1. McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 30 Farm Policy

2. 1- 2 ©2012 The McGraw-Hill Companies, All Rights ReservedMcGraw-Hill/Irwin 30-2 Chapter Outline Farm Prices Since 1950 Price Variation As A Justification For Government Intervention Consumer And Producer Surplus Analysis Of Price Floors Price Support Mechanisms And Their History Kick It Up a Notch

3. 1- 3 ©2012 The McGraw-Hill Companies, All Rights ReservedMcGraw-Hill/Irwin 30-3 Farm Prices Since 1950 Raw food commodity prices have increased much more slowly than overall inflation. From 1982 to 2008 overall inflation was 101%. Most food commodities cost less in 2008 than in 1982 in nominal terms (50% less in real terms.) Hog prices in 2000 yielded less than 45% of their 1982 levels.

4. 1- 4 ©2012 The McGraw-Hill Companies, All Rights ReservedMcGraw-Hill/Irwin 30-4 Farm Price Indexes

5. 1- 5 ©2012 The McGraw-Hill Companies, All Rights ReservedMcGraw-Hill/Irwin 30-5 Corn and Gasoline Corn is the main ingredient in ethanol. E85 (available mostly in the Midwest) is a substitute for gasoline. Recent spikes in gasoline prices have motivated increased corn planting.

6. 1- 6 ©2012 The McGraw-Hill Companies, All Rights ReservedMcGraw-Hill/Irwin 30-6 Corn and Gasoline Prices Relative to their 2000 level

7. 1- 7 ©2012 The McGraw-Hill Companies, All Rights ReservedMcGraw-Hill/Irwin 30-7 Price Variability as the Justification for Government Intervention Argument for intervention on this ground Highly variable prices create an unstable income for farmers reducing their interest in farming. Argument against intervention on this ground Using options markets and crop insurance farmers can dampen the impact of this variability.

8. 1- 8 ©2012 The McGraw-Hill Companies, All Rights ReservedMcGraw-Hill/Irwin 30-8 Price Floors A Price Floor (a price below which a commodity may not sell) is set to protect farmers from prices that go “too low.”

9. 1- 9 ©2012 The McGraw-Hill Companies, All Rights ReservedMcGraw-Hill/Irwin 30-9 Farm Markets Without Subsidies P S D Q/t P* Q* A C H Value to the Consumer: 0ACQ* Consumers Pay Producers: 0P*CQ* The Variable Cost to Producers: 0HCQ* Consumer Surplus: P*AC Producer Surplus: HP*C 0

10. 1- 10 ©2012 The McGraw-Hill Companies, All Rights ReservedMcGraw-Hill/Irwin 30-10 Price Floors P S D Q/t P* Q* A C H G Price Floor B P floor QDQD Value to the Consumer: 0ABQ D Consumers Pay Producers: 0P floor BQ D The Variable Cost to Producers: 0HGQ D Consumer Surplus: P floor AB Producer Surplus: HP floor BG DWL BCG 0

11. 1- 11 ©2012 The McGraw-Hill Companies, All Rights ReservedMcGraw-Hill/Irwin 30-11 Government Purchase of Excess Goods P S D Q/t Price Floor P* Q* A B C E F H G I J P floor QSQS QDQD Value to the Consumer: 0ABQ D Consumers Pay Producers: 0P floor BQ D Government Pays Producers: Q D BEQ s The Variable Cost to Producers: 0HEQ S Consumer Surplus: P floor AB Producer Surplus: HP floor E DWL ECF 0

12. 1- 12 ©2012 The McGraw-Hill Companies, All Rights ReservedMcGraw-Hill/Irwin 30-12 P S D Q/t Price Floor P* Q* A B C E F H G I J P floor QSQS QDQD Value to the Consumer: 0AFQ S Consumers Pay Producers: 0JFQ S Government Pays Producers: JP floor EF The Variable Cost to Producers: 0HEQ S Consumer Surplus: JAF Producer Surplus: HP floor E DWL ECF Government Lowers the Price to Consumers 0

13. 1- 13 ©2012 The McGraw-Hill Companies, All Rights ReservedMcGraw-Hill/Irwin 30-13 Variable Floors The Eau Claire Rule: the wholesale price floor on milk is set as a function of the distance between a given community and Eau Claire, Wisconsin. This subsidizes milk production on the coasts of the United States.

14. 1- 14 ©2012 The McGraw-Hill Companies, All Rights ReservedMcGraw-Hill/Irwin 30-14 What Would Happen Without Price Floors Prices would fall. Production would fall. Farmers would leave the industry until the price of commodities reached a level consistent with zero economic profit (normal profit).

15. 1- 15 ©2012 The McGraw-Hill Companies, All Rights ReservedMcGraw-Hill/Irwin 30-15 History of Price Supports: Buying Programs Began in the 1930s. Reached a peak in the 1980s. The federal government purchased vast quantities of corn, soybeans, milk to be stored. The milk was powdered or turned into blocks of American Cheese. The cheese given away to the poor in the 1982 recession (which was the origin of the phrase “government cheese”.)

16. 1- 16 ©2012 The McGraw-Hill Companies, All Rights ReservedMcGraw-Hill/Irwin 30-16 History of Price Supports: Output Restrictions The buying programs were ended in the 1980s and were replaced with programs where the government offered higher prices for limited production. The programs purchased dairy herds and slaughtered them. Ordered grain farmers to set aside plots if they wanted the subsidized price.