2. Lecture 4: Common Agricultural Policy Based on Sloman Chapter 3.4 and Chapter 8, Swann Lecture 4: Common Agricultural Policy Based on Sloman Chapter 3.4 and Chapter 8, Swann

3. CAP- The Common Agricultural policy Massively complex, massively expensive policy.Massively complex, massively expensive policy. Hard to understand without seeing how it developed.Hard to understand without seeing how it developed. CAP started as simple price support policy in 1962.CAP started as simple price support policy in 1962. Objective: To stabilise pricesObjective: To stabilise prices AND provide income support for social reasonsAND provide income support for social reasons

4. Farm Size Distribution in EU(1987) Very skewed ownership: biggest 7 per cent of farmers owned ½ of the land smallest 50 per cent of farmers owned only 7 per cent of the land. Source: Baldwin & Wyplosz

5. Changes in Farm size 1970-1987 Source: Baldwin & Wyplosz

6. AGRICULTURE AND AGRICULTURAL POLICY AgricultureAgriculture –Many producers, all price takers –Many consumers, all price takers –free entry and exit –As close to perfect competition as could imagine So why intervene in Agriculture sector?So why intervene in Agriculture sector?

7. AGRICULTURE AND AGRICULTURAL POLICY Why governments intervene in agricultureWhy governments intervene in agriculture –to reduce price fluctuations –to raise farm incomes –to protect rural communities –to encourage greater self-sufficiency in food Causes of short-term price fluctuationsCauses of short-term price fluctuations –fluctuations in demand & instability –fluctuations in the harvest

8. fig Suppose we have a crop which takes a year to grow and is grown only once year, DADA P1P1 Q1Q1 P Q O a SASA e.g. Hops for Beer Suppose now that demand were to rise but supply cannot respond immediately

9. fig What will happen to Price? Suppose we have a crop which takes a year to grow and is grown only once year, DADA P1P1 Q1Q1 P Q O a SASA e.g. Hops for Beer Suppose now that demand were to rise but supply cannot respond immediately

10. fig So price rises to P 2 Since supply is fixed, the price is determined by the available supply at Q 1. DADA P1P1 Q1Q1 P Q O a DBDB P2P2 SASA

11. But next period farmers observe that the price of hops was very high So now they all want to grow hops At P 2, what will the supply be?

12. fig DADA P1P1 Q1Q1 P Q O a DBDB P2P2 At P 2, the following year supply increases to Q 3 Q3Q3 SASA

13. fig DADA P1P1 Q1Q1 P Q O a DBDB P2P2 But now Supply exceeds demand so price must fall to P 3 Q3Q3 P3P3 SASA

14. fig DADA P1P1 Q1Q1 P Q O a DBDB P2P2 Q3Q3 P3P3 Q4Q4 But next period farmers see lower price and decide to supply less: Q 4 SASA

15. fig DADA P1P1 Q1Q1 P Q O a DBDB P2P2 Q3Q3 P3P3 Q4Q4 Notice here that we are spiraling through time to an equilibrium This is a stable Cobweb SASA

16. fig Suppose instead that the supply curve was very flat. DADA P1P1 Q1Q1 P Q O a SASA Now what will happen to Price?

17. fig Suppose instead that the supply curve was very flat. DADA P1P1 Q1Q1 P Q O a SASA Now what will happen to Price?

18. fig Since supply is fixed, again the price must rise to P 2 P1P1 Q1Q1 P Q O a DADA DBDB SASA

19. fig Since supply is still fixed at Q 1, again the price must rise to P 2 P1P1 Q1Q1 P Q O a DADA DBDB SASA P2P2 But next period farmers observe that the price of hops was very high So now they all want to grow hops

20. fig DADA P1P1 Q1Q1 P Q O a DBDB P2P2 Now Supply Increases to Q 5 Q5Q5 SASA At P2, what will the supply be in this case?

21. fig DADA P1P1 Q1Q1 P Q O a DBDB P2P2 Q5Q5 SASA But again Supply exceeds demand so price must fall to P 5 P5P5

22. fig DADA P1P1 Q1Q1 P Q O a DBDB P2P2 Q5Q5 SASA But at P 5 next period farmers decide to supply Q 6 P5P5 Q6Q6

23. fig DADA P1P1 Q1Q1 P6P6 Q O a DBDB P2P2 Q5Q5 SASA But if only Q 6 is supplied demand will exceed supply and price will rise to P 6 P5P5 Q6Q6

24. fig DADA P1P1 Q1Q1 P6P6 Q O a DBDB P2P2 Q5Q5 SASA P5P5 Q6Q6 But Now the price and quantity are gradually spiraling away from equilibrium. This is an unstable cobweb.

25. Summary of Cobweb Effects With a demand SHIFT and supply fixed yearly, a sudden rise in demand will see a big increase in income. The lagged response next year can generate cyclical fluctuations in prices over the next few years. When Q goes up and P fall, income PxQ can also fluctuate. Not all cobwebs are stable

26. fig Supply Side Shock D PEPE QEQE P Q O e LRS LRS is the long-run supply curve. SRS E is the expected supply this year. SRS E PAPA QAQA SRS A SRS A is the actual supply this year. e.g. Bad harvest

27. fig Supply Side Shock D PEPE QEQE P Q O LRS So price rises, what about income? P E eQ E O=ab is expected income SRS E PAPA QAQA SRS A ac= actual income Overall depends on size of c relative to b e a b c

28. fig Supply Side Shock D PEPE QEQE P Q O LRS If demand is more inelastic, c>b and income rises. SRS E PAPA QAQA SRS A ac= actual income Overall depends on size of c relative to b e a b c

29. fig Supply Side Shock D PEPE QEQE P Q O LRS But if it is a good crop and demand is inelastic, SRS E PAPA QAQA SRS A c < b and income falls So variability in incomes leads to pressure for government intervention e a b c

30. REASONS FOR INTERVENTION Causes of short-term price (and income?) fluctuationsCauses of short-term price (and income?) fluctuations –fluctuations in demand –fluctuations in the harvest (supply) Causes of declining farm incomesCauses of declining farm incomes –low income elasticity of demand –increases in supply

31. Decline in farm incomes over time 1 P QO P1P1 D1D1 S1S1 Q1Q1

32. P QO P1P1 P2P2 D1D1 S1S1 S2S2 Q1Q1 Q2Q2 An improvement in farm efficiency! But with inelastic demand, income will fall as before Decline in farm incomes over time 1

33. P QO P1P1 P2P2 D1D1 S1S1 S2S2 D2D2 Q1Q1 Q2Q2 How might farmers gain? Need an increase in demand due to rising income in other sectors. But if demand does not move out much there may be no income gain Decline in farm incomes over time 2

34. P QO P1P1 P2P2 D1D1 S1S1 S2S2 D2D2 Q1Q1 Q2Q2 If income elasticity of demand is low, the D curve only moves out a little and there may be no income gain Decline in farm incomes over time 3

35. Evidence on Income elasticities of demand for various foodstuffs Note NEGATIVE values imply these are inferior goods so demand falls as income rises Source: Sloman from; National Food Survey 2000 (National Statistics, 2001), extracted from Tables 6.1, 6.3, 6.4 and 6.5

36. RECAP on REASONS FOR INTERVENTION in Competitive market Causes of short-term price fluctuationsCauses of short-term price fluctuations –fluctuations in demand –fluctuations in the harvest (supply) Causes of declining farm incomesCauses of declining farm incomes –increases in supply –low or negative income elasticity of demand

37. AGRICULTURE AND AGRICULTURAL POLICY Types of government intervention in agricultureTypes of government intervention in agriculture –buffer stocks –subsidies –high fixed prices –reducing supply –structural policies

38. Buffer stocks to stabilise prices P QO PgPg D Q1Q1 Existed in all six original member states

39. Buffer stocks to stabilise prices 1 P QO PgPg D Sa1Sa1 Qs1Qs1 Q1Q1 Bought into buffer stock

40. Buffer stocks to stabilise prices 2 P QO PgPg D Sa2Sa2 Qs2Qs2 Released from buffer stock Q1Q1

41. Buffer stocks to stabilise prices 3 P QO PgPg D Sa2Sa2 Qs2Qs2 But income still fluctuating, now worse Extra income in good times Income in Bad Times Normal Q1Q1

42. AGRICULTURE AND AGRICULTURAL POLICY Buffer stocksBuffer stocks –buffer stocks to stabilise prices –buffer stocks to stabilise farm incomes

43. Recall Elasticity Formula If elasticity equals 1 it means the percentage increase in quantity is the same as the percentage fall in prices So if the percentage price and income change is the same then income stays the same

44. Buffer stocks to stabilise incomes P QO D a P1P1

45. P QO D Y a P1P1 P d = 1 Buffer stocks to stabilise incomes

46. P QO D Sa2Sa2 Q2Q2 Q1Q1 Sa1Sa1 Y a P1P1 Buffer stocks to stabilise incomes 1

47. P QO D Sa2Sa2 Q2Q2 Q1Q1 Sa1Sa1 Y a P1P1 P2P2 Buffer stocks to stabilise incomes

48. P QO D Sa2Sa2 Q2Q2 Q1Q1 Sa1Sa1 Q 2 Y a b c P1P1 P 2 P2P2 Bought into buffer stock Buffer stocks to stabilise incomes

49. P QO D Sa3Sa3 Q3Q3 Q1Q1 Sa1Sa1 Y a P1P1 Buffer stocks to stabilise incomes 2

50. P QO D Sa3Sa3 Q3Q3 Q1Q1 Sa1Sa1 Y a P1P1 P3P3 Buffer stocks to stabilise incomes

51. P QO D Sa3Sa3 Q3Q3 Q1Q1 Sa1Sa1 Q 3 Y a d e P1P1 P 3 P3P3 Released from buffer stock Buffer stocks to stabilise incomes

52. AGRICULTURE AND AGRICULTURAL POLICY SubsidiesSubsidies –effects on price and output –the incidence of a subsidy –Subsidy is an amount paid for every unit produced. It reduces the cost to the farmer of supplying the good and moves the supply curve down and out.

53. Effect of subsidies on foodstuffs in which the country is self-sufficient 1 P QO D QeQe PePe S

54. Effect of subsidies on foodstuffs in which the country is self-sufficient P QO D QeQe PePe S + subsidy S

55. Effect of subsidies on foodstuffs in which the country is self-sufficient P QO D Q1Q1 QeQe PePe P1P1 S + subsidy S Note at P e farmers willing to supply Q 2, But then Supply exceeds demand Q2Q2 so price must fall to P 1

56. Effect of subsidies on foodstuffs in which the country is self-sufficient 2 P QO D Q1Q1 QeQe PePe PgPg P1P1 S + subsidy S Subsidy

57. Effect of subsidies on foodstuffs in which the country is self-sufficient P QO D Q1Q1 QeQe PePe PgPg P1P1 S + subsidy S Subsidy Note two parts to the subsidy in this example: 1.Getting higher price P g 2.But also selling more, S 1 Depends on p D

58. Effect of subsidies on foodstuffs which are partly imported P Q O D PwPw S EU S world

59. Effect of subsidies on foodstuffs which are partly imported P Q O D QdQd PwPw S EU S world QS1QS1 Imports

60. Effect of subsidies on foodstuffs which are partly imported P Q O D QdQd PwPw S + subsidy S EU S world QS1QS1

61. Effect of subsidies on foodstuffs which are partly imported P Q O D QS2QS2 QdQd PwPw S + subsidy S EU S world QS1QS1 Imports

62. P Q O D QS2QS2 QdQd PwPw PgPg S + subsidy S EU S world QS1QS1 Effect of subsidies on foodstuffs which are partly imported

63. P Q O D QS2QS2 QdQd PwPw PgPg S + subsidy S EU S world QS1QS1 Effect of subsidies on foodstuffs which are partly imported

64. Problems of Oversupply EU switches from net food import to exporter in most products.EU switches from net food import to exporter in most products. Source: Baldwin & Wyplosz

65. EU citizen Attitudes to the CAP Support among those questioned for direct support to farmers was on average 62Support among those questioned for direct support to farmers was on average 62 42% - in the number of respondents who felt that the CAP ensured that agricultural produce was safe to eat42% - in the number of respondents who felt that the CAP ensured that agricultural produce was safe to eat Lack of information continues to be a problem -'Don't know' answers in the poll ranged from 24 - 35%.Lack of information continues to be a problem -'Don't know' answers in the poll ranged from 24 - 35%.

66. EU citizen attitudes to the OBJECTIVES of the CAP Question NewEU 15 Should the EU use its agricultural policy to….. Yes ensure that agricultural products are healthy and safe? 88%90% favour and improve life in the countryside?88%77% ensure stable and adequate incomes for farmers?86%77% promote the respect of the environment?84%87% help farmers to adapt their production to consumers' expectations?84%80% protect medium or small sized farms?83%81% defend farmers' interests in their dealings with intermediaries and distributors ?81%69% make European agriculture more competitive on world markets?80%77% encourage the diversification of agricultural products and activities?80%73% reduce development disparities between regions?80%72% protect European agricultural products?78%73% favour methods of organic production?69%72%