Chapter 28
Farm Policy
McGraw-Hill/Irwin
Copyright © 2010 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
28-2
You Are Here
28-3
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.
28-4
Farm Price Indexes
28-5
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.
28-6
Corn and Gasoline Prices
Relative to their 2000 level
28-7
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.
28-8
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.”
28-9
Farm Markets Without Subsidies
• Value to the Consumer:
• 0ACQ*
• Consumers Pay Producers:
S
• 0P*CQ*
• The Variable Cost to Producers:
• 0HCQ*
• Consumer Surplus:
• P*AC
• Producer Surplus:
• HP*C
P
A
P*
C
H
D
0
Q*
Q/t
28-10
Price Floors
P
S
A
B
Pfloor
Price Floor
P*
C
G
H
D
0 QD Q*
• Value to the Consumer:
• 0ABQD
• Consumers Pay
Producers:
• 0PfloorBQD
• The Variable Cost to
Producers:
• 0HGQD
• Consumer Surplus:
• PfloorAB
• Producer Surplus:
• HPfloorBG
• DWL
• BCG
Q/t
28-11
Government Purchase of Excess Goods
•
P
S
A
•
•
B
E
Pfloor
Price Floor
•
I
P*
C
•
G
•
H
F
J
0
D
QD Q*
QS
•
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
• ECF
Q/t
28-12
Government Lowers the Price to
Consumers
•
P
S
A
B
•
E
Pfloor
•
Price Floor
•
I
P*
C
G
•
H
•
F
J
D
0
QD Q*
QS
•
Q/t
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
28-13
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.
28-14
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).
28-15
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”.)
28-16
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.
28-17