Presentation on theme: "Agricultural Economics"— Presentation transcript:
1 Agricultural Economics Lecture 3: Government Intervention in AgriculturePowerpoint tranparencies from Penson, et. al. 3rd. Ed.
2 Normal Rationale for Government Intervention Support/protect an infant industryCurb market powers of imperfect competitors to promote social goodProvide for food securityProvide for consumer health and safetyProvide for environmental quality
3 Seeds of Farm Income Problem Inelastic demand for raw agricultural productsIncreasing productivity leads to commodity surpluses and low pricesLow income elasticity mutes any help from a strong general economyStrong dollar weakens export demand for farm productsHigh asset fixity and interest sensitivity
4 Let’s assume that themarket equilibriumoccurs at point E1,which corresponds toa price of P1 and aquantity of Q1.
5 Increasing supply causing movement along demandcurve from E1 to E2 willcause prices to fall morethan the increase quantity,or %P > %Q.Stated another way, area0P2E2Q2 is less than area0P1E1Q1.
6 inelastic demand curve D1 and equilibrium price P1. Let’s start with aninelastic demand curveD1 and equilibriumprice P1.E1
7 Page 273 Movement along an inelastic demand curve translates into a sharply lower priceP3 at equilibrium E3.Page 273
8 Page 273 A more elastic demand curve means equilibrium would occur at E2 ratherthan E3. This preventsa sharper drop in totalfarm revenue given bydemand curve D1.Page 273
9 Forms of Government Intervention Adjusting production to market demandPrice and income support paymentsForeign trade enhancementsCrop insuranceSubsidized creditOther forms
10 Consumer Issues Adequate and cheap food supply Nutrition and health issuesFood subsidy issuesRural community issues
11 Resource Issues Soil erosion and land use issues Adequacy of water supply issuesHired farm labor issuesEnergy issues
12 International IssuesAdequacy of world food supply
13 Note major differences between low, middle and high incomecountries….
14 International Issues Adequacy of world food supply Movement towards free trade
15 Price and Income Support A Historical perspective Commodity acquisition-loan rate mechanismSet-aside mechanismTarget price mechanismCommodities covered by government programs
16 The Loan Rate Approach to Supporting Farm Prices and Income
17 Market 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.
18 Market Level Effects of Loan Rates The Commodity CreditCorporation of the USDAbegan in the Thirties toacquire excess supply at thedesired price its through non-recourse loan provisions.The goal was to shift demandfrom D to D+CCCACQ, pullingup the price from PF to PG.Note that consumer demandactually fell from QF to QD.
19 Market Level Effects of Loan Rates The CCC stored the surplusQD-QG in metal bins atgreat expense to taxpayers.This approach had the un-wanted effects of increasingsupply from (QF to QG) in asector already plagued byover production.
20 Market Level Effects of Loan Rates Consumer surplus woulddecline from area tojust area 6. Thus, they areeconomically worse-off as aresult of this approach.Producer surplus wouldincrease from area 1+2 toarea , a gainof area
21 Firm Level Effects of Loan Rates The individual firm underfree market conditions willproduce quantity qF if itexpected the free marketprice PF, and earn profitequal to area 1.
22 Firm Level Effects of Loan Rates The increase in CCCacquired stocks pullingthe price up to PG willcause participatingfarmers to increase itsproduction from quantityqF to qG, increasing itsprofits by area 2.
23 The Set-Aside Approach to Supporting Farm Prices and Income
24 Market 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.
25 Market Level Effects of Set-Aside Requirements Shifting the market supplycurve from SMKT to SMKT*through set-aside require-ments reduces productionfrom QF to QG. The marketequilibrium moves from E1to E2.
26 Market Level Effects of Set-Aside Requirements Consumer surplus wouldfall from area tojust area 7. Thus, consumersare worse-off economically.Producer surplus wouldincrease from area toarea As long as area 6is greater that area 2+3,producers are better-off.
27 Market Level Effects of Set-Aside Requirements Importantly, the set-asideapproach does not encourageproduction of quantity QS asthe CCC loan rate approachdid.
28 Firm Level Effects of Set-Aside Requirements The individual producerunder this approach wouldsupply qG rather than qFor qS.Profit would increaseover free market levels aslong as area 4 was greaterthan area 2+3.
29 Deficiency Payment Mechanism The deficiency payment was equal to qnantity 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.
30 Deficiency Payment Mechanism To receive this payment, the farmer had to participant in the Acreage Reduction Program (ARP) which implemented the set-aside requirements. The Findley amendment reduced this payment by 15%.
31 The Current Approach to Supporting Farm Prices and Income
33 Domestic Demand Expansion: Value Added Products Let’s assume that the freemarket conditions result ina price of PF and quantityQF.Market equilibrium occursat E1.
34 Domestic Demand Expansion: Value Added Products 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.
35 Domestic Demand Expansion: Value Added Products Consumer surplus in thismarket would go fromarea 2+5 to area Ifarea 4 exceeds area 2,consumers are better-off.Producers would be betteroff by area 2+3 as we movefrom E1 to E2.
36 Export Demand Expansion: Enhancements Let’s assume the originalDemand curve is DD, givingus a market clearing priceof PDD and correspondingquantity of QMM at marketequilibrium E1.
37 Export Demand Expansion: Enhancements Consumer surplus wouldbe area 2+5 while producersurplus would be area 1.
38 Export Demand Expansion: Enhancements 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 bearea 4.