Government
Intervention in
Agriculture
Chapter 11
Topics of Discussion
Defining the Farm Problem
Forms of government intervention
Price and income support mechanisms
Phasing out of supply management
Domestic demand expansion
Importance of export demand
Importance of Government Payments
To Net Farm Income
Pre FAIR Act
FAIR Act
More market driven ag.
policy under FAIR Act
(1996 Farm Bill)
2002
Bill
FAIR = Federal Agriculture Improvement and Reform Act
Page 212
The Farm Problem
Many agricultural commodities exhibit
inelastic consumer demand
Individual farmers lack market power
In contrast to many manufacturers
Interest sensitivity
Production credit
Capital purchases
International trade important market
Tends to be more volatile
Asset fixity and excess capacity
The Farm Problem
$
Market Equilibrium
D
S1
S2
P1
P2
ΔP
Q1 Q2
ΔQ
Q
 Assume we have an inelastic
demand for a particular
crop
 Also assume that due to
great weather conditions
there is an increase in
supply due to record yields
→ A shift out of supply
curve at every price
 Results in price falling
relatively more than the
market clearing quantity
Page 199
The Farm Problem
What happens to total
$
D
S1
S2
 Total revenue under
original equilibrium was
area 0P1AQ1
 Total revenue under the
new equilibrium is 0P2BQ2
A
P1
P2
farm revenue when you
have an inelastic demand
and an increase in supply?
B
ΔP
We know that total
0
Q1 Q2
ΔQ
Q
revenue to this sector has
↓, (i.e., 0P2BQ2< 0P1AQ1)
 How do we know this?
Page 199
The Farm Problem
$
D1
P1
P3
P2
Q1 Q 2 Q3
In contrast, with a
S1
S2
relatively elastic demand
curve, D2
 Shift in supply will result in
price P3 instead of P2
 Shift in supply will result in
quantity Q3 rather than Q2
D2  Compared to inelastic
demand, a larger impact on
quantity and less of an
impact on price
Q  What happens to total
revenue?
Page 199
The Farm Problem
Farms and ranchers in the aggregate
exhibit conditions of perfect competition
Large number of producers
Producing a homogenous product (i.e., corn,
soybeans, wheat, etc)
No one farmer has sufficient market power
to influence the market equilibrium price
If a single producer suffers a disastrous year in
terms of yield, he alone will suffer as market
price is not impacted
The Farm Problem
Agricultural sector is one of the most
highly capitalized sector in the U.S.
economy
More capital invested per worker
Farmers must obtain short, medium and
long-term loans to purchase variable and
fixed inputs
→ a change in interest rates will have a
significant impact on production costs
The Farm Problem
Quarterly Agricultural Interest Rates (%), 7th District
20.0
17.5
Operating
Real Estate
15.0
12.5
10.0
7.5
19
76
1
19
78
1
19
80
1
19
82
1
19
84
1
19
86
1
19
88
1
19
90
1
19
92
1
19
94
1
19
96
1
19
98
1
20
00
1
20
02
1
20
04
1
20
06
1
20
08
1
20
10
1
5.0
The Farm Problem
High interest rates in the U.S. economy
increases the value of the dollar in
foreign currency markets
More units of foreign currency per U.S. $
Makes U.S. exports more expensive
Many agricultural commodities (i.e.,
wheat, corn, soybeans, etc) are highly
dependent on export markets
For many agricultural commodities excess
supply relative to domestic market
Reduced export demand → Downward
pressure on commodity prices
The Farm Problem
Asset fixity refers to the difficulty
farmers have in disposing of capital
equipment such as tractors, combines,
silos, etc when downsizing or shutting
down the business
When commodity prices are low and
farmers are downsizing the value of these
assets may be quite low relative to purchase
price
The Farm Problem
Excess Capacity refers to the fact that the
agricultural sector can produce more
than it can sell
Can have times with significant stocks of
storable commodities such as corn, wheat
and cheese
→Downward pressure on commodity prices
Technological change can shift the supply
curve to the right for all prices
Leads to excess capacity
The Farm Problem
Combined effect of asset fixity and excess
capacity
↓ in farm asset values when there exists
surplus commodity stocks
Government Intervention in Agriculture
There is a history of state and Federal
government intervention in agriculture
 Designed to improve economic conditions
 Provide appropriate level of environmental
quality as discussed previously
In terms of improving economic conditions
a number of intervention types
 Adjusting production to market demand
 Price and income support programs
 Foreign trade enhancements
Government Intervention in Agriculture
Adjusting production to market demand
 ↓ amount of resources employed to produce a
surplus product
 Primarily land
 Example: Pay farmers not to produce by
requiring land normally planted to be idled
 → supply will decline
 → Market prices will improve
Government Intervention in Agriculture
Every 5 years or so the U.S. Congress
enacts legislation known as the Farm Bill
 Food Security Act of 1985
 Food, Agriculture, Conservation and Trade
Act of 1990
 Federal Agricultural Improvement and
Reform Act of 1996
 Farm Security and Rural Investment Act of
2002
 Food, Conservation and Energy Act of 2008
Government Intervention in Agriculture
U.S. Farm Bills
 The primary agricultural and food policy tool
of the U.S. Federal gov’t.
 Concerned with both agriculture and all other
programs under control of USDA
 i.e., food stamp and WIC programs
Purpose of Farm Bills
 Amends/suspends provisions of permanent law
 Re-authorizes/amends/repeals provisions of
previous temporary agricultural acts
 Enact new policy initiatives
Government Intervention in Agriculture
$
P2
P1
0
D
S2
E2
E1
Q2 Q1
 S1→original supply curve
 Policies restricting
S1
resource use shifts curve
to S2
 Market equilibrium
moves from E1 to E2
 Total revenue
 Original: OP1E1Q1
 After move: OP2E2Q2
 Does total revenue
increase?
Q
 Depends on demand
elasticity
Government Intervention in Agriculture
Another strategy to improve economic
conditions is to directly support farm
prices and income
 Obtained by gov’t setting a price floor
 Price floor supported by gov’t purchases
surplus commodities
 Dairy product price support program
Another alternative is to support farm
incomes through direct transfers
 RMA and revenue insurance via the 1996
farm bill
Government Intervention in Agriculture
A third approach to improving economic
conditions is to impact foreign trade
“rules of the game”
 Establish tariffs on specific commodities
 Set commodity quotas
A tariff on a specific imported commodity
 Essentially a tax
 Increases it domestic price
 Could make U.S. sourced commodity more
price competitive→increased demand
Government Intervention in Agriculture
A quota limits the
$
P2
P1
D
S2
E2
E1
S1
quantity than can be
imported for a
particular commodity
By restricting supply
you again shift the
supply to the left at
every price
 ↑ equilibrium price
0
Q2 Q1
Q
Government Intervention in Agriculture
Another alternative is to ↑ demand for
U.S. agricultural products in foreign
markets by reducing export price
The Federal gov’t can subsidize
purchase of U.S. agricultural
commodities
Example: The Dairy Export
Incentive Program (DEIP)
Government Intervention in Agriculture
Dairy Export Incentive Program
 Initiated in 1985 and still in existence
 Designed to ↑ dairy product demand: butter,
non-fat dry milk and cheese
 Develop export markets where U.S. products
are not competitively priced
USDA pays cash to exporters to sell U.S.
dairy products at prices lower than the
exporter's price
 USDA makes up the difference
Government Intervention in Agriculture
Low own-price elasticity and ↑ supply can
cause farm incomes to ↓ sharply
Lets review 4 agricultural policies that
have been used to soften the effect of ↓
farm incomes
 Loan rate programs
 Set-Aside mechanism
 Establishment of target prices
 Counter-cyclical payments mechanism
Dairy Product Price Support Program
Program established in 1949
CCC offers to purchse nonperishable
dairy products at a specified
(intervention) price and in a specified
form
Cheese
Butter
Non-Fat dry milk
No-limit on amount that can be sold to
the CCC
Introduction to Agricultural Economics, 5th ed
Penson, Capps, Rosson, and Woodward
© 2010 Pearson Higher Education,
Upper Saddle River, NJ 07458. • All Rights Reserved.
Dairy Product Price Support Program
Dormant when market prices are above
intervention prices
Activated when supply of products
exceeds demand at the intervention price
Previous versions set support prices to
essentially set a minimum milk price
Now purchase price of products are
explicitly set by newest Farm Bill
Introduction to Agricultural Economics, 5th ed
Penson, Capps, Rosson, and Woodward
© 2010 Pearson Higher Education,
Upper Saddle River, NJ 07458. • All Rights Reserved.
Dairy Product Price Support Program
Public policy issues
Effectiveness in establishing a realistic price
floor
Distortion in allocation of milk and relative
product prices
Impact on U.S. dairy trade
Introduction to Agricultural Economics, 5th ed
Penson, Capps, Rosson, and Woodward
© 2010 Pearson Higher Education,
Upper Saddle River, NJ 07458. • All Rights Reserved.
Budget Costs of Dairy Price Supports
Introduction to Agricultural Economics, 5th ed
Penson, Capps, Rosson, and Woodward
© 2010 Pearson Higher Education,
Upper Saddle River, NJ 07458. • All Rights Reserved.
Introduction to Agricultural Economics, 5th ed
Penson, Capps, Rosson, and Woodward
© 2010 Pearson Higher Education,
Upper Saddle River, NJ 07458. • All Rights Reserved.
The Loan Rate Mechanism
Commodity Loan
$
DMKT
SMKT
PF
E
0
QF
Q
Rate: Sets minimum
prices for farmers
that participate in
the program
 Commodities such as
wheat, corn and
cotton
 Lets examine how
this program works
at the sector or
market level for
wheat
The Loan Rate Mechanism
Wheat market
$
D
SMKT
Excess
Supply
 PF, QF: market clearing
price and quantity
USDAwants to support
PG
prices at PG > PF
PF
0
 Quantity demanded = QD
 Quantity supplied = QG
 Excess Supply of QG - QD
E
QD
QF
QG
Q
The Loan Rate Mechanism
 USDA’s Commodity Credit Corporation
(CCC) acts as purchasing agent for the
Federal gov’t.
CCC makes a loan to participating farms
at the desired fixed price, PG
Loan plus interest must be paid back
within 9-12 months
If not profitable to repay the loan due to
low wheat price
 Producer can repay the loan with
collateral (the crop) as payment
The Loan Rate Mechanism
DMKT+CCCQ
$
The goal is to shift
DMKT
SMKT
PG
PF
0
E
QD
QF
QG
Q
demand from D to
D+CCCQ
→ ↑ price from PF to
PG
Consumer demand ↓
from QF to QD due to
higher price
The Loan Rate Mechanism
DMKT+CCCQ
$
Total taxpayer cost of
DMKT
SMKT
PG
A
PF
0
= Area QDABQG
B
E
QD
QF
QG
purchases to achieve
the target price would
be PG x (QG – QD)
Q
The Loan Rate Mechanism
The CCC store the surplus QG-QD at
taxpayer expense
This approach has the unwanted
effect of increasing supply from (QF
to QG) in a sector already plagued by
surplus production
The Loan Rate Mechanism
DMKT+CCCQ
$
DMKT
6
PG
5
4
3
PF
2
E
1
0
QD
QF
QG
Consumer surplus
declines from area
3+4+6 to area 6
SMKT
 There welfare
decreases by area 3+4
Producer surplus
increases from area 1+2
to area 1+2+3+4+5
 There is a welfare
gain of area 3+4+5

Total economic surplus
Q
increases by area 5
The Loan Rate Mechanism
 The individual firm
$
SFIRM
PG
 Profit = area 1
2
PF
 CCC purchases → the
E
price ↑ to PG
1
0
under free market
conditions will produce
quantity qF at price PF
qF
qG
Q
 Participating farmers ↑
production from qF to qG
 Profits ↑ by the area 2
 Total profit = areas 1 + 2
The Set-Aside Mechanism
Significant problem with the loan program
Successive years of low prices → government
stocks of grains and other agricultural
commodities can become quite large relative to
production
→Large expenditures to pay for storage
To control the size of these stocks, the 1990
Farm Bill adopted a set-aside requirement
for program participation
The Set-Aside Mechanism
Set-aside requirements
 Farmers must remove a certain % of cropland
from production
 Condition for receiving program benefits
 Used for a majority for most major food and
feed grains to reduce surplus production such as
corn and wheat
Crop-specific %’s determined in part by
expected ratio of ending stocks to total use
The Set-Aside Mechanism
Major Problem
Farmers will set-aside their poorest land first
and crop the remaining acres more intensely
 Results in larger supply and lower prices than
desired by policy-makers
1995 Farm Bill eliminated the ability of
USDA to require set-asides
The Set-Aside Mechanism
 What are the market-level
$
impacts?
D
SMKT
PG
PF
0
E1
QG
QF
QS
Q
 SMKT, market supply curve
prior to acreage restrictions
 E1 is initial equilibrium at
PF,QF
 Assume the Federal gov’t
wants to support farm price
at level PG
The Set-Aside Mechanism
 Assume that X% of land
Why is SMKT* curved?
$
D
must be idled
SMKT*
SMKT
7
E2
PG
6
5
PF
1
0
 Welfare effects
4
3
E1
2
QG
 Resulting supply curve,
SMKT*
 Achieve desired point
QF QS
 Farmers give up areas 2 +3
but gain area 6
 On net, farmers gain as
area 6 > areas (2 + 3)
 Consumers lose sum of
areas 4, 5 and 6
Q  Net loss to society =sum of
areas 3+4
The Set-Aside Mechanism
 Unlike CCC purchases,
$
D
the set-aside program does
not encourage production
as under loan-rate
program
SMKT*
7
SMKT
E2
PG
6
5
4
3
PF
1
0
E1
2
QG
QF QS
Q
The Set-Aside Mechanism
At the firm level the set$
D
SFirm*
SFirm
PG
4
aside program causes
output to be reduced from
qF to qG
Welfare Impacts (PS)




3
PF
1
0
2
qG
qF
Q
Before policy = 1 + 2 + 3
After policy = 1 + 4
Gain = 4 – 2 – 3
Whether gain is positive or
negative depends on
 Supply elasticities
 Demand elasticities
 Amount of shift of S
Page 208
The Target Price Mechanism
Another method for assisting with the
maintenance of farm income has been the
use of target price deficiency payments
The Federal government sets a
predefined target price for particular
crops
 Payment/bushel is based on the difference
between the target price and the market
price or loan rate, whichever is higher
Page 209
Target Price Deficiency Payment Mechanism
Deficiency payment = QM x (TP – max(MP, LR))
shown as the blue shaded area
TP = Target Price MP = Market price
LR = Loan Rate
Page 209
Recent Approaches
to Supporting
Farm Prices and Income
1996-2002 Policy
The 1996 FAIR Act many of previously reviewed
mechanisms
 Loan rate mechanism remained
 Set-aside program eliminated
 Deficiency mechanisms eliminated
Participating farmers receive fixed contract
payments that were phased out over time
Farmers were “free” to plant whatever crops
they desire and still receive contract payments.
No longer had a variable safety net should crop
prices drop due to weak export demand.
Pages 212-214
The 2002 Farm Bill
Began in 2002 and expired in 2007
Retained loan rate mechanism
Retained a fixed payment mechanism
introduced under FAIR Act in 1996
Added a new counter-cyclical mechanism
Updating base acres and program yields
Risk management tools such as enhanced
crop insurance coverage
Pages 212-213
Milk Income Loss Contract Program
Milk Income Loss Contract (MILC)
Program
Target price deficiency payment program but
for dairy
Direct payments to dairy farmers when milk
price falls below a specified level
First enacted under the 2002 Farm Bill
Since 2002, $3.9 Bil payed to U.S. dairy
producers
Individual farm payments are limited by an
annual production cap
Program unpopular in regions with large herds
Milk Income Loss Contract Program
Countercyclical Payments
Established via 2002 Farm Bill
Applied to a number of grain crops
Countercyclical Payment: The payment
($/bu) = TP – EP
EP = effective price
= max(12 month avg market price, LR +
DP) where DP is a direct payment rate
DP is based on commodity base acres not what
you plant that year
Page 210
Countercyclical Payments
D
S
TP
3
PF
exceed planted acres
The maximum
countercyclical payment
= sum of areas 3 and 4
4
1
LR
Payment acres cannot
2
Q
Page 210
Some Demand Side
Options
Domestic Demand Expansion
 Increased farm income
D1
D2
S
PG
PF
E2
E1
QF QG
can be obtained through
domestic demand
expansion
 → Shifting out farm
products demand curve in
the U.S.
 Profits increase by area
PFPGE2E1
Page 210
Domestic Demand Expansion
 Producer surplus impacts
D2
D1
S
5
PG
PF
 Consumer surplus impacts
4
2
 PS before shift = 1
 PS after shift = 1 + 2 + 3
 PS Gain = 2 + 3 > 0
E2
3
E1
1
 CS before shift = 2 + 5
 CS after shift = 4 + 5
 CS Gain = 4 – 2 0?
 Societal surplus = 3 + 4 > 0
QF QG
Page 213
Domestic Demand Expansion
 How can domestic demand be shifted out and
therefore result in higher equilibrium prices
and quantities?
School feeding and other nutrition service
programs (i.e., Food Stamps, WIC)
Advertising and promotional programs
The gov’t can subsidize the development of
uses for farm products
 i.e., state and Federal subsidies in the use
of ethanol as a gasoline extender
Page 213
Export Demand Expansion
 Many agricultural commodities are highly
dependent on foreign markets for purchases
 For agriculture as whole > 20% of the value of total
production is exported
 The importance of export market varies by
commodity
Exports as % of Current Production
Commodity
07/08
08/09
09/10
10/11
Corn
18.3
15.6
14.7
14.7
Wheat
61.5
40.1
39.1
44.8
Soybeans
41.6
43.3
43.5
41.5
Note: Exports originate from both current and stocks. The
above gives some sense of importance of foreign markets
Page 213
Export Demand Expansion
 Remember that
S
PDD
E1
DD
QDD QDD
domestic demand for
many agricultural
products are inelastic
 Export Demand
tends to be more
elastic than domestic
demand
TD
 At a given price,
domestic demand +
export demand =
total demand
Page 213
Export Demand Expansion
 P0 = price where
Po
Eo
S
E2
PTD
PDD
E1
DD
export demand = 0
 E1 represents
equilibrium with no
export demand
 E2 represents
equilibrium with
export demand
TD
 Price and quantity
both increase
QDD QDD
Page 213
Export Demand Expansion
 What the welfare impacts

Eo
Po
S
5
PTD
4
2
PDD
E2
3

E1
1
TD
DD
QDD QDD

of having trade?
Producer Surplus
 Before trade = 1
 After trade = 1 + 2 + 3
 Gain = 2 + 3
Domestic Consumer
Surplus
 Before trade = 2 + 5
 After trade = 5
 Loss = 2
Foreign Consumer Surplus
at E2 = 4
Page 213
Summary
USDA has tried to support prices and incomes by
acquiring/storing excess supply at desired price
USDA supply side approaches to supporting farm
prices and incomes included set-aside rates and
deficiency payments
FAIR Act decoupled supports from planting
decisions; resulted in large supplemental
payments during 1999-2001 period. New bill
restored safety net with counter-cyclical payments
Demand side approaches designed to promote
domestic and/or export demand
Chapter 18 focuses on why
nations trade ….