agri 2312 chapter 11 government intervention in agriculture

Introduction to Agricultural Economics, 5th edPenson, Capps, Rosson, and Woodward

© 2010 Pearson Higher Education,Upper Saddle River, NJ 07458. • All Rights

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GovernmentIntervention in

Agriculture

Chapter 11



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Topics of Discussion

Defining the “Farm Problem”Forms of government interventionConsumer issues Price and income support mechanisms Phasing out of supply managementDomestic demand expansionImportance of export demand



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The “Farm Problem”

Inelastic demand and a bumper cropLack of market powerInterest sensitivityTrade sensitivityAsset fixity and excess capacity



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Page 199

An increase in supply causes price to fall more sharply than the quantity clearing the market.

An increase in supply causes price to fall more sharply than the quantity clearing the market.



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Page 199

If the demand curve is more elastic (D2), the price will only fall to price P2 rather than P3 for a given increase in supply.

If the demand curve is more elastic (D2), the price will only fall to price P2 rather than P3 for a given increase in supply.



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Price and Income Support:A Historical perspective

Commodity acquisition-loan rate mechanism

Set-aside mechanismTarget price mechanismCommodities covered by government

programs



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The CCC’s Loan RateApproach to SupportingFarm Prices and Income



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Page 205

Market Level Effects of Loan RatesMarket Level Effects of Loan Rates

Free market equilibriumoccurs at point E. Let’sassume that PF is belowa politically acceptableprice, and that the pricedesired by policymakersis PG.

Free market equilibriumoccurs at point E. Let’sassume that PF is belowa politically acceptableprice, and that the pricedesired by policymakersis PG.



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Page 205


The Commodity CreditCorporation of the USDAbegan in the Thirties to acquire excess supply at thedesired price its through non-recourse loan provisions.

The goal was to shift demand from D to D+CCCACQ, pulling up the price from PF to PG. Note that consumer demandactually fell from QF to QD.

The Commodity CreditCorporation of the USDAbegan in the Thirties to acquire excess supply at thedesired price its through non-recourse loan provisions.

The goal was to shift demand from D to D+CCCACQ, pulling up the price from PF to PG. Note that consumer demandactually fell from QF to QD.



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Page 205


The CCC stored the surplus QD-QG in metal bins atgreat expense to taxpayers.

This approach had the un-wanted effects of increasingsupply from (QF to QG) in a sector already plagued by surplus production.

The CCC stored the surplus QD-QG in metal bins atgreat expense to taxpayers.

This approach had the un-wanted effects of increasingsupply from (QF to QG) in a sector already plagued by surplus production.



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Page 205


Consumer surplus woulddecline from area 3+4+6 tojust area 6. Thus, they areeconomically worse-off as aresult of this approach.

Producer surplus wouldincrease from area 1+2 toarea 1+2+3+4+5, a gainof area 3+4+5.

Consumer surplus woulddecline from area 3+4+6 tojust area 6. Thus, they areeconomically worse-off as aresult of this approach.

Producer surplus wouldincrease from area 1+2 toarea 1+2+3+4+5, a gainof area 3+4+5.



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Page 206

Firm Level Effects of Loan RatesFirm Level Effects of Loan Rates

The individual firm underfree market conditions willproduce quantity qF if itexpected the free market price PF, and earn profitequal to area 1.

The individual firm underfree market conditions willproduce quantity qF if itexpected the free market price PF, and earn profitequal to area 1.



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Page 206

Firm Level Effects of Loan RatesFirm Level Effects of Loan Rates

The increase in CCCacquired stocks pullingthe price up to PG willcause participating farmers to increase itsproduction from quantityqF to qG, increasing itsprofits by area 2.

The increase in CCCacquired stocks pullingthe price up to PG willcause participating farmers to increase itsproduction from quantityqF to qG, increasing itsprofits by area 2.



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The Set-AsideApproach to SupportingFarm Prices and Income



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Page 207

Market Level Effects of Set-Aside RequirementsMarket Level Effects of Set-Aside Requirements

Free market equilibriumoccurs at point E1. Let’sassume that PF is belowa politically acceptableprice, and that the pricedesired by policymakersagain is PG.

Free market equilibriumoccurs at point E1. Let’sassume that PF is belowa politically acceptableprice, and that the pricedesired by policymakersagain is PG.



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Page 207


Shifting the market supplycurve from SMKT to SMKT*through set-aside require-ments reduces productionfrom QF to QG. The market equilibrium moves from E1

to E2.

Shifting the market supplycurve from SMKT to SMKT*through set-aside require-ments reduces productionfrom QF to QG. The market equilibrium moves from E1

to E2.



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Page 207


Consumer surplus would fall from area 4+5+6+7 tojust area 7. Thus, consumersare worse-off economically.

Producer surplus wouldincrease from area 1+2+3 toarea 1+6. As long as area 6is greater that area 2+3, producers are better-off.

Consumer surplus would fall from area 4+5+6+7 tojust area 7. Thus, consumersare worse-off economically.

Producer surplus wouldincrease from area 1+2+3 toarea 1+6. As long as area 6is greater that area 2+3, producers are better-off.



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Page 207


Importantly, the set-asideapproach does not encourageproduction of quantity QS asthe CCC loan rate approachdid.

Importantly, the set-asideapproach does not encourageproduction of quantity QS asthe CCC loan rate approachdid.



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PF

PG

SFIRM*

SFIRM

qG qF qS

Firm Level Effects of Set-Aside RequirementsFirm Level Effects of Set-Aside Requirements

12

3

4

Page 208

Producer surplusBefore policy = 1+2+3After policy = 1+4Gain = 4 – 2 – 3

Producer surplusBefore policy = 1+2+3After policy = 1+4Gain = 4 – 2 – 3



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9

Deficiency Payment MechanismDeficiency Payment Mechanism

The deficiency payment was equal to quantity QM multiplied by the difference between the announced target price and either the loan rate or market price (blue shaded area above), which ever was higher.

The deficiency payment was equal to quantity QM multiplied by the difference between the announced target price and either the loan rate or market price (blue shaded area above), which ever was higher.



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Recent Approachesto Supporting

Farm Prices and Income



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1996-2002 PolicyThe FAIR Act signed into law in 1996 eliminated many

of these mechanisms.The loan rate mechanism remained, but the set-aside

and deficiency mechanisms were deleted.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. Pages 212-214



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The 2002 Farm BillBegan in 2002 and expired in 2007Retained loan rate mechanism Retained a fixed payment mechanism

introduced under FAIR Act in 1996Added a new counter-cyclical mechanism Updating base acres and program yieldsRisk management tools such as enhanced crop

insurance coverage

Pages 212-213



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Countercyclical PaymentsD S

LR

PF

TP

1

2

34

Q

Payment acres cannot exceed planted acres. The maximum countercyclical payment here is equal to areas 3+4

Payment acres cannot exceed planted acres. The maximum countercyclical payment here is equal to areas 3+4

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Importance of Government Payments at Sector



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Importance of Government PaymentsTo Net Farm Income


Page 212



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Page 212

Pre FAIR ActPre FAIR Act FAIR ActFAIR Act



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Page 212


Lowered safety netunder FAIR Act…




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Page 212




2002Bill

2002Bill



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The 2008 Farm BillBegan in 2002 and expired in 2007Retained loan rate mechanism Retained a fixed payment mechanism

introduced under FAIR Act in 1996Added a new counter-cyclical mechanism Updating base acres and program yieldsRisk management tools such as enhanced crop

insurance coverage

Page 211-213



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Some Demand Side Options



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Page 213

Domestic Demand Expansion: Value Added ProductsDomestic Demand Expansion: Value Added Products

Let’s assume that the freemarket conditions result ina price of PF and quantityQF.

Market equilibrium occursat E1.

Let’s assume that the freemarket conditions result ina price of PF and quantityQF.

Market equilibrium occursat E1.



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Page 213


Policies designed to promoteresearch that would enhancevalue added demand forfarm products would shiftthe demand curve out to theright.

This would increase price toPG and quantity to QG.

Policies designed to promoteresearch that would enhancevalue added demand forfarm products would shiftthe demand curve out to theright.

This would increase price toPG and quantity to QG.



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Page 213


Consumer surplus in thismarket would go fromarea 2+5 to area 4+5. Ifarea 4 exceeds area 2, consumers are better-off.

Producers would be betteroff by area 2+3 as we movefrom E1 to E2.

Consumer surplus in thismarket would go fromarea 2+5 to area 4+5. Ifarea 4 exceeds area 2, consumers are better-off.

Producers would be betteroff by area 2+3 as we movefrom E1 to E2.



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Page 215

Export Demand Expansion: EnhancementsExport Demand Expansion: Enhancements

Let’s assume the originalDemand curve is DD, givingus a market clearing priceof PDD and correspondingquantity of QMM at marketequilibrium E1.

Let’s assume the originalDemand curve is DD, givingus a market clearing priceof PDD and correspondingquantity of QMM at marketequilibrium E1.



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Page 215


Consumer surplus wouldbe area 2+5 while producersurplus would be area 1.

Consumer surplus wouldbe area 2+5 while producersurplus would be area 1.



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Page 215


By enhancing export demandthrough subsidies to clientnations, the government canshift the demand curve outto TD beginning at E0.

Domestic consumer surpluswould decline by area 2 butproducer surplus wouldincrease by area 2+3. Atequilibrium E2, foreignconsumer surplus would be area 4.

By enhancing export demandthrough subsidies to clientnations, the government canshift the demand curve outto TD beginning at E0.

Domestic consumer surpluswould decline by area 2 butproducer surplus wouldincrease by area 2+3. Atequilibrium E2, foreignconsumer surplus would be area 4.



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Summary USDA has tried to support prices and incomes by

acquiring/storing excess supply at desired support 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 1999-2001 period. New bill restored the safety net with counter-cyclical payments.

Demand side approaches designed to promote domestic and/or export demand.



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Chapter 12 focuses on general economic conditions ….

agri 2312 chapter 11 government intervention in agriculture

Business

quantity q fto q g

net farm income page

p fto p g

market price blue shaded

price desired

desired price

acceptable price

q payment acres