Characteristics of the Farming Industry
The farming industry in the United States and other industrialized countries is very competitive. It is an example of an industry that is nearly purely competitive.
Characteristics of the farming industry include the following:
1. There are many farmers.
2. There are relatively low barriers to enter the farming industry.
3. Farmers competing in the same market sell identical or nearly identical products.
4. Buyers of agricultural products have significant information about the product.
Farm Production and Elasticity
We have observed the following about production in the farming industry:
1. Productivity has increased considerably.
2. Demand for farm products is income inelastic.
3. Demand for farm products is price inelastic.
Productivity has increased considerably because of tremendous advances in technology, automation, fertilizer techniques, and genetic engineering.
Due to these the advances, the supply curves of farm products, such as wheat, grain, oats, peanuts, meat, fruits, and dairy products, have experienced significant shifts to the right (see graph below). The demand for food has increased, also, but not as much. This is because income elasticity of demand is relatively low.
People’s incomes have increased considerably during the past century. However, there is a limit to how much most people can and want to eat. Therefore, the demand has increased only a fraction of how much supply has increased. Some people have shifted to more-expensive types of food. But the total demand for all food products has not increased very much. The result is that the equilibrium price has decreased, and the equilibrium quantity has increased.
As a percentage, the price has decreased more than the quantity has increased. This is because the price elasticity of demand for food is also inelastic. If, for example, food prices decrease by 100%, people may only consume 30% more food (for the same reason that income elasticity of demand is low).
In the graph above, farmers’ revenue at the old price and quantity of $5 and 900 products, respectively (the intersection of D1 and S1), is $5 times 900, or $4,500. At the new price of $3 and the new quantity of 1200 (the intersection of D2 and S2), revenue is $3 times 1,200, or $3,600. Revenue has decreased. Decreases in revenue have caused many farmers financial hardship, and a significant number of farmers in industrialized countries have been forced to exit the industry.
Government Farm Programs
Governments have attempted to stem the outflow of farm businesses by financially supporting farmers. The following programs were started in the 1930s:
1. Price Supports
2. Acreage Restrictions
3. Target Prices
4. Direct Subsidies and Loan Programs
5. Foreign Import Restrictions
Price supports are price floors (minimum prices) established by a government in order to increase revenue of suppliers. In the graph below, let’s say that the free market equilibrium price of wheat is $3, and the free market equilibrium quantity is 1,200. As part of the price support program, the government requires farmers to sell their product for a price of a minimum of $5 (the price floor). The higher-than-equilibrium price increases the quantity supplied to 1,500, but decreases the quantity demanded to 1,000. Therefore, a surplus results in the amount of 500 (1,500 minus 1,000) products. Farmers’ revenue increases from $3,600 ($3 times 1,200) to $7,500 ($5 times 1,500). The government promises to purchase the surplus of 500 products, which it stores and sells later, donates to poor countries or poor groups in our population, or simply throws away. The advantage of this program is that farmers benefit financially. The disadvantages are that food prices increase, and taxes increase because of government expenses related to the purchasing and storing of the surplus.
For a video explanation of government price supports, please watch:
Acreage restrictions encourage farmers to decrease their production. Farmers agree to not use a certain number of acres of their previously farmed land. In return, the government pays farmers a certain amount for each idle acre. In the graph below, supply decreases from S1 to S2. Equilibrium price increases from $3 to $6, and equilibrium quantity decreases from 1,200 to 1,000. This increases farmers’ revenue from $3,600 ($3 times 1,200) to $6,000 ($6 times 1,000).
The advantage of this program is that farmers benefit financially. The disadvantage is that food prices and taxes increase. A further problem with this program is that when farmers are encouraged to leave a number of acres of their land idle, they leave their least-productive land idle. The land they do cultivate, they use more efficiently (for example, by applying more fertilizers). The overall effect is that supply doesn’t decrease much at all, and, therefore, the equilibrium price doesn’t increase much. Thus, in practice, acreage restriction programs are merely direct subsidy programs in disguise.
For a video explanation of government acreage restrictions, please watch:
Target prices are similar to price supports. The government promises farmers a higher price compared to the free market equilibrium price. The difference is that farmers are encouraged to sell all of their production, so that there is no surplus. In the graph below, the free market equilibrium price is $3. The target price is $4.50. At this price, farmers produce 1,500 products. In order to sell 1,500 products, however, farmers need to lower the price to $1.50. At this price, consumers are willing to purchase all 1,500 products. The government promises to make up the difference in the two prices: $4.50 minus $1.50, or $3. This is called the deficiency payment. The advantage of this program is that it benefits farmers financially. Furthermore, consumer prices decrease. The disadvantage is that taxes increase considerably due to the sizeable deficiency payments.
For a video explanation of government deficiency payments (target prices), please watch:
Direct Subsidies, Loan Programs, and Import Restrictions
Direct subsidies are direct payments by the government to farmers. Financial assistance frequently takes the form of guaranteed loans. Direct subsidies and loan programs help farmers financially, but raise taxes.
Import restrictions are usually import tariffs (import taxes) or quotas (limitations on the amount) on foreign farm products. Import restrictions help domestic farmers, but raise consumer prices, and reduce economic efficiency.
In the United States, the Federal Agricultural Improvements and Reform (FAIR) Act of 1996 eliminated acreage restrictions and target prices. Assistance to farmers shifted to direct subsidies, loan guarantees, and import restrictions.
The Farm Security Act of 2002 replaced the FAIR Act of 1996. Direct subsidies and loans increased, and some programs included a combination of price supports and acreage restrictions. The yearly cost to the United States government (and its tax payers) is estimated at over $20 billion per year. One of the main criticisms of today’s farm programs is that most of the financial assistance goes to large, relatively well-off farmers.