What isAgriculturalEconomics?

Chapter 1

Impact of reduced wheat supply on world wheat prices in the U.S.

How can a value be placed on wildlife not part of a commercial harvest?

What are the benefits vs. the costs of using the above vaccine that could prevent the spread of salmonella?

Discussion Topics

Scope of economicsDefinition of economicsDefinition of agricultural economicsWhat do agricultural economists do?

General Overview

Agricultural economics studies agriculture and the food industry in its many dimensions

The agricultural economist is concerned with the entire food and fiber systemPurchased and non-purchased inputs usedProduction of primary productProcessing into final productDistribution to final consumption pointConsumption of the final product

General Overview

Study of agricultural economics covers much more than activities of farmers or ranchers.Some economists deal with issues of resource

conservation, pollution control, and water management.

Others study the agribusiness sector as purchasers, processors, and distributors of food and fiber products.

General Overview

The objective of any scientific inquiry is to:Observe and describe a particular set of

phenomenaOrganize those observations into

recognizable patternsFormulate laws where sufficient regularity

warrants The laws give scientist a basis on which to

make predictions

General OverviewEconomics is a social science, and social

scientists must deal with the laws of human nature Humans are not consistent in their behavior

→ the laws of the social scientist are less reliable than hard sciences

→ more open to exception than those of physical/biological scientists.

Nevertheless, economic behavior of most persons is generally consistent, and thus, predictable to some degree Certainty varies across phenomena

Definition of Economics

“…a social science concerned with how consumers, producers, and societies choose among alternative competing uses of scarce resources in the process of producing, exchanging, and consuming goods and services”

Page 5

Definition of Economics

Page 5

The study of economics rests on three foundations:Self-interestScarcity and Choice

Without scarcity, there would be no need for an allocation system

Definition of Economics

Page 5

Choice is important because without choices there is no decision to be made.Since economics is about decision making &

allocation without choices there would be no need for economics

Self-interest Drives the consumer to purchase more at a

lower priceIt also drives the producer to produce as

efficiently as possibleAll economic activity is driven by self-interest

Scarce Resources

Pages 2-3

Resources describes anything tangibleWheat, barbed wire, hamburgers, water,

labor, clean air

Every resource is relatively scarce→ availability of every resource is insufficient

to satisfy all of its potential users

Scarcity creates need for a system to allocate resources among potential usersNeed a theory by which allocation takes place

Scarce ResourcesNatural and biological resources

3.5 million square miles of land surface954 million acres of land in farmsLimited supply of crude oil/natural gas

reservesHuman resources

141.1 million people in U.S. civilian labor force

Manufactured resources3.9 million miles of highways121.4 million tons of steel making capacity

Pages 2-3

Making ChoicesResource scarcity forces consumers and

producers to make choicesOpportunity cost – an implicit cost associated

with economic decisions often not reflected in the market

Specialization – comparative advantage and the basis for trade between countries

Individual decisions – maximization of consumer utility and producer profits

Societal decisions – production possibilities given existing resources (solar technology subsidies vs. carbon tax)

Pages 3-4

An Example ofSpecialization

Relative strengths of Kansas:Strong in wheat production

Relative strengths of Kansas:Strong in wheat production

Page 4

Surplus of WheatShortage of OrangesShortage of Potatoes

Kansas

Specialization Example

Page 4

Shortage of WheatShortage of OrangesSurplus of Potatoes

Relative strengths of Idaho:Strong in potato production

Relative strengths of Idaho:Strong in potato production

Idaho

Specialization Example

Page 4 Relative strengths of Florida:Strong in Orange production

Relative strengths of Florida:Strong in Orange production

Shortage of WheatSurplus of OrangesShortage of Potatoes

Florida

Specialization Example

Page 4

Shortage of WheatSurplus of OrangesShortage of Potatoes

Surplus of WheatShortage of OrangesShortage of Potatoes

Shortage of WheatShortage of OrangesSurplus of Potatoes

Potat

oes

Potatoes

Specialization Example

Florida

Idaho

Kansas

Whe

at

Wheat

Oranges

Oranges

Each state specializes in what it doesbest and trades with other states…

Each state specializes in what it doesbest and trades with other states…

Basis of EconomicsEvery economic system must resolve 5

basic issuesWhat to produceHow to produce itHow much to produceWhen to produceFor whom to produce

Every society must answer these questionsInstitutional & political systems of each

society determine the manner in which these decisions will be made

Basis of Economics

Pages 5-6

One allocation mechanism lies in the free market or price systemIndividual producer and consumers,

restricted only by financial resources, are free to choose what, how, how much, and when to produce or consume. Financial resources of each consumer resolves the

“for whom” question

Another mechanism is the command systemAll decisions are made by a central planning

agency or individual

Basis of EconomicsAdvantage of the price system is consumer

sovereignty and freedom The price system is an efficient mechanism

for the what, how, how much, and when decisions

There are some shortcomings:The old adage, that the rich get richer and the

poor get poorer, has some validityThere are a number of resources that a price

system cannot efficiently allocate. Frequently called public or nonmarket goods i.e., education, national defense, fire protection,

wilderness areas, clean air, etc.

Basis of EconomicsAdvantages of a command system are that it

is very effective in allocating public goodsCan be quite egalitarian in for whom decisions

Disadvantage of command system is the loss of individual freedom in economic decisionsInherent inefficiencies of central planning

agencies

Scope of Economics

Pages 5-6

Economics can be divided into three parts:MicroeconomicsMarket economicsMacroeconomics

As the level of aggregation changes economic tools may also changeWhat makes sense for decision-making by

the individual may not necessarily be valid for a group or an entire economy

Level of aggregationdiffers

Scope of Economics

Pages 5-6

Microeconomics concerned with the economics of individual producers and consumers.

The microeconomics of production examines the economics of individual producers or firms How does a firm acquire resources and

combine them in the production process? What is the difference between cost

minimization and profit maximization

Scope of Economics

Pages 5-6

Production management decisions impacting firm profit include:Which inputs to purchase

Multiple inputs to choose from Should this choice depend on input prices?

What production technique to use Multiple production technology Technology determines input utilization

Which product to produce Multiple products to choose from

How much of each product to produce Should this depend on product prices?

When to produce them

Scope of Economics

Pages 5-6

Another branch of microeconomics concerned with the individual consumer behaviorThe microeconomics of consumption

The consumer is faced with the economic problem of deciding what to purchase with limited resourcesMoney and time are two such resources

Scope of Economics

Pages 5-6

The individual consumer must make a number of consumption decisions over time May not be the product of conscious

deliberation May be habitual or impulsive

The consumer must decide what to buy and what not to buy

Consumer must also decide when to consume

Scope of Economics

Pages 5-6

Each consumer faces the inevitability of scarcity in the form of a limited budgetGiven this scarcity, each consumer uses

his/her sovereignty to resolve the for whom allocative decision

Scope of Economics

Pages 5-6

A market is established when potential buyers and sellers interact to negotiate prices and exchange goods

Market versus a marketplace.Former (i.e., Market) refers to

interaction of buyers and sellersThe latter (i.e. Marketplace) refers to a

physical location

Scope of Economics

Pages 5-6

Market economics encompasses the study of the dealings in a particular commodity Interaction of all potential buyers and sellers

In the neoclassical model, each participant in a market is a price taker Collective decisions of all participants in a

market determine the price An individual consumer has no impact on

price

Scope of Economics

Pages 5-6

As a price taker the only decision each producer/consumer can make is a choice of whether or not to sell/buy at the market priceAs the number of yes votes changes, in

aggregate, the price will also change

Scope of Economics

Pages 5-6

Four characteristics of a commodity that are impacted by the marketing of a good from producer to final consumerTimePlaceFormPossession

Scope of Economics

Pages 5-6

It is a complex system that transforms a Minnesota farmer’s August wheat harvest to a New York banker’s toast in JanuaryForm of the wheat must be changed to

bread The place moves from MN to NYTime changes from August to JanuaryPossession changes from farmer to banker

Scope of Economics

Pages 5-6

Macroeconomics concerned with the entire economic systemCity, state, national or international level

Questions considered What are the linkages within the

economic system as a whole? What are the economy-wide impacts of

changes in policies or institutions? What impacts the unemployment and

inflation rates, the balance of payments, and the Federal deficit?

Scope of Economics

Pages 5-6

Economic system performance at the macro level is important to agricultural producers and consumers Micro management decisions are

predicated on existing macro-economic conditions i.e., Do I expand my cheese plant given low

interest rates?

Scope of Economics

Pages 5-6

Macroeconomics deals with the economic impacts of public policiesi.e., food stamps, pesticide usage

restrictions or agricultural price supports On each sector of the economy individually

and the entire economy collectively

The macroeconomist also concerned with international issues

Scope of Economics

Pages 5-6

U.S. agricultural sector: International markets are increasingly importantForeign buyers are one of the most

important market for U.S. crop production 40% of cropland used to produce food & fiber

exportedImports—particularly petroleum—are

are important in the cost structure of U.S. farmers, food processors, and distributors

We share a humanitarian concern for world’s population that lives in hunger

What is Agricultural Economics?

“…an applied social science that deals with how producers, consumers, and societies use scarce resources in the production, processing, marketing, and consumption of food and fiber products”

Page 6

Economic Models

Economists like to abstract from the complexity of the real world via the use economic models Simplification of and abstraction from

observed data

Economic ModelsAn economic model

Is a theoretical construct developed via logical reasoning

Represents economic processes Variables that describe the system Logical and/or quantitative relationships

between these variables• i.e., Unemployment rate and mortgage lending rates

Simplified framework used to illustrate complex processes

Sometimes, but not always, based on mathematical techniques

Economic ModelsSimplification is important for economic

models given the enormous complexity of economic processes

Complexity arises from diversity of factors that determine economic activity Individual/cooperative decision making Resource limitations Environmental & geographical constraints Institutional and legal requirements Purely random fluctuations (i.e. weather)

Economic ModelsWhen developing an economic model the

economist must make a reasoned choice of: Which variables are relevant Which relationships between these

variables are relevant Which ways of analyzing and presenting

this information are useful i.e., model type/structure

Economic ModelsEconomic models when properly

constructed Remove extraneous information Isolate useful approximations of key

relationships More can be understood about

relationships in question than by trying to understand entire economic process

Economic ModelsA common economic model: Perfect

Competition → a number of assumptions about the firm and its environment The firm small relative to the market and

its actions will not impact the market Firm manager tries to maximize profits

given a particular resource endowment

Are the assumptions valid? If not, results may not be appropriate

Economic ModelsIdeally, economic models approximate

reality in a manner that enhances ones ability to conceptualize and understand real world eventsModels provide the economist with an

internally consistent mechanism for conceptualizing problems

They force the economist to reason in a systematic, logical and deductive manner

Ceteris Paribus

Ceteris paribus: is a Latin phrase that roughly translates: everything else being equal An economic principle is valid only when

all other external factors remain the same

Use of ceteris paribus gives economics much of the logical rigor required in a scientific inquiry

Opportunity CostOpportunity cost: Important termAll economic resources have value

Value usually determined in a marketplace where resource user pays prevailing price

Sometimes resources have economic value, butthose resources are not purchased in a market

In this last case economists use opportunity costs to determine the resource’s economic value Though there is no market price

Opportunity Cost

Opportunity cost is the economic value of a resource in its highest value alternative use

Common mistake: Price vs. CostPrice is a per-unit concept

i.e., What is the price of a gallon of gasoline?Cost refers to the concept of prices times

quantity purchased i.e., What did it cost to fill up your car?

Opportunity CostOpportunity costs cannot be

measured directly Can only be estimated indirectly We will review some of these methods

later

Opportunity CostThe study of economics is all about

economic values—costs vs. returns When available, we use market prices

to determine economic value. When market prices are not available,

we use the concept of opportunity cost to estimate those values

Returns can be measured in terms of $ or in terms of satisfaction (or utility)

Diminishing ReturnsIn models of the economics of

production and consumption the concept of diminishing returns is keyAs you increase the amount of something,

ceteris paribus you will eventually reach a point where you increase at a decreasing rate i.e., Diminishing returns with respect to

amount of labor used to produce a crop

Diminishing ReturnsConsumer side: Law of diminishing

marginal utility Marginal utility: The additional utility

(satisfaction) associated with one additional unit of a good being consumed—ceteris paribus

→ Amount of utility gained from consuming a good eventually increases but at a decreasing rate Assuming consumption of everything else

stays constant

Diminishing ReturnsProduction side: Law of diminishing

marginal product If you add a certain level of an input to

fixed amounts of other inputs, the additional production from this extra input will eventually decrease i.e., If you add additional units of fertilizer

to a fixed amount of land, eventually response per unit of fertilizer begins to increase but at a decreasing rate

Can eventually turn negative Too much fertilizer can burn a crop, ↓yield

MarginalityOne of the greatest contributions of

economics is the concept of marginality Marginal refers to an additional or

incremental unit of something

Most economic analyses deal not with marginal value of production or consumption However, it is on the margin where the

economic decisions are made

MarginalityThe consumer’s relevant economic

question:Is the marginal utility associated with

purchasing one additional unit of a good greater than the marginal cost of acquiring that unit?

MarginalityRegardless of current total

satisfaction (utility) level if the marginal utility is greater than the

marginal costthe consumer can increase total utility

by consuming this marginal unit

The same basic principle applies to productionIf marginal value of output is greater

than the marginal cost of production then produce that marginal unit

Marginality

↓ Marginal returns (MR) as fertilizer amount ↑ ceteris paribus

Mar

gin

al C

osts

an

d R

etu

rns

Quantity of Fertilizer/Acre

20

15

10

Q1 Q2 Q3

Marginal cost (MC) of obtaining additional fertilizer is constant and equals fertilizer price

Economical input useoccurs at the margin

$/lb fert.

MarginalityUsing marginal analyses one can

determine the behavior that will maximze profit, minimize cost, maximize utility or maximize social welfareIgnoring total costs or returns &

concentrating on marginal costs and returns

From the economist’s perspective, everything happens on the margin

Logical FallaciesMany economists go astray because

they fall into one of four logical traps Known to snare large numbers of

agricultural economics studentsI have fallen into some of these

The Four TrapsCorrelation-CausationCompositionPost Hoc Zero-Sum Game

Logical Fallacies

Correlation-Causation FallacyCorrelation refers to two events that

share some sort of mutual relationship in a regular and predictable manner

Causation refers to two events in which there is a cause-and-effect relationship between two events

Logical Fallacies

When two events have a causal relationship, they also have a correlation

Fallacy is assuming that if two events are correlated they must be related in some sort of causative manner

Logical Fallacies

Frequently, events that are correlated behave in a mutual relationship because they are both related in a causative fashion to some 3rd event

Logical FallaciesFallacy of Composition

Asserts that what is true of a part is, therefore, true of the whole

In many situations, it is perfectly valid to reason that what is true for the individual must also be true for the group

A farmer who attempts to maximize profits also provides food at the lowest possible price If each farmer freely attempts to do what is in

his/her best interest both farmers and consumers benefit

Logical FallaciesThere are instances where individual

self-interest may not be in the group’s best interest Fallacy of composition example

Basketball spectator can improve his view of a game by standing. By so doing he is better off Society as a whole is worse off because he

destroys the view for others

Logical Fallacies

In making the fallacy of composition the spectator would declare: If I stand up, I can see better → → If everyone stood up, everyone could

see better In fact this would not be the case

Logical FallaciesPost Hoc Fallacy: post hoc, ergo

propter hoc (Latin) Translation: After this, therefore

because of this Fallacy is the belief that because one

event precedes another, the first causes the second i.e., the rooster, convinced that his crowing

causes the sun to rise is guilty of this fallacy

Logical FallaciesZero-Sum Game Fallacy

Common in economics: If someone gains, someone else must lose

This is the heart of the nearly universal suspicion that both producers and consumers are repeatedly exploited by “middlemen”

Often expressed by the question: Who got the better part of the deal?

Logical FallaciesThe basis of economics is exchange

Usually a good/service exchanged for $

A skeptic: In a transaction the buyer and seller are equally worse offTo the contrary, both are better off, for

each has acquired something he wanted more than what he had If they weren’t better off they would never

have traded in the first place

Logical FallaciesA completed economic transaction

with no coercion is a win–win situationRather than a win–lose situation as

suggested by this fallacy

As a result of the exchange, perceived value controlled by each is increased

Logical FallaciesAs long as transactions

Are conducted without coercion nor constraint

→ an ↑ in the value held by one participant does not necessarily have to be the result of a ↓ in the value held by the other

Usually both should be better off

Fact, Beliefs and ValuesEconomics is concerned with the

value system of individuals and society

Important to distinguish between facts, beliefs and valuesFacts are what we know to be the caseBeliefs are what we think to be the caseValues are what we think should be the

case

In SummaryResource scarcity - natural, human

and manufactured – forces individuals and societies to make choices

Comparative advantage leads to trade

Micro vs. MacroeconomicsReviewed scope of economicsDefinition of agricultural economics

Chapter 2 presents an overview of the U.S. food and fiber industry…