Chapter 28Farm Policy

Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

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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

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You Are Here

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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.

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Farm Price Indexes

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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.

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Corn and Gasoline PricesRelative to their 2000 level

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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.

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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.”

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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

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Price Floors

P S

D

Q/t

P*

Q*

A

C

H

G

Price Floor

BPfloor

QD

• Value to the Consumer:

• 0ABQD

• Consumers Pay

Producers:

• 0PfloorBQD

• The Variable Cost to

Producers:

• 0HGQD

• Consumer Surplus:

• PfloorAB

• Producer Surplus:

• HPfloorBG

• DWL• BCG0

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Government Purchase of Excess Goods

P S

D

Q/t

Price Floor

P*

Q*

A

B

C

E

F

H

G

I

J

Pfloor

QSQD

• Value to the Consumer:

• 0ABQD

• Consumers Pay Producers:

• 0PfloorBQD

• Government Pays Producers:

• QDBEQs

• The Variable Cost to

Producers:

• 0HEQS

• Consumer Surplus:

• PfloorAB

• Producer Surplus:

• HPfloorE

• DWL

• ECF0

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P S

D

Q/t

Price Floor

P*

Q*

A

B

C

E

F

H

G

I

J

Pfloor

QSQD

• 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

• DWL

• ECF

Government Lowers the Price to Consumers

0

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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.

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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).

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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”.)

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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.