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?


Scope of economics

Definition of economics

Definition of agricultural economics

What do agricultural economists do?


Agricultural economics studies agriculture and the food industry in its many dimensions

The agricultural economist is concerned with the entire food and fiber system

Purchased and non-purchased inputs used

Production of primary product

Processing into final product

Distribution to final consumption point

Consumption of the final product


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.


The objective of any scientific inquiry is to:

Observe and describe a particular set of phenomena

Organize those observations into recognizable patterns

Formulate laws where sufficient regularity warrants
 The laws give scientist a basis on which to make predictions


Economics 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

“…a social science concerned with how consumers, producers, and societies choose among alternative
uses of
in the process of producing, exchanging, and consuming goods and services”
Page 5


The study of economics rests on three foundations:

Self-interest

Scarcity and

Choice

Without scarcity, there would be no need for an allocation system
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 price

It also drives the producer to produce as efficiently as possible

All economic activity is driven by self-interest
Page 5

Scarce Resources

Resources describes anything tangible

Wheat, 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 users

Need a theory by which allocation takes place
Pages 2-3

Scarce Resources

Natural and biological resources

3.5 million square miles of land surface

954 million acres of land in farms

Limited supply of crude oil/natural gas reserves

Human resources

141.1 million people in U.S. civilian labor force

Manufactured resources

3.9 million miles of highways

121.4 million tons of steel making capacity
Pages 2-3

Making Choices

Resource scarcity forces consumers and producers to make choices

Opportunity 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 of
Specialization

Specialization Example

Surplus of Wheat

Shortage of Oranges

Shortage of Potatoes
Relative strengths of Kansas:
Strong in wheat production
Page 4

Specialization Example

Shortage of Wheat

Shortage of Oranges

Surplus of Potatoes
Relative strengths of Idaho:
Strong in potato production Page 4

Specialization Example

Shortage of Wheat

Surplus of Oranges

Shortage of Potatoes
Relative strengths of Florida:
Strong in Orange production Page 4

Specialization Example
Kansas 
Surplus of Wheat

Shortage of Oranges

Shortage of Potatoes
Florida
Idaho
Potatoes
Oranges

Shortage of Wheat

Shortage of Oranges

Surplus of Potatoes
Each state specializes in what it does best and trades with other states…

Shortage of Wheat

Surplus of Oranges

Shortage of Potatoes
Page 4

Basis of Economics

Every economic system must resolve 5 basic issues

What to produce

How to produce it

How much to produce

When to produce

For whom to produce

Every society must answer these questions

Institutional & political systems of each society determine the manner in which these decisions will be made

Basis of Economics

One allocation mechanism lies in the free market or price system

Individual 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 system

All decisions are made by a central planning agency or individual
Pages 5-6

Basis of Economics

Advantage 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 validity

There 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 Economics

Advantages of a command system are that it is very effective in allocating public goods

Can be quite egalitarian in for whom decisions

Disadvantage of command system is the loss of individual freedom in economic decisions

Inherent inefficiencies of central planning agencies

Scope of Economics

Economics can be divided into three parts:

Microeconomics

Market economics

Macroeconomics
Level of aggregation differs

As the level of aggregation changes economic tools may also change

What makes sense for decision-making by the individual may not necessarily be valid for a group or an entire economy Pages 5-6

Scope of Economics

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
Pages 5-6

Scope of Economics

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
Pages 5-6

Scope of Economics

Another branch of microeconomics concerned with the individual consumer behavior

The microeconomics of consumption

The consumer is faced with the economic problem of deciding what to purchase with limited resources

Money and time are two such resources
Pages 5-6

Scope of Economics

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
Pages 5-6

Scope of Economics

Each consumer faces the inevitability of scarcity in the form of a limited budget

Given this scarcity, each consumer uses his/her sovereignty to resolve the for whom allocative decision
Pages 5-6

Scope of Economics

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 sellers

The latter (i.e. Marketplace) refers to a physical location
Pages 5-6

Scope of Economics

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
Pages 5-6

Scope of Economics

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 price

As the number of yes votes changes, in aggregate, the price will also change
Pages 5-6

Scope of Economics

Four characteristics of a commodity that are impacted by the marketing of a good from producer to final consumer

Time

Place

Form

Possession
Pages 5-6

Scope of Economics

It is a complex system that transforms a
Minnesota farmer’s August wheat harvest to a New York banker’s toast in
January

Form of the wheat must be changed to bread

The place moves from MN to NY

Time changes from August to January

Possession changes from farmer to banker
Pages 5-6

Scope of Economics

Macroeconomics concerned with the entire economic system

City, 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?
Pages 5-6

Scope of Economics

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?
Pages 5-6

Scope of Economics

Macroeconomics deals with the economic impacts of public policies
 i.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
Pages 5-6

Scope of Economics

U.S. agricultural sector: International markets are increasingly important

Foreign buyers are one of the most important market for U.S. crop production

40% of cropland used to produce food & fiber exported

Imports—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
Pages 5-6

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 Models

An 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 Models

Simplification 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 Models

When 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 Models

Economic 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 Models

A 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 Models

Ideally, economic models approximate reality in a manner that enhances ones ability to conceptualize and understand real world events

Models 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 Cost

Opportunity cost : Important term

All economic resources have value

Value usually determined in a marketplace where resource user pays prevailing price

Sometimes resources have economic value, but those 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. Cost

Price 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 Cost

Opportunity costs cannot be measured directly

Can only be estimated indirectly

We will review some of these methods later

Opportunity Cost

The 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 Returns

In models of the economics of production and consumption the concept of diminishing returns is key

As 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 Returns

Consumer 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 Returns

Production 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

Marginality

One 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

Marginality
 The 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?

Marginality

Regardless of current total satisfaction (utility) level
 if the marginal utility is greater than the marginal cost
 the consumer can increase total utility by consuming this marginal unit

The same basic principle applies to production

If marginal value of output is greater than the marginal cost of production then produce that marginal unit

Marginality
$/lb fert.
↓
Marginal returns ( MR ) as fertilizer amount ↑ ceteris paribus
Marginal cost (MC) of obtaining additional fertilizer is constant and equals fertilizer price
20
15
10
Economical input use occurs at the margin
Q
1
Q
2
Q
3
Quantity of Fertilizer/Acre

Marginality

Using marginal analyses one can determine the behavior that will maximze profit, minimize cost, maximize utility or maximize social welfare

Ignoring total costs or returns & concentrating on marginal costs and returns
 From the economist’s perspective, everything happens on the margin

Logical Fallacies

Many economists go astray because they fall into one of four logical traps

Known to snare large numbers of agricultural economics students

I have fallen into some of these

The Four Traps

Correlation-Causation

Composition

Post Hoc

Zero-Sum Game

Logical Fallacies

Correlation-Causation Fallacy

Correlation 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 3 rd event

Logical Fallacies

Fallacy 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 Fallacies

There 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 Fallacies

Post 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 Fallacies

Zero-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 Fallacies

The basis of economics is exchange

Usually a good/service exchanged for $

A skeptic: In a transaction the buyer and seller are equally worse off

To 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 Fallacies

A completed economic transaction with no coercion is a win–win situation

Rather than a win–lose situation as suggested by this fallacy

As a result of the exchange, perceived value controlled by each is increased

Logical Fallacies

As 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 Values

Economics is concerned with the value system of individuals and society

Important to distinguish between facts, beliefs and values

Facts are what we know to be the case

Beliefs are what we think to be the case

Values are what we think should be the case


Resource scarcity - natural, human and manufactured – forces individuals and societies to make choices

Comparative advantage leads to trade

Micro vs. Macroeconomics

Reviewed scope of economics

Definition of agricultural economics