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 • Kick It Up a Notch
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.
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.
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.
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.”
Farm Markets Without Subsidies • Value to the Consumer: • 0ACQ* • Consumers Pay Producers: • 0P*CQ* • The Variable Cost to Producers: • 0HCQ* • Consumer Surplus: • P*AC • Producer Surplus: • HP*C P A S P* C H D 0 Q* Q/t
B Pfloor Price Floor G QD Price Floors • Value to the Consumer: • 0ABQD • Consumers Pay • Producers: • 0PfloorBQD • The Variable Cost to • Producers: • 0HGQD • Consumer Surplus: • PfloorAB • Producer Surplus: • HPfloorBG • DWL • BCG P S A P* C H D 0 Q* Q/t
Government Purchase of Excess Goods • 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 P S A B E Pfloor Price Floor I P* C G H F J D 0 Q* QS Q/t QD
Government Lowers the Price to Consumers • 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 P S A B E Pfloor Price Floor I P* C G H F J D Q/t Q* QS QD 0
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.
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).
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”.)
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.