1. © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved. McGraw-Hill/Irwin Chapter 27 Farm Policy

2. © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved. McGraw-Hill/Irwin Chapter Outline FARM PRICES SINCE 1950 PRICE VARIATION AS A JUSTIFICATION FOR GOVERNMENT INTERVENTION CONSUMER AND PRODUCER SURPLUS ANALYSIS OF PRICE FLOORS PRICE SUPPORT MECHANISMS AND THEIR HISTORY

3. © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved. McGraw-Hill/Irwin Farm Prices Since 1950 Raw food commodity prices have increased much more slowly than overall inflation. From 1982 to 2002 overall inflation was 82%. Most food commodities cost less in 2000 than in 1982 in nominal terms (40% less in real terms.) Hog prices in 2000 yielded less than 40% of their 1982 levels.

4. © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved. McGraw-Hill/Irwin Farm Price Indexes

5. © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved. McGraw-Hill/Irwin Price Variability as the Justification for Government Intervention Argument for intervention on this ground –Highly variable prices create an unstable income for farmers reducing their interest in farming. Argument against intervention on this ground –Using options markets and crop insurance farmers can dampen the impact of this variability.

6. © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved. McGraw-Hill/Irwin Price Floors A Price Floor (a price below which a commodity may not sell) is set to protect farmers from prices that go “too low.”

7. © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved. McGraw-Hill/Irwin Farm Markets Without Subsidies P S D Q/t P* Q* A C H Value to the Consumer: 0ACQ* Consumers Pay Producers: 0P*CQ* The Variable Cost to Producers: 0HCQ* Consumer Surplus: P*AC Producer Surplus: HP*C 0

8. © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved. McGraw-Hill/Irwin Price Floors P S D Q/t P* Q* A C H G Price Floor B P floor QDQD Value to the Consumer: 0ABQ D Consumers Pay Producers: 0P floor BQ D The Variable Cost to Producers: 0HGQ D Consumer Surplus: P floor AB Producer Surplus: HP floor BG DWL BCG 0

9. © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved. McGraw-Hill/Irwin Government Purchase of Excess Goods P S D Q/t Price Floor P* Q* A B C E F H G I J P floor QSQS QDQD Value to the Consumer: 0ABQ D Consumers Pay Producers: 0P floor BQ D Government Pays Producers: Q D BEQ s The Variable Cost to Producers: 0HEQ S Consumer Surplus: P floor AB Producer Surplus: HP floor E DWL ECF 0

10. © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved. McGraw-Hill/Irwin P S D Q/t Price Floor P* Q* A B C E F H G I J P floor QSQS QDQD Value to the Consumer: 0AFQ S Consumers Pay Producers: 0JFQ S Government Pays Producers: JP floor EF The Variable Cost to Producers: 0HEQ S Consumer Surplus: JAF Producer Surplus: HP floor E DWL ECF Government Lowers the Price to Consumers 0

11. © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved. McGraw-Hill/Irwin Variable Floors The Eau Claire Rule: the wholesale price floor on milk is set as a function of the distance between a given community and Eau Claire, Wisconsin. This subsidizes milk production on the coasts of the United States.

12. © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved. McGraw-Hill/Irwin What Would Happen Without Price Floors Prices would fall. Production would fall. Farmers would leave the industry until the price of commodities reached a level consistent with zero economic profit (normal profit).

13. © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved. McGraw-Hill/Irwin History of Price Supports: Buying Programs Began in the 1930s. Reached a peak in the 1980s. The federal government purchased vast quantities of corn, soybeans, milk to be stored. The milk was powdered or turned into blocks of American Cheese. The cheese given away to the poor in the 1982 recession (which was the origin of the phrase “government cheese”.)

14. © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved. McGraw-Hill/Irwin History of Price Supports: Output Restrictions The buying programs were ended in the 1980s and were replaced with programs where the government offered higher prices for limited production. The programs –purchased dairy herds and slaughtered them. –Ordered grain farmers to set aside plots if they wanted the subsidized price.