Government Intervention in Agriculture

GovernmentIntervention in Agriculture Chapter 11

Topics of Discussion • Defining the Farm Problem • Forms of government intervention • Price and income support mechanisms • Phasing out of supply management • Domestic demand expansion • Importance of export demand 2

Net Farm Income With and Without Direct Government Payments More market driven ag. policy under FAIR Act (1996 Farm Bill) Bil. ($2005) FAIR Act Pre FAIR Acts NFI with Govt. Payments 2002 Bill NFI without Govt. Payments 3 Page 212

Government Payments as a % of Net Farm Income % 4 Page 212

The Farm Problem • Many agricultural commodities exhibit inelastic consumer demand • Individual farmers lack market power • In contrast to some input suppliers • Interest sensitivity • Capital intensive operations • Production credit • Capital purchases • International trade important market • Tends to be more volatile • Asset fixity and excess capacity 5

TheFarm Problem • Assume we have an inelastic demand for a particular crop • Also assume that due to great weather conditions there is an increase in supply due to record yields • → A shift out of supply curve at every price • Results in price falling relatively more than the market clearing quantity Market Equilibrium $ D S1 S2 P1 P2 ΔP Q Q1 Q2 Page 199 ΔQ 6

TheFarm Problem • What happens to total farm revenue when you have an inelastic demand and an increase in supply? • Total revenue under original equilibrium was area 0P1AQ1 • Total revenue under the new equilibrium is 0P2BQ2 • We know that total revenue to this sector has ↓, (i.e., 0P2BQ2< 0P1AQ1) • How do we know this? $ D S1 S2 A P1 P2 B ΔP Q 0 Q1 Q2 ΔQ 7 Page 199

TheFarm Problem • In contrast, with a relatively elastic demand curve, D2 • Shift in supply will result in price P3 instead of P2 • Shift in supply will result in quantity Q3 rather than Q2 • Compared to inelastic demand, a larger impact on quantity and less of an impact on price • What happens to total revenue? $ D1 S1 S2 P1 P3 P2 D2 Q Q1 Q2 Q3 Page 199 8

TheFarm Problem • Farms and ranchers in the aggregate exhibit conditions of perfect competition • Large number of producers • Producing a homogenous product (i.e., corn, soybeans, wheat, etc) • No one farmer has sufficient market power to influence the market equilibrium price • If a single producer suffers a disastrous year in terms of yield, he alone will suffer as market price is not impacted 10

TheFarm Problem • Agricultural sector is one of the most highly capitalized sector in the U.S. economy • More capital invested per worker • Farmers must obtain short, medium and long-term loans to purchase variable and fixed inputs • → a change in interest rates will have a significant impact on production costs 12

TheFarm Problem 13

TheFarm Problem • High interest rates in the U.S. economy increases the value of the dollar in foreign currency markets • More units of foreign currency per U.S. $ • Makes U.S. exports more expensive • Many agricultural commodities (i.e., wheat, corn, soybeans, etc) are highly dependent on export markets • For many agricultural commodities excess supply relative to domestic market • Reduced export demand → Downward pressure on commodity prices 15

TheFarm Problem U.S. Corn and Soybean Exports as a % of Production % Soybeans Corn 16

TheFarm Problem % of Dairy Solids Dramatic Drop In Milk Prices Dairy Exports Dairy Imports 17

TheFarm Problem % 18

TheFarm Problem • Asset fixity refers to the difficulty farmers have in disposing of capital equipment when downsizing or shutting down the business • Tractors, combines, silos, etc • When commodity prices are low and farmers are downsizing the value of these assets may be quite low relative to purchase price • Could owe more on purchase loan than asset is worth in the used market 20

TheFarm Problem • Excess Capacity refers to the fact that the agricultural sector can produce more than it can sell • Can have times with significant stocks of storable commodities such as corn, wheat and cheese • →Downward pressure on commodity prices • Technological change can shift the supply curve to the right for all prices • Leads to excess capacity 21

TheFarm Problem U.S. Corn and Soybean Stocks as a % of Production 22

TheFarm Problem • Combined effect of asset fixity and excess capacity • ↓ in farm asset values when there exists surplus commodity stocks 23

Government Intervention in Agriculture • There is a history of state and Federal government intervention in agriculture • Designed to improve economic conditions • Provide appropriate level of environmental quality as discussed previously • In terms of improving economic conditions a number of intervention types • Adjusting production to market demand • Price and income support programs • Foreign trade enhancements 24

Government Intervention in Agriculture • Adjusting production to market demand • ↓ amount of resources employed to produce a surplus product • Primarily land • Example: Pay farmers not to produce by requiring land normally planted to be idled • → Supply curve will shift up • → Market prices will improve 25

Government Intervention in Agriculture • Every 5 years or so the U.S. Congress enacts legislation known as the Farm Bill • Food Security Act of 1985 • Food, Agriculture, Conservation and Trade Act of 1990 • Federal Agricultural Improvement and Reform Act of 1996 • Farm Security and Rural Investment Act of 2002 • Food, Conservation and Energy Act of 2008 • Debate concerning the 2012 Farm Bill is already starting 26

Government Intervention in Agriculture • U.S. Farm Bills • The primary agricultural and food policy tool of the U.S. Federal gov’t. • Concerned with both agriculture and all other programs under control of USDA • i.e., Food Stamp and WIC programs • Purpose of Farm Bills • Amends/suspends provisions of permanent law • Re-authorizes/amends/repeals provisions of previous temporary agricultural acts • Enact new policy initiatives 27

Government Intervention in Agriculture Allocation of U.S.D.A Expenditures 28

Government Intervention in Agriculture $ D S2 • S1→original supply curve • Policies restricting resource use shifts curve to S2 • Market equilibrium moves from E1 to E2 • Total revenue • Original: OP1E1Q1 • After move: OP2E2Q2 • Does total revenue increase? • Depends on demand elasticity S1 P2 E2 P1 E1 Q 0 Q2 Q1 29

Government Intervention in Agriculture • Another strategy to improve economic conditions is to directly support farm prices and income • Obtained by gov’t setting a price floor • Price floor supported by government purchasing surplus commodities • Dairy product price support program (DPPSP) • Another alternative is to support farm incomes through direct transfers • USDA-RMA and subsidization of crop insurance premiums 30

Dairy Product Price Support Program • Program established in 1949 • CCC offers to purchase nonperishable dairy products at a specified (intervention) price and in a specified form • Cheese • Butter • Non-fatdry milk • No-limit on amount that can be sold to the CCC 31

Dairy Product Price Support Program • Dormant when market prices are above intervention prices • Activated when supply of products exceeds demand at the intervention price • Previous versions set support prices to essentially set a minimum milk price • Now purchase price of products are explicitly set by newest Farm Bill 32

Dairy Product Price Support Program • Public policy issues • Effectiveness in establishing a realistic and adequate milk price floor • Distortion in allocation of milk and relative product prices to products not being demanded by the open market • Impact on U.S. dairy trade • Keeps the price of some commodities artificially high and hurts our ability to export these goods. 33

Budget Costs of Dairy Price Supports

Government Intervention in Agriculture • A third approach to improving economic conditions is to impact foreign trade “rules of the game” • Establish tariffs on specific commodities • Set commodity quotas • A tariff on a specific imported commodity • Essentially a tax • Increases it domestic price • Could make U.S. sourced commodity more price competitive → increases demand from foreign customers 36

Government Intervention in Agriculture $ D S2 • A quota limits the quantity than can be imported for a particular commodity • By restricting supply you again shift the supply to the left at every price • ↑ equilibrium price S1 P2 E2 P1 E1 Q 0 Q2 Q1 37

Government Intervention in Agriculture • Another alternative is to ↑ demand for U.S. agricultural products in foreign markets by reducing export price • The Federal gov’t can subsidize purchase of U.S. agricultural commodities • Example: The Dairy Export Incentive Program (DEIP) 38

Government Intervention in Agriculture • Dairy Export Incentive Program • Initiated in 1985 and still in existence • Designed to ↑ dairy product demand: butter, non-fat dry milk and cheese • Develop export markets where U.S. products are not competitively priced • USDA pays cash to exporters to sell U.S. dairy products at prices lower than the exporter's price • USDA makes up the difference 39

Government Intervention in Agriculture • Low own-price elasticity and ↑ supply can cause farm incomes to ↓ sharply • Lets review 4 agricultural policies that have been used to soften the effect of ↓ farm incomes • Loan rate programs • Set-Aside mechanism • Establishment of target prices • Counter-cyclical payments mechanism 40

The Loan Rate Mechanism $ DMKT • Commodity Loan Rate: Sets minimum prices for farmers that participate in the program • Commodities such as wheat, corn and cotton • Lets examine how this program works at the sector or market level for wheat SMKT PF E Q 0 QF 41

The Loan Rate Mechanism $ D • Wheat market • PF, QF: market clearing price and quantity • USDAwants to support prices at PG > PF • Quantity demanded = QD • Quantity supplied = QG • Excess Supply of QG - QD SMKT Excess Supply PG PF E Q 0 QG QF QD 42

The Loan Rate Mechanism • USDA’s Commodity Credit Corporation (CCC) acts as purchasing agent for the Federal gov’t. • CCC makes a loan to participating farms at the desired fixed price, PG • Loan plus interest must be paid back within 9-12 months • If not profitable to repay the loan due to low wheat price • Producer can repay the loan with collateral (the crop) as payment 43

The Loan Rate Mechanism • The goal is to shift demand from D to D+CCCQ • → ↑ price from PF to PG • Consumer demand ↓ from QF to QD due to higher price • Government purchases QG − QD DMKT+CCCQ $ Gov’t purchase DMKT SMKT PG PF E Q 0 QG QF QD 44

The Loan Rate Mechanism • Total taxpayer cost of purchases to achieve the target price would be PG x (QG – QD) • = Area QDABQG DMKT+CCCQ $ DMKT SMKT A PG B PF E Q 0 QG QF QD 45

The Loan Rate Mechanism • The CCC stores the surplus QG-QD at taxpayer expense • This approach has the unwanted effect of increasing supply from (QF to QG) in a sector already plagued by surplus production 46

The Loan Rate Mechanism DMKT+CCCQ • Consumer surplus declines from area 3+4+6 to area 6 • Consumer welfare decreasesby area 3+4 • Producer surplus increases from area 1+2 to area 1+2+3+4+5 • There is a welfare gain of area 3+4+5 • Total economic surplus increases by area 5 $ DMKT SMKT 6 PG 5 4 3 PF E 2 1 Q 0 QG QF QD 47

The Loan Rate Mechanism • The individual firm under free market conditions will produce quantity qF at price PF • Profit = area 1 • CCC purchases → the price ↑ to PG • Participating farmers ↑ production from qF to qG • Profits ↑ by the area 2 • Total profit = areas 1 + 2 $ SFIRM PG 2 PF E 1 Q 0 qG qF 48

The Set-Aside Mechanism • Significant problem with the loan program • Successive years of low prices → government stocks of grains and other agricultural commodities can become quite large relative to production • →Large expenditures to pay for storage • To control the size of these stocks, the 1990 Farm Bill adopted a set-aside requirement for program participation 49

The Set-Aside Mechanism • Set-aside requirements • Farmers must remove a certain % of cropland from production • Condition for receiving program benefits • Used for a majority for most major food and feed grains to reduce surplus production such as corn and wheat • Crop-specific %’s determined in part by expected ratio of ending stocks to total use 50

Government Intervention in Agriculture