COPYRIGHT © 2008 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo,
and South-Western are trademarks used herein under license.
12-1
The Rural Sector vs. the Urban Sector: Some Statistics
• Rural sector is home to almost 50 million
inhabitants, while urban sector comprises close
to 250 million people
• Average person in rural sector makes $25,000
per year, while average person in urban sector
draws $35,000 per year
• Rural poverty rate of 13.9 percent is higher than
urban poverty rate of 12.2 percent
• Unemployment rate is 5.6 percent in rural sector,
whereas it is 5.0 percent in urban sector
12-2
Characteristics of Agriculture
•
Certain characteristics of agriculture
distinguish farm sector from remainder of
economy:
1. Inelastic demand for farm products in short
run
2. Extensive technological change in past half
century
3. Immobile resources
12-3
Inelastic Demand
• When we say product has inelastic
demand, mean that its buyers are
relatively unresponsive to changes in price
– Buyers show little variation in quantity they
buy when price changes
• Case for most farm commodities
12-4
Inelastic Demand
• Price stability
– If demand is inelastic, small fluctuations in
supply that might result from either
exceptionally good or bad weather will have
resounding effect on prices that farmers
receive for products
• Farm income
– If good weather causes increase in supply,
which causes price to decrease, then overall
farm income will also fall
12-5
Inelastic Demand
12-6
Technological Change
• Although number of Americans engaged in
agriculture is much smaller than a half century
ago, technological changes have caused supply
of farm products to increase markedly
• Compared with large increase in supply,
increase in Americans’ demand for food over
time has been relatively small
– Combined effects of large long-run increase in supply
and modest increase in demand have greatly
decreased real price (price as adjusted for effects of
inflation) of farm products
12-7
Technological Change (cont.)
12-8
Immobile Farm Resources
• Principal resource in farming is land
– With exception of land near rapidly growing
cities, which can be developed, few
alternative uses for most farmland
• Either farmland lies fallow or someone farms it
– Agriculture’s main resource is slow to respond to
adverse industry conditions
12-9
Government Policy Toward Agriculture
• U.S. government extensively involved in
agriculture since Great Depression of 1930s
– Entire country was in distress during 1930s, but
agriculture suffered more than other sectors
• Congress passed Agricultural Adjustment Act in 1933 to
restore standing of farm incomes relative to incomes in rest
of economy
• Objectives of farm policy have been to stabilize
conditions in farming and to increase farm
incomes
– Programs devised to affect supply of agricultural
products, demand for agricultural products, and price
received by farmers
12-10
Price Supports
• Legally imposed minimum prices of goods
or services
– Minimum prices set a “floor” below which
market price is not permitted to fall
• To have effect on market, price floors must be
above market equilibrium price
– Markets tend to clear at equilibrium price and quantity
» Shortages and surpluses are rationed away
(rationing function of price)
◦
When agricultural prices are kept artificially
high, cannot perform rationing function
12-11
A Hypothetical Example: Supply and Demand of Wheat
12-12
A Hypothetical Example: Supply and Demand of Wheat (cont.)
12-13
Price Supports (cont.)
• Method by which some U.S. farm prices are
supported is indirect, but result is same as price
floor
– Prices supported by granting farmers loans on stored
commodities through Commodity Credit Corporation
(CCC)
• Farmers can get loans on value of commodities at rate
established by government
– Put up commodities as collateral
» If market price is above loan rate, farmer can withdraw
commodity from storage, sell commodity, repay loan, and
keep profits
» If market price is below support price, farmer simply
surrenders commodity to government instead of repaying
loan
12-14
Price Supports (cont.)
• By means of price supports, income is
redistributed to farm sector from taxpayers
in general
– Whenever income is redistributed, some
groups gain and others lose
• Taxpayers are obvious losers
– Taxes are used to buy and store surplus at artificially
high prices, and higher prices lead to at least slightly
higher food prices
• Farm sector is gainer
– Lion’s share of support goes to large farmers, because
subsidy is paid on per-unit-of-output basis
12-15
Programs to Restrict Supply
•
Policies to decrease amount produced and offered for sale
12-16
Programs to Restrict Supply (cont.)
• Programs to reduce the supply of farm products
appeared preferable to rigid price supports in 1930s and
remain preferable today
– Soil Bank
• Encouraged long-term withdrawal of farmland from production of
any crops and stricter compliance with acreage controls on specific
crops
– Set-Aside program
• Farmers paid for setting aside and not farming proportion of total
acres, and guaranteed support prices on crops grown on remaining
acreage
– Payment-in-Kind (PIK) program
• Farmers given surplus commodities from government’s storehouses
instead of cash
– 10-year plan
• Encouraged farmers to put highly erodible acres in long-term supply
restriction program
12-17
Efforts to Increase Demand
• Efforts to decrease supply accompanied by efforts to increase
domestic and international demand for U.S. agricultural
products
– Domestic examples:
• Surplus commodities distributed to public schools for use in lunch
program
• Food stamps distributed to poor
• Cheese and milk powder distributed to poor
– International examples:
• Foreign food assistance programs
– When U.S. surpluses accumulate, distribute more food abroad
– When surpluses smaller, send less food aid to less-developed countries
• Export subsidies (government financial assistance)
– Make agricultural exports “more competitive” (cheaper) to foreign
consumers
» Causes increase in foreign demand for U.S. agricultural products
because U.S. prices will be lower than those of other countries
» Dumping: Exporting goods at low prices, even below cost of
production
12-18
Recent Agricultural Policy
• Freedom to Farm Bill (1996)
– Eliminated target prices and deficiency payments on some crops such
as feed grains and wheat
– Provided income support payments based on acreage
– Eliminated restrictions on what farmers could plant and remain eligible
for government farm programs
• Farm Security and Rural Investment Act (2002)
– Pros:
• Expands programs for farmland conversion and rural development
• Will provide $191 billion in direct subsidies to farmers over next decade
– Cons:
• Doesn’t alter price distortions and commodity overproduction that have
resulted from previous farm bills
• Eliminates many provisions that would have targeted assistance to small
and medium-size farms
• Fails to address concentration in U.S. farm industry
• Fails to strengthen competition in rural America
• Will cost U.S. consumers additional $271 billion in form of higher food prices
12-19
An Evaluation of U.S. Farm Policy
• Government policies have not solved core
farm problem of declining real incomes to
small and medium-sized farmers, and
have had some unforeseen side effects
– By treating symptom rather than cause, have
contributed to increasingly concentrated
agricultural sector and promoted productive
techniques that have harmful environmental
consequences
12-20
Treating a Symptom
• Low price of farm products is symptom of
resource allocation problem in economy
– Produce too many farm products in
comparison with other goods
• Solution is to decrease resources devoted to
farming
– As long as prices are supported artificially, will be
incentive to continue to overproduce
» Government policies are part of farm problem
because they encourage retention in agriculture of
resources that would otherwise leave farming and
be used for other purposes
12-21
Increasing Concentration in Agriculture
•
Trend toward greater concentration (domination by few large firms) in
agriculture
12-22
Harmful Environmental Effects
• Modern farming reliant on chemical fertilizers to increase yield per
acre to thereby obtain more government payments
• Relies on pesticides to decrease insect damage and maximize yield
• Creates nitrate pollution of water wells in farm states
• Irrigation in lower Midwest has damaged aquifers (underground
water supplies serving large areas) but increased bushels per acre
on which deficiency payments are earned
• Commodity programs have encouraged production of crops
particularly likely to cause erosion, because these crops often have
had high target prices
• Huge cattle feedlots, factory hog farms, and dairies with 1,200 cows
on relatively few acres create significant problems of odor and waste
disposal
• BOTTOM LINE: Farm life is neither particularly healthy nor
environmentally benign, and government programs have contributed
to adverse effects
12-23
Biotechnology
• Production of genetically modified organisms (GMOs)
has increased greatly over recent years
– Farmers use GMOs as means of preventing crop disease and
reducing pesticide use
• U.S. agricultural companies have taken lead in
developing biotechnology, in which seed varieties are
genetically altered in order to increase yields
• Some people have characterized biotechnology as
means to solve world hunger
• Opponents maintain there are severe environmental and
health risks of biotechnology and technology will do little
to help with world hunger reduction
– Development of GMOs will benefit large multinational
corporations, and not smaller farmers or consumers of
agricultural products
12-24
Food Production and Hunger
• Some economists argue that heavily subsidized
agricultural sector produces commodities that
compete unfairly with those of less-developed
countries (LDCs)
– Problem of world hunger has far less to do with global
food production and a lot more to do with how
produce is distributed
• Low-income people in poor countries cannot afford to buy
enough food for themselves and their families
– Most residents of less-developed countries earn
incomes through crop production
• When U.S. and European agricultural products flood world
markets, causing very low agricultural prices, poor farmers in
less-developed countries earn little income from production
of food and have little incentive to produce food
12-25
Food Production and Hunger (cont.)
– Import tariffs on products that LDCs’ country farmers
can produce cheaper than rich country farmers are
high in order to prevent agricultural commodities
produced by LDCs from entering United States and
other prosperous countries
• Rich-country governments receive large amounts of money
from trade barriers that cost less-developed countries
hundreds of billions of dollars
– Patents owned by U.S. multinational corporations and
agribusinesses prevent outsiders from producing
genetically modified food and allow large U.S.
corporations to flood world market with agricultural
products
12-26
Can Agricultural Policy be Improved?
• The answer: Certainly!
– However, the following must be done to
achieve improvement:
• Politicians and news media need to deflate myths
of “Little House on the Prairie” farmer, as well as
myth that needy farmers benefit from agricultural
programs
12-27
Alternatives for Improvement
• Untie amount of food production to amount of government benefit
– Instead, government might simply assure all farmers an adequate
income, perhaps at twice the poverty line
• If income for farmer falls below, government writes a check
• If income for farmer rises above, farmer receives no check
• Rather than distorting markets with artificial prices, government can
work on providing appropriate incentives (subsidies) to farmers who
engage in environmental protection and appropriate disincentives
(taxes) to farmers who do not engage in environmentally sound
practices
• To solve problem of world hunger, poverty must be addressed
– World’s wealthiest countries need to:
• Provide real development assistance rather than just food aid
• Reduce or eliminate trade restrictions and agricultural subsidies that so
severely harm well-being of less-developed country residents
12-28
The Economic Left and the Economic Right
• THE ECONOMIC LEFT
(Liberal)
– Comfortable supporting
agricultural programs
both within and outside
their states, but do not
wholeheartedly endorse
them and many believe
they should be gradually
phased out
– Would like government
efforts to reduce
concentration in
agricultural markets and
to ensure environmental
protection
• THE ECONOMIC
RIGHT (Conservative)
– Argue that price supports,
target prices, and supply
restriction programs have
contributed to farm
problem instead of solving
it
– Encourage less
government antitrust
activity and fewer
government
environmental regulations
12-29
Appendix 1: Inelastic Demand
•
Price stability
– Combination of weather-related supply fluctuations and inelastic
demand results in large fluctuations in agricultural prices in short run
12-30
Appendix 1: Inelastic Demand (cont.)
•
Farmers’ incomes
12-31
Appendix 2: Target Prices with Deficiency Payments
•
Under target pricing, farmers receive direct payments
– Payments are called deficiency payments
12-32
Appendix 2: Target Prices with
Deficiency Payments (cont.)
•
Differences between target prices and price
supports:
1. Because market price is much lower than target
price, cost of farm commodities does not drive up
cost of food
2. Because prices are lower for consumers whether in
U.S. or export market, American farm products are
more competitive on world markets at lower prices
3. Market is less distorted by target prices than by price
supports, because no surplus is created
4. Costs to taxpayers of target prices and deficiency
payments are easier to count because costs
associated with surpluses are not incurred
12-33