Agriculture:Farmers’ Problems, Government Policies, and

Unintended Effects

Del Mar College

John Daly©2002 South-Western Publishing, A Division of Thomson Learning

Agriculture & High Productivity

• Increased productivity in the agricultural sector has pushed the supply curve of farm products rightward

• Increased productivity results in lower prices for consumers and lower revenues for farmers.

High Productivity Doesn’t Always Benefit Farmers as a Group

Owing to increased agricultural productivity, the supply curve shifts rightward. As a result, equilibrium price falls and equilibrium quantity rises. The demand curve between E1 and E2 is inelastic so total revenue is lower at E2 than at E1.

Agriculture and Income Elasticity

• Recall that income elasticity of demand measures the responsiveness of a change in quantity demanded to changes in income.

• The combination of income inelasticity of demand for food and high agricultural productivity leads to the demand for food increasing and the supply of food increasing even more.

• Supply increases that outstrip demand increases lead to falling prices.

High Productivity and Income Inelasticity Together

Both the demand for and supply of food have been increasing for most of this century. High productivity in the agriculture sector, relative to income inelasticity for food, has meant that supply has increased by more than demand. As a result, prices have fallen.

Agriculture and Price Inelasticity

• If market demand is inelastic and supply is subject to severe shifts from season to season, price changes are likely to be large and total revenue is likely to be highly volatile.

• The demand for many agricultural products is inelastic.• The supply of many food products changes from one year

to the next because it depends not only on technological and productivity changes but also on the weather.

• The instability in price and total revenue increases the uncertainties of farming.

Large Price Changes and Volatile Total Revenue

If demand is inelastic and supply is subject to severe changes from season to season, price changes will be large and total revenue will be volatile. Suppose the supply curve shifts from SB to SG. As a result, price falls from PB to PG, and total revenue falls from PB x QB to PG x QG.

Price Variability and Futures Contracts

• Farm incomes were at the mercy of annual fluctuations in farm prices. This is why some of the government’s agricultural programs were started.

• Futures Contract: An obligation to make or take delivery of a specified quantity of a good at a particular time in the future at a price agreed on when the contract is signed.

The Changing Farm Picture

• There are fewer farms in this country today than there were in the first half of the twentieth century.

• Farm employment has declined from 10 million in the late 1940s to 2.8 million today.

Q & A

• Explain how a farmer can protect herself against adverse price swings.

• An individual farmer could be in any of the following situations:

a) Bad weather for all farmers including himself.b) Good weather for all farmers including himselfc) Bad weather for all other farmers but good weather for

himself.

Which situation would the farmer prefer and why?• For farmers as a group when would increased

productivity lead to higher revenue?

Agricultural Polices Before the FAIR Act

• Farmers had not been able to control supply by themselves, and thereby, couldn’t control price.

• Price support is a price floor, a government guaranteed minimum price.

• The effects of price supports are: a surplus, fewer exchanges, higher prices paid by consumers of crop X, and government purchase and storage of the surplus

Effects of an Agricultural Price Support

At a price support of $6 per bushel, consumers of crop X pay higher prices, and a surplus results. Fewer bushels of crop X are bought by private citizens, and the government buys and stores the surplus (for which taxpayers pay)

Restricting Supply

• Prices of agricultural products can be increased directly by price supports or indirectly by restricting supply.

• Acreage Allotment Program: restricts output by limiting the number of farm acres that can be used to produce a particular crop.

• Marketing Quota System: sets a limit on the quantity of a product that a farmer is allowed to bring to market.

• Soil Bank System: farmers were paid to take part of their land out of cultivation.

The Objective of Supply-Restricting Agricultural Policies

The objective of all varieties of supply – restricting agricultural policies is to shift the supply curve leftward and raise price.

Target Prices and Deficiency Payments

• Target Price: a guaranteed price; if the market price is below the target price, the farmer receives a deficiency payment equal to the difference between the market price and the target price.

• Deficiency payment = target price – market price

The Target Price System

With target prices, the government guarantees farmers a price per unit of product produced. For example, if government sets the target price of crop X at $6 per bushel, farmers produce Q1 bushels. When this quantity is placed in the market, consumers will only pay $2 per bushel. The difference between the $6 target price and the $2 price consumers pay is the deficiency payment per bushel that government pays farmers.

Q & A

• If the target price for a bushel of wheat is $7, what will the per-unit deficiency payment equal?

• Can agricultural policies that are designed to benefit farmers who rent their land benefit the landowners instead? Explain your answer.

Federal Agriculture Improvement and Reform Act of 1996 (FAIR)

• Instead of subsidizing or restricting the supply of crops, the government simply gives each farmer a check and lets him grow anything he wants or nothing at all.

• The FAIR Act repealed target prices and deficiency payments and supply-restricting policies on such crops as wheat, feed grains, cotton, and rice.

Production Flexibility Contract Payments

• Production Flexibility Contract Payments: direct payments to farmers who produced certain crops in any year fr9om 1991 to 1995.

• Payment=Contract Acreage x 0.85 x Yield per acre x Crop Payment Rate

FAIR Act Facts

• The FAIR Act allows farmers to react to market fundamentals by allowing farmers to grow any crop without loss of support.

• The costs of the program stabilized federal farm spending instead of farm income.

• Nonrecourse Commodity Loans is a particular type of price support.

What the FAIR Act Doesn’t Do

• It does not move agriculture from a system of price supports , acreage restrictions to a completely free market.

• Price supports remain in various forms• Import restrictions remain on certain products.• Doesn’t prevent Congress from establishing

emergency assistance for farmers when crop prices are low, droughts are severe, and so on.

Q & A

• A farmer’s contract acreage is 1,000 acres, yield per acre is 100 bushels of crop, and the crop payment is 28¢ a bushel. What is this farmer’s production flexibility contract payment?

• It’s been said of the FAIR Act that farmer now have much greater flexibility to make planting decisions. Why is this so?