Chapter 30 Farm Policy McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc All rights reserved 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 • Kick It Up a Notch McGraw-Hill/Irwin ©2012 The McGraw-Hill Companies, All Rights Reserved 30-2 1-2 Farm Prices Since 1950 • Raw food commodity prices have increased much more slowly than overall inflation • From 1982 to 2008 overall inflation was 101% • Most food commodities cost less in 2008 than in 1982 in nominal terms (50% less in real terms.) • Hog prices in 2000 yielded less than 45% of their 1982 levels McGraw-Hill/Irwin ©2012 The McGraw-Hill Companies, All Rights Reserved 30-3 1-3 Farm Price Indexes McGraw-Hill/Irwin ©2012 The McGraw-Hill Companies, All Rights Reserved 30-4 1-4 Corn and Gasoline • Corn is the main ingredient in ethanol • E85 (available mostly in the Midwest) is a substitute for gasoline • Recent spikes in gasoline prices have motivated increased corn planting McGraw-Hill/Irwin ©2012 The McGraw-Hill Companies, All Rights Reserved 30-5 1-5 Corn and Gasoline Prices Relative to their 2000 level McGraw-Hill/Irwin ©2012 The McGraw-Hill Companies, All Rights Reserved 30-6 1-6 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 McGraw-Hill/Irwin ©2012 The McGraw-Hill Companies, All Rights Reserved 30-7 1-7 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.” McGraw-Hill/Irwin ©2012 The McGraw-Hill Companies, All Rights Reserved 30-8 1-8 Farm Markets Without Subsidies P A P* S 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 D McGraw-Hill/Irwin Q* Q/t ©2012 The McGraw-Hill Companies, All Rights Reserved 30-9 1-9 Price Floors• P S A Pfloor B Price Floor P* • Consumers Pay Producers: • 0PfloorBQD • The Variable Cost to Producers: • 0HGQD • Consumer Surplus: • PfloorAB • Producer Surplus: • HPfloorBG C G H D QD Q* McGraw-Hill/Irwin Value to the Consumer: • 0ABQD • DWL Q/t • BCG ©2012 The McGraw-Hill Companies, All Rights Reserved 30-10 1-10 P Government Purchase of Excess • Value to the Consumer: Goods • 0ABQ D S A B Pfloor P* • Government Pays Producers: • QDBEQs • The Variable Cost to Producers: • 0HEQS • Consumer Surplus: • PfloorAB • Producer Surplus: • HPfloorE C G H F J Consumers Pay Producers: • 0PfloorBQD E Price Floor I • D QD Q* McGraw-Hill/Irwin QS • DWL Q/t • ECF ©2012 The McGraw-Hill Companies, All Rights Reserved 30-11 1-11 Government Lowers the Price to Consumers P S A B Pfloor E • Value to the Consumer: • 0AFQS • Consumers Pay Producers: • 0JFQS • Government Pays Producers: • JPfloorEF • The Variable Cost to Producers: • 0HEQS • Consumer Surplus: • JAF Producer Surplus: • HPfloorE Price Floor I P* C G H F J D QD Q* McGraw-Hill/Irwin QS • Q/t • DWL • ECF ©2012 The McGraw-Hill Companies, All Rights Reserved 30-12 1-12 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 McGraw-Hill/Irwin ©2012 The McGraw-Hill Companies, All Rights Reserved 30-13 1-13 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) McGraw-Hill/Irwin ©2012 The McGraw-Hill Companies, All Rights Reserved 30-14 1-14 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”.) McGraw-Hill/Irwin ©2012 The McGraw-Hill Companies, All Rights Reserved 30-15 1-15 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 McGraw-Hill/Irwin ©2012 The McGraw-Hill Companies, All Rights Reserved 30-16 1-16 ... the main ingredient in ethanol • E85 (available mostly in the Midwest) is a substitute for gasoline • Recent spikes in gasoline prices have motivated increased corn planting McGraw-Hill/Irwin ©2012... 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... inflation • From 1982 to 2008 overall inflation was 101% • Most food commodities cost less in 2008 than in 1982 in nominal terms (50% less in real terms.) • Hog prices in 2000 yielded less than 45% of