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12-1 COPYRIGHT © 2008 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under.

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Presentation on theme: "12-1 COPYRIGHT © 2008 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under."— Presentation transcript:

1 12-1 COPYRIGHT © 2008 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license.

2 12-2 The Rural Sector vs. the Urban Sector: Some Statistics Rural sector is home to almost 50 million inhabitants, while urban sector comprises close to 250 million people Average person in rural sector makes $25,000 per year, while average person in urban sector draws $35,000 per year Rural poverty rate of 13.9 percent is higher than urban poverty rate of 12.2 percent Unemployment rate is 5.6 percent in rural sector, whereas it is 5.0 percent in urban sector 12-2

3 12-3 Characteristics of Agriculture Certain characteristics of agriculture distinguish farm sector from remainder of economy: 1.Inelastic demand for farm products in short run 2.Extensive technological change in past half century 3.Immobile resources 12-3

4 12-4 Inelastic Demand When we say product has inelastic demand, mean that its buyers are relatively unresponsive to changes in price –Buyers show little variation in quantity they buy when price changes Case for most farm commodities 12-4

5 12-5 Inelastic Demand Price stability –If demand is inelastic, small fluctuations in supply that might result from either exceptionally good or bad weather will have resounding effect on prices that farmers receive for products Farm income –If good weather causes increase in supply, which causes price to decrease, then overall farm income will also fall 12-5

6 12-6 Inelastic Demand 12-6

7 12-7 Technological Change Although number of Americans engaged in agriculture is much smaller than a half century ago, technological changes have caused supply of farm products to increase markedly Compared with large increase in supply, increase in Americans’ demand for food over time has been relatively small –Combined effects of large long-run increase in supply and modest increase in demand have greatly decreased real price (price as adjusted for effects of inflation) of farm products 12-7

8 12-8 Technological Change (cont.) 12-8

9 12-9 Immobile Farm Resources Principal resource in farming is land –With exception of land near rapidly growing cities, which can be developed, few alternative uses for most farmland Either farmland lies fallow or someone farms it –Agriculture’s main resource is slow to respond to adverse industry conditions 12-9

10 12-10 Government Policy Toward Agriculture U.S. government extensively involved in agriculture since Great Depression of 1930s –Entire country was in distress during 1930s, but agriculture suffered more than other sectors Congress passed Agricultural Adjustment Act in 1933 to restore standing of farm incomes relative to incomes in rest of economy Objectives of farm policy have been to stabilize conditions in farming and to increase farm incomes –Programs devised to affect supply of agricultural products, demand for agricultural products, and price received by farmers 12-10

11 12-11 Price Supports Legally imposed minimum prices of goods or services –Minimum prices set a “floor” below which market price is not permitted to fall To have effect on market, price floors must be above market equilibrium price –Markets tend to clear at equilibrium price and quantity »Shortages and surpluses are rationed away (rationing function of price) ◦When agricultural prices are kept artificially high, cannot perform rationing function 12-11

12 12-12 A Hypothetical Example: Supply and Demand of Wheat 12-12

13 12-13 A Hypothetical Example: Supply and Demand of Wheat (cont.) 12-13

14 12-14 Price Supports (cont.) Method by which some U.S. farm prices are supported is indirect, but result is same as price floor –Prices supported by granting farmers loans on stored commodities through Commodity Credit Corporation (CCC) Farmers can get loans on value of commodities at rate established by government –Put up commodities as collateral »If market price is above loan rate, farmer can withdraw commodity from storage, sell commodity, repay loan, and keep profits »If market price is below support price, farmer simply surrenders commodity to government instead of repaying loan 12-14

15 12-15 Price Supports (cont.) By means of price supports, income is redistributed to farm sector from taxpayers in general –Whenever income is redistributed, some groups gain and others lose Taxpayers are obvious losers –Taxes are used to buy and store surplus at artificially high prices, and higher prices lead to at least slightly higher food prices Farm sector is gainer –Lion’s share of support goes to large farmers, because subsidy is paid on per-unit-of-output basis 12-15

16 12-16 Programs to Restrict Supply Policies to decrease amount produced and offered for sale 12-16

17 12-17 Programs to Restrict Supply (cont.) Programs to reduce the supply of farm products appeared preferable to rigid price supports in 1930s and remain preferable today –Soil Bank Encouraged long-term withdrawal of farmland from production of any crops and stricter compliance with acreage controls on specific crops –Set-Aside program Farmers paid for setting aside and not farming proportion of total acres, and guaranteed support prices on crops grown on remaining acreage –Payment-in-Kind (PIK) program Farmers given surplus commodities from government’s storehouses instead of cash –10-year plan Encouraged farmers to put highly erodible acres in long-term supply restriction program 12-17

18 12-18 Efforts to Increase Demand Efforts to decrease supply accompanied by efforts to increase domestic and international demand for U.S. agricultural products –Domestic examples: Surplus commodities distributed to public schools for use in lunch program Food stamps distributed to poor Cheese and milk powder distributed to poor –International examples: Foreign food assistance programs –When U.S. surpluses accumulate, distribute more food abroad –When surpluses smaller, send less food aid to less-developed countries Export subsidies (government financial assistance) –Make agricultural exports “more competitive” (cheaper) to foreign consumers »Causes increase in foreign demand for U.S. agricultural products because U.S. prices will be lower than those of other countries »Dumping: Exporting goods at low prices, even below cost of production 12-18

19 12-19 Recent Agricultural Policy Freedom to Farm Bill (1996) –Eliminated target prices and deficiency payments on some crops such as feed grains and wheat –Provided income support payments based on acreage –Eliminated restrictions on what farmers could plant and remain eligible for government farm programs Farm Security and Rural Investment Act (2002) –Pros: Expands programs for farmland conversion and rural development Will provide $191 billion in direct subsidies to farmers over next decade –Cons: Doesn’t alter price distortions and commodity overproduction that have resulted from previous farm bills Eliminates many provisions that would have targeted assistance to small and medium-size farms Fails to address concentration in U.S. farm industry Fails to strengthen competition in rural America Will cost U.S. consumers additional $271 billion in form of higher food prices 12-19

20 12-20 An Evaluation of U.S. Farm Policy Government policies have not solved core farm problem of declining real incomes to small and medium-sized farmers, and have had some unforeseen side effects –By treating symptom rather than cause, have contributed to increasingly concentrated agricultural sector and promoted productive techniques that have harmful environmental consequences 12-20

21 12-21 Treating a Symptom Low price of farm products is symptom of resource allocation problem in economy –Produce too many farm products in comparison with other goods Solution is to decrease resources devoted to farming –As long as prices are supported artificially, will be incentive to continue to overproduce »Government policies are part of farm problem because they encourage retention in agriculture of resources that would otherwise leave farming and be used for other purposes 12-21

22 12-22 Increasing Concentration in Agriculture Trend toward greater concentration (domination by few large firms) in agriculture 12-22

23 12-23 Harmful Environmental Effects Modern farming reliant on chemical fertilizers to increase yield per acre to thereby obtain more government payments Relies on pesticides to decrease insect damage and maximize yield Creates nitrate pollution of water wells in farm states Irrigation in lower Midwest has damaged aquifers (underground water supplies serving large areas) but increased bushels per acre on which deficiency payments are earned Commodity programs have encouraged production of crops particularly likely to cause erosion, because these crops often have had high target prices Huge cattle feedlots, factory hog farms, and dairies with 1,200 cows on relatively few acres create significant problems of odor and waste disposal BOTTOM LINE: Farm life is neither particularly healthy nor environmentally benign, and government programs have contributed to adverse effects 12-23

24 12-24 Biotechnology Production of genetically modified organisms (GMOs) has increased greatly over recent years –Farmers use GMOs as means of preventing crop disease and reducing pesticide use U.S. agricultural companies have taken lead in developing biotechnology, in which seed varieties are genetically altered in order to increase yields Some people have characterized biotechnology as means to solve world hunger Opponents maintain there are severe environmental and health risks of biotechnology and technology will do little to help with world hunger reduction –Development of GMOs will benefit large multinational corporations, and not smaller farmers or consumers of agricultural products 12-24

25 12-25 Food Production and Hunger Some economists argue that heavily subsidized agricultural sector produces commodities that compete unfairly with those of less-developed countries (LDCs) –Problem of world hunger has far less to do with global food production and a lot more to do with how produce is distributed Low-income people in poor countries cannot afford to buy enough food for themselves and their families –Most residents of less-developed countries earn incomes through crop production When U.S. and European agricultural products flood world markets, causing very low agricultural prices, poor farmers in less-developed countries earn little income from production of food and have little incentive to produce food 12-25

26 12-26 Food Production and Hunger (cont.) –Import tariffs on products that LDCs’ country farmers can produce cheaper than rich country farmers are high in order to prevent agricultural commodities produced by LDCs from entering United States and other prosperous countries Rich-country governments receive large amounts of money from trade barriers that cost less-developed countries hundreds of billions of dollars –Patents owned by U.S. multinational corporations and agribusinesses prevent outsiders from producing genetically modified food and allow large U.S. corporations to flood world market with agricultural products 12-26

27 12-27 Can Agricultural Policy be Improved? The answer: Certainly! –However, the following must be done to achieve improvement: Politicians and news media need to deflate myths of “Little House on the Prairie” farmer, as well as myth that needy farmers benefit from agricultural programs 12-27

28 12-28 Alternatives for Improvement Untie amount of food production to amount of government benefit –Instead, government might simply assure all farmers an adequate income, perhaps at twice the poverty line If income for farmer falls below, government writes a check If income for farmer rises above, farmer receives no check Rather than distorting markets with artificial prices, government can work on providing appropriate incentives (subsidies) to farmers who engage in environmental protection and appropriate disincentives (taxes) to farmers who do not engage in environmentally sound practices To solve problem of world hunger, poverty must be addressed –World’s wealthiest countries need to: Provide real development assistance rather than just food aid Reduce or eliminate trade restrictions and agricultural subsidies that so severely harm well-being of less-developed country residents 12-28

29 12-29 The Economic Left and the Economic Right THE ECONOMIC RIGHT (Conservative) –Argue that price supports, target prices, and supply restriction programs have contributed to farm problem instead of solving it –Encourage less government antitrust activity and fewer government environmental regulations THE ECONOMIC LEFT (Liberal) –Comfortable supporting agricultural programs both within and outside their states, but do not wholeheartedly endorse them and many believe they should be gradually phased out –Would like government efforts to reduce concentration in agricultural markets and to ensure environmental protection 12-29

30 12-30 Appendix 1: Inelastic Demand Price stability –Combination of weather-related supply fluctuations and inelastic demand results in large fluctuations in agricultural prices in short run 12-30

31 12-31 Appendix 1: Inelastic Demand (cont.) Farmers’ incomes 12-31

32 12-32 Appendix 2: Target Prices with Deficiency Payments Under target pricing, farmers receive direct payments –Payments are called deficiency payments 12-32

33 12-33 Appendix 2: Target Prices with Deficiency Payments (cont.) Differences between target prices and price supports: 1.Because market price is much lower than target price, cost of farm commodities does not drive up cost of food 2.Because prices are lower for consumers whether in U.S. or export market, American farm products are more competitive on world markets at lower prices 3.Market is less distorted by target prices than by price supports, because no surplus is created 4.Costs to taxpayers of target prices and deficiency payments are easier to count because costs associated with surpluses are not incurred 12-33

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