with counter-cyclical payments
Demand side approaches designed to promote domestic and/or export demand 74

75. Chapter 18 focuses on why nations trade ….75