Agri 2312 chapter 11 government intervention in agriculture

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AGRICULTURAL ECONOMICS

AGRICULTURAL ECONOMICS

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  • 1. Government Intervention in Agriculture Chapter 11
  • 2. Topics of Discussion
    • Defining the “Farm Problem”
    • Forms of government intervention
    • Consumer issues
    • Price and income support mechanisms
    • Phasing out of supply management
    • Domestic demand expansion
    • Importance of export demand
  • 3. The “Farm Problem”
    • Inelastic demand and a bumper crop
    • Lack of market power
    • Interest sensitivity
    • Trade sensitivity
    • Asset fixity and excess capacity
  • 4. Page 199 An increase in supply causes price to fall more sharply than the quantity clearing the market.
  • 5. Page 199 If the demand curve is more elastic (D 2 ), the price will only fall to price P 2 rather than P 3 for a given increase in supply.
  • 6. Price and Income Support: A Historical perspective
    • Commodity acquisition-loan rate mechanism
    • Set-aside mechanism
    • Target price mechanism
    • Commodities covered by government programs
  • 7. The CCC’s Loan Rate Approach to Supporting Farm Prices and Income
  • 8. Page 205 Market Level Effects of Loan Rates Free market equilibrium occurs at point E. Let’s assume that P F is below a politically acceptable price, and that the price desired by policymakers is P G .
  • 9. Page 205 Market Level Effects of Loan Rates The Commodity Credit Corporation of the USDA began in the Thirties to acquire excess supply at the desired price its through non- recourse loan provisions. The goal was to shift demand from D to D+CCC ACQ , pulling up the price from P F to P G . Note that consumer demand actually fell from Q F to Q D .
  • 10. Page 205 Market Level Effects of Loan Rates The CCC stored the surplus Q D -Q G in metal bins at great expense to taxpayers. This approach had the un- wanted effects of increasing supply from (Q F to Q G ) in a sector already plagued by surplus production.
  • 11. Page 205 Market Level Effects of Loan Rates Consumer surplus would decline from area 3+4+6 to just area 6. Thus, they are economically worse-off as a result of this approach. Producer surplus would increase from area 1+2 to area 1+2+3+4+5, a gain of area 3+4+5.
  • 12. Page 206 Firm Level Effects of Loan Rates The individual firm under free market conditions will produce quantity q F if it expected the free market price P F , and earn profit equal to area 1.
  • 13. Page 206 Firm Level Effects of Loan Rates The increase in CCC acquired stocks pulling the price up to P G will cause participating farmers to increase its production from quantity q F to q G , increasing its profits by area 2.
  • 14. The Set-Aside Approach to Supporting Farm Prices and Income
  • 15. Page 207 Market Level Effects of Set-Aside Requirements Free market equilibrium occurs at point E 1 . Let’s assume that P F is below a politically acceptable price, and that the price desired by policymakers again is P G .
  • 16. Page 207 Market Level Effects of Set-Aside Requirements Shifting the market supply curve from S MKT to S MKT * through set-aside require- ments reduces production from Q F to Q G . The market equilibrium moves from E 1 to E 2 .
  • 17. Page 207 Market Level Effects of Set-Aside Requirements Consumer surplus would fall from area 4+5+6+7 to just area 7. Thus, consumers are worse-off economically. Producer surplus would increase from area 1+2+3 to area 1+6. As long as area 6 is greater that area 2+3, producers are better-off.
  • 18. Page 207 Market Level Effects of Set-Aside Requirements Importantly, the set-aside approach does not encourage production of quantity Q S as the CCC loan rate approach did.
  • 19. P F P G S FIRM * S FIRM q G q F q S Firm Level Effects of Set-Aside Requirements 1 2 3 4 Page 208 Producer surplus Before policy = 1+2+3 After policy = 1+4 Gain = 4 – 2 – 3
  • 20. Page 209 Deficiency Payment Mechanism The deficiency payment was equal to quantity Q M multiplied by the difference between the announced target price and either the loan rate or market price (blue shaded area above), which ever was higher .
  • 21. Recent Approaches to Supporting Farm Prices and Income
  • 22. 1996-2002 Policy
    • The FAIR Act signed into law in 1996 eliminated many of these mechanisms.
    • The loan rate mechanism remained, but the set-aside and deficiency mechanisms were deleted .
    • 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
  • 23. 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
  • 24. Countercyclical Payments D S LR PF TP 1 2 3 4 Q Payment acres cannot exceed planted acres. The maximum countercyclical payment here is equal to areas 3+4 Page 210
  • 25. Importance of Government Payments at Sector
  • 26. Importance of Government Payments To Net Farm Income Page 212
  • 27. Importance of Government Payments To Net Farm Income Page 212 Pre FAIR Act FAIR Act
  • 28. Importance of Government Payments To Net Farm Income Page 212 Pre FAIR Act FAIR Act Lowered safety net under FAIR Act…
  • 29. Importance of Government Payments To Net Farm Income Page 212 Pre FAIR Act FAIR Act Lowered safety net under FAIR Act… 2002 Bill
  • 30. The 2008 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
    Page 211-213
  • 31. Some Demand Side Options
  • 32. Page 213 Domestic Demand Expansion: Value Added Products Let’s assume that the free market conditions result in a price of P F and quantity Q F . Market equilibrium occurs at E 1 .
  • 33. Page 213 Domestic Demand Expansion: Value Added Products Policies designed to promote research that would enhance value added demand for farm products would shift the demand curve out to the right. This would increase price to P G and quantity to Q G .
  • 34. Page 213 Domestic Demand Expansion: Value Added Products Consumer surplus in this market would go from area 2+5 to area 4+5. If area 4 exceeds area 2, consumers are better-off. Producers would be better off by area 2+3 as we move from E 1 to E 2 .
  • 35. Page 215 Export Demand Expansion: Enhancements Let’s assume the original Demand curve is DD, giving us a market clearing price of P DD and corresponding quantity of Q MM at market equilibrium E 1 .
  • 36. Page 215 Export Demand Expansion: Enhancements Consumer surplus would be area 2+5 while producer surplus would be area 1.
  • 37. Page 215 Export Demand Expansion: Enhancements By enhancing export demand through subsidies to client nations, the government can shift the demand curve out to TD beginning at E 0 . Domestic consumer surplus would decline by area 2 but producer surplus would increase by area 2+3. At equilibrium E 2 , foreign consumer surplus would be area 4.
  • 38. Summary
    • USDA has tried to support prices and incomes by acquiring/storing excess supply at desired support 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 the safety net with counter-cyclical payments.
    • Demand side approaches designed to promote domestic and/or export demand .
  • 39. Chapter 12 focuses on general economic conditions ….