*Chapter 8* Price supports, Parity, and Cost of Production BY Kelly Braswell Robby Adams
Review and Introduction: Why do we have price supports and when were they launched? -I-In the 1930s to keep prices high in a period of falling prices. This chapter describes the parity-price and cost-of-production approaches to setting price supports. It also analyzes price settings to increase market stability and emphasizes why there is no economically defensible means of determining correct levels for price supports.
What is parity pricing? -Parity is defined as the price that gives a unit of a commodity the same purchasing power in the current period that it had in the period 1910-1914. -The period of 1910-1914 is known as the golden period of agriculture because prices received, when compared with prices paid my farmers, were highly favorable during the era. -The 1930s was the most favorable peacetime period for agriculture since the civil war, using the golden period as a base price.
Examples: bushel of wheat that could buy a pair of pants in 1910. a bushel of wheat should still buy a pair of pants even though the price of pants has gone up. Parity index is the current index of prices paid by farmers for commodities, interest, taxes, and wage rates expressed in the 1910-14 base. -In order to receive the number we need you multiply the price of the commodity by the parity index. Since the 1930s the prices of commodities have been considered below the parity level.
There has been much debate over what the parity level should be. -Should it be supported at 75%, 80%, or even 90%. -The debates are over products like milk, wheat and other products that have price supports. Of course any kind of system that has price supports based on parity will have problems with surplus product. In 1948 the parity formula was modernized. It allowed for the calculation of commodities that were not widely grown in the Golden Period, like soybeans. This type of approach has been declining but still not eliminated.
1.The use of parity prices hinders the functioning of the market process. 2.In tying price relationships to a base period, parity fails to allow for differences in changes in productivity over time. 3. The use of parity prices reduces the competitiveness of domestic products in both foreign and domestic markets, resulting in either surpluses or the imposition of production controls or restrictions on input usage. 4.Because incomes are determined by both quantity produced and price, parity prices likely will have only a small effect on farmers income. 5.The problem of selecting the appropriate level of parity price is similar to that of determining the long-discredited just price. Shortcomings of the Parity-Price Approach
Cost of Production The Food and Agriculture Act of 1977 embraced cost of production as the primary guide in determining the level of farm product price supports. However, cost of production, like parity pricing, is not any better for determining what the level of production should be. Cost of production is based on opportunity cost. Review: what is opportunity cost? Land is a unique asset. Why?
*Opportunity cost for each farmer is different. Whether it be on machinery, buildings or other durable resources. *A person looking in can not determine or measure what a farmer uses to asses his problems and make decisions. The next item to consider is different producers will have different cost. We all know that farmers have their own beliefs about what to use on their crop whether it be rain dances or a certain type of fertilizer or planting crops by the phases in moon. Companys have been created to help farmers keep their records. This has shown that the effective level of price supports will be above cost of some farmers and below cost of others.
Not all differences can be associated with opportunity cost, some come with accuracy of data. Competition can also affect price levels. Those in input markets tend to force expected costs at the farm level toward expected product price. If product price is supported above the market level, competition for the resulting profits will cause costs to rise to equal product price. The capitalization process ensures that a price support program that increases price will tend to cause costs to rise to equal price. Taking all this into consideration, even though farms or organizations have different cost for resources and such, all have the same ratio when it comes to product price verses cost.
*In the standard neoclassical model of competitive industry demand and cost of production are independent of each other. *However, in agriculture we have specialized resources, like land, and costs cannot be determined independently of demand or product price. ** The fact that cost cannot be determined independently of demand or product price when there are specialized resources is highly important for U.S. Agricultural policy. *So final conclusion is that cost of production is not a defensible basis for ag price supports either. *Cost of production as a basis for setting prices supports was de-emphasized in the 1981 farm bill, but the national Ag Cost of Production Standards Review board was established to review annually the cost of production procedures used by the USDA.
Price Setting to Increase Market Stability One of the problems in price setting is information. As we learned in chapter 3 ( ha) it is hard to get accurate information. We can not know what the market clearing price will be before plant a crop. *Market prices for U.S. farm products are also influenced more more by supply and demand factors in other countries. It is unlikely that government generated forecasts will be as accurate as say market generated futures prices for farm products. *So setting prices to increase market instability without distorting resource use is not an attainable goal. Market stability is no more defensible than parity or cost of production as a rationale for government price setting.