Supply) Relative To Fixed Inelastic Demand Curves Produce Large Changes in Equilibrium

Chapter 19 - Agriculture: Economics and Policy
Chapter 19 Agriculture: Economics and Policy
QUESTIONS
1. Carefully evaluate: “The supply and demand for agricultural products are such that small
changes in agricultural supply result in drastic changes in prices. However, large changes in
agricultural prices have modest effects on agricultural output.” (Hint: A brief review of the
distinction between supply and quantity supplied may be helpful.) Do exports increase or reduce
the instability of demand for farm products? Explain. LO1
Answer: First sentence: Shifts in the supply curve of agricultural goods (changes in
supply) relative to fixed inelastic demand curves produce large changes in equilibrium
prices. Second sentence: But these drastic changes in prices produce only small changes
in equilibrium outputs (where quantities demanded equals quantities supplied) because
demands are inelastic.
Because exports are volatile from one year to the next, they increase the instability of
demand for farm products.
2. What relationship, if any, can you detect between the facts that farmers’ fixed costs of
production are large and the supply of most agricultural products is generally inelastic? Be
specific in your answer. LO1
Answer: Because fixed costs are a significant portion of total costs, average variable
costs for agricultural producers will tend to be small, and shut-down points will occur
only at relatively low prices. As long as prevailing prices exceed these levels, farmers
will produce close to capacity to recoup as much of their fixed costs as possible.
3. Explain how each of the following contributes to the farm problem: LO1, LO2
a. The inelasticity of demand for farm products.
b. The rapid technological progress in farming.
c. The modest long‐run growth in demand for farm commodities.
d. The volatility of export demand.
Answer: (a) Because the demand for most farm products is inelastic, the frequent
fluctuations in supply brought about by weather and other factors have relatively small
effects on quantity demanded, but large effects on equilibrium prices of farm products.
Farmers’ sales revenues and incomes therefore are unstable. (b) Technological
innovations have decreased production costs, increased long-run supply for most
agricultural goods, and reduced the prices of farm output. These declines in prices have
put a downward pressure on farm income. (c) The modest long-run growth in the
demand for farm products has not been sufficient to offset the expansion of supply,
resulting in stagnant farm income. (d) Foreign demand has been unpredictable. Any
change in demand will affect farm prices but farmers cannot easily adjust production.
4. The key to efficient resource allocation is shifting resources from low-productivity to high‐
productivity uses. In view of the high and expanding physical productivity of agricultural
resources, explain why many economists want to divert additional resources away from farming
in order to achieve allocative efficiency. LO2
19-1
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Answer: Economic efficiency is only partly a matter of high productivity or low

marginal costs. Allocative efficiency depends on the requirement that the marginal
benefit to society of producing another unit of a particular good exceeds the marginal
cost. Even though total benefits to society from the production of most agricultural
goods are high, low marginal costs are matched by low marginal benefits. In the case of
agricultural markets subject to support prices, marginal costs at prevailing production
levels exceed marginal benefits as measured by free market prices. This is the reason
many economists contend resources should be moved out of these sectors.
5. Explain and evaluate: “Industry complains of the higher taxes it must pay to finance subsidies
to agriculture. Yet the trend of agricultural prices has been downward while industrial prices have
been moving upward, suggesting that on balance agriculture is actually subsidizing industry.”
LO3
Answer: According to this statement, one can distinguish transfers of income by using
the concept of price parity. Since the parity ratio for farmers has declined they have
necessarily been subsidizing industry. Changes in relative prices cannot be used to make
these sorts of statements. Agricultural prices have declined relative to industrial prices
largely because of decreases in costs in agriculture. Subsidies to agriculture have also
increased the supply of many agricultural products. Lower agricultural prices are
therefore partially the result of subsidies from industry to agriculture.
6. “Because consumers as a group must ultimately pay the total income received by farmers, it
makes no real difference whether the income is paid through free farm markets or through price
supports supplemented by subsidies financed out of tax revenue.” Do you agree? LO3
Answer: This argument is fallacious for two reasons. First, not all consumers of a
particular good are taxpayers or vice versa. Taxpayers are forced to fund price-support
programs for agricultural goods (e.g., peanuts or sugar) whether or not they choose to
consume these particular items. Second, and more important, price-support programs do
not allow us to subsidize through taxation what we would otherwise be spending at the
checkout counter since these programs increase both prices and taxes as well as taking
resources away from more efficient domestic uses, lessening the rate of exodus from
farming and distorting world agricultural markets.
7. If in a given year the indexes of prices received and paid by farmers were 120 and 165,
respectively, what would the parity ratio be? Explain the meaning of that ratio. LO3
Answer: Prices received by farmers would have increased by 20 percent since the base
year (1910) whereas price paid by farmers would have increased by 65 percent during the
same time period.
Parity ratio = prices received by farmers/prices paid by farmers = 120/165 = 73 percent
In this year, a unit of farm output can buy only 73 percent of other goods relative the base
year.
19-2
whole or part.
8. Explain the economic effects of price supports. Explicitly include environmental and global
impacts in your answer. On what grounds do economists contend that price supports cause a
misallocation of resources? LO3
Answer: Price supports benefit farmers, harm consumers, impose costs on society, and
contribute to problems in world agriculture. Farmers benefit because the prices they
receive and the output they produce both increase, expanding their gross incomes.
Consumers lose because the prices they pay for farm products rise and quantities
purchased decline. Society as a whole bears several costs. Surpluses of farm products
will have to be bought and stored, leading to a greater burden on taxpayers. Domestic
economic efficiency is lessened as the artificially high prices of farm products lead to an
overallocation of resources to agriculture. The environment suffers: the greater use of
pesticides and fertilizers contributes to water pollution; farm policies discourage crop
rotation; and price supports encourage farming of environmentally sensitive land. The
efficient use of world resources is also distorted because of the import tariffs or quotas
that such programs often require. Finally, domestic overproduction leads to supply
increases in international markets, decreasing prices and causing a decline in the gross
incomes of foreign producers.
9. Use supply and demand curves to depict equilibrium price and output in a competitive market
for some farm product. Then show how an above‐equilibrium price floor (price support) would
cause a surplus in this market. Demonstrate in your graph how government could reduce the
surplus through a policy that (a) changes supply or (b) changes demand. Identify each of the
following actual government policies as primarily affecting the supply of or the demand for a
particular farm product: acreage allotments; the food‐stamp program; the Food for Peace
program; a government buyout of dairy herds; export promotion. LO3
Answer:
Average allotments: decrease supply

Food stamp program: increase demand
Food-for-Peace: increase demand
Government buyout of dairy herds: decrease in supply
Export promotion: increase in demand
19-3
whole or part.
10. Do you agree with each of the following statements? Explain why or why not. LO3, LO4
a. The problem with U.S. agriculture is that there are too many farmers. That is not the fault of
farmers but the fault of government programs.
b. The Federal government ought to buy up all U.S. farm surpluses and give them away to
developing nations.
c. All industries would like government price supports if they could get them; agriculture has
obtained price supports only because of its strong political clout.
Answer:
(a) Yes, historically the problem has been one of too many farmers, and public policy
has been oriented toward supporting farm prices and incomes rather than fixing the
resource allocation problem. Further, price and income supports have kept people in
agriculture that otherwise would have moved to nonfarm occupations.
(b) No, this is not the best way for the U.S. to provide foreign aid. This policy would
contribute to the misallocation of resources in the U.S. and prevent a more efficient
solution. Farmers elsewhere in the world who might have a comparative advantage
over American farms would be harmed, perhaps forcing them to leave the industry.
(c) While strong political clout has played a role in the price supports given to farmers,
there were other more important factors. Government has subsidized American
agriculture since the 1930s. Agricultural prices and incomes are more volatile than in
most other industries. Small changes in farm output translate into a relatively large
change in price because the demand for these products is price inelastic. In the
absence of government intervention, agricultural markets are highly competitive and
farmers have no control over the price they receive for their goods. However,
farmers must buy their supplies and capital equipment in markets where producers
have a high degree of control over price. This disparity and disadvantage along with
a variety of other arguments has been used to justify farm subsidies over the years.
Likewise, government support programs come with government intervention into
management decisions by farmers.
11. What are the effects of farm subsidies such as those of the United States and the
European Union on (a) domestic ‐agricultural prices, (b) world agricultural prices, and (c) the
international allocation of agricultural resources? LO3
Answer: Domestic agricultural prices are obviously higher than they would be in the
absence of subsidies. The reason for the subsidies in the first place is that market
equilibrium prices were lower than farmers believed they should be. Without subsidies
farm product prices would initially fall to the lower equilibrium price. It is also argued
that subsidies protect inefficient farmers, and without such programs only the efficient,
low-cost producers would remain. To the extent that this is true, farm prices would
remain lower than the current support prices that exist for many products.
The situation on world markets is somewhat more complex because the European Union
(EU) subsidizes its exports of agricultural products on world markets. Thus, the supply
of these products is greater than it would be under competitive market conditions, and the
world prices of many products are depressed.
19-4
whole or part.
There is an international misallocation of agricultural resources. Wherever there is a

farm subsidy program without programs restricting supply, there will be an expansion of
production in response to the above-market price supported. Without such restrictions,
continuing farm subsidies would mean that more than the efficient amount of resources is
devoted to production of subsidized products. The over-allocation occurs both within
and among countries. Farmers in countries that might more efficiently import
agricultural products and use these resources more productively in other pursuits are
encouraged to remain in agriculture as long as their governments subsidize this type of
production. Meanwhile, farmers in countries without farm programs face artificially
depressed world market prices and find it is not profitable to raise farm products for
export. In a free-market world, they might be more efficient producers than their
subsidized neighbors.
12. Use public choice theory to explain the persistence of farm subsidies in the face of major
criticisms of those subsidies. If the special‐interest effect is so strong, what factors made it
possible in 1996 for the government to end price supports and acreage allotments for several
crops? LO4
Answer: Rent-seeking behavior occurs when a group (a labor union, a firm in a specific
industry or farmers producing a particular crop) uses political means to transfer income
or wealth to itself at the expense of another group or society as a whole. The
special-interest effect involves a program or policy that benefits a small group greatly,
while a much larger group individually suffers relatively small losses. Farmers have been
relatively successful in both rent-seeking and special interest legislation. A combination
of factors has led to a change in the politics of farm subsidies. As the farm population
has declined, agriculture’s political power has also diminished. Also, more farmers have
become resentful of government intrusion into their decision-making.
13. What was the major intent of the Freedom to Farm Act of 1996? Do you agree with the
intent? Why or why not? Did the law succeed in reducing overall farm subsidies? Why or why
not? LO5
Answer: The intent of the Freedom to Farm Act of 1996 was to allow markets, not
government programs, to determine what products farmers grow, where they are grown,
and their total outputs. To ease the transition away from farm subsidies, farmers were to
receive guaranteed, but declining, annual “transition payments” through 2002.
Most economists agree that market allocation of resources is more efficient than the use
of government programs. The overall output of agricultural products is likely to increase
although prices are likely to be more volatile. This will increase the risk to farmers, but
will benefit consumers and tax payers.
During 1998 and 1999, agricultural prices were low and farm incomes fell. Farmers, who
had gotten used to financial help from the government-support programs, realized that
there was a downside to allowing the market to determine prices and, therefore, farm
incomes.
Emergency aid payments caused farm subsidies to average $20 billion annually for 1999-
2002, more than before the Freedom to Farm Act was passed.
19-5
whole or part.
14. Distinguish the major features of direct subsidies, countercyclical payments, and marketing
loan subsidies under the Food, Conservation, and Energy Act of 2008. In what way do
countercyclical payments and marketing loans help reduce the volatility of farm income? In what
way do direct subsidies perpetuate the long‐run farm problem of too many resources in
agriculture? LO5
Answer: Direct subsidies guarantee a specific cash payment regardless of current prices
or production levels. Countercyclical payments are provided only when crop prices fall
below a target price. Marketing loan subsidies allow farmers to repay loans with crops if
the “loan price” is not met.
Direct payments protect against price and output variability; the latter two protect against
price fluctuations. This helps to solve the problem of income instability. The direct
subsidies perpetuate the long-run farm problem by discouraging resources from moving
into other markets where, in the absence of government payments, they would receive
higher incomes.
15. LAST WORD What groups benefit and what groups lose from the U.S. sugar subsidy
program?
Answer: The benefits accrue to the sugar producers in the United States, but the costs are
heavy on U.S. consumers and foreign producers. The estimated cost to U.S. consumers is
about $1 billion per year in terms of higher sugar prices. As a result of import quotas,
foreign sugar imports have declined from 30 percent of our sugar consumption in 1975 to
about 3-4 percent today. Foreign producers in less developed countries have suffered
with export earnings declining as much as $7 billion per year which, in turn, means lower
incomes in these poor countries. Also, the sugar barred from sale in the U.S. contributes
to larger supplies on world markets, depressing the world price for sugar and further
lowering foreign producer incomes. That situation may worsen because the U.S.
subsidies have caused U.S. sugar production to increase to the point where we may
become a sugar exporter and add to the competitive situation abroad. Further losses are
incurred with such a misallocation of the world’s resources and a shift of demand toward
corn-based and artificial sweeteners. This shift has contributed to an estimated 7000 lost
jobs in the last decade in sugar refineries in this country and American candy
manufacturers may add to the losses as they consider moving abroad where sugar is less
expensive.
PROBLEMS
1. Suppose that corn currently costs $4 per bushel and that wheat currently costs $3 per bushel.
Also assume that the price elasticity of corn is .10 while the price elasticity of wheat is .15. For
the following questions about elasticities, simply use the percentage changes that are provided
rather than attempting to calculate those percentage changes yourself using the midpoint formula
given in Chapter 4. LO1
a. If the price of corn fell by 25 percent to $3 per bushel, by what percentage would the quantity
demanded of corn increase? What if the price of corn fell by 50 percent to $2 per bushel?
b. To what value would the price of wheat have to fall in order to induce consumers to increase
their purchases of wheat by 5 percent?
19-6
whole or part.
c. If the government imposes a $.40 per bushel tax on corn so that the price of corn rises by ten
percent to $4.40 per bushel, by what percentage would the quantity demanded of corn decrease?
If the initial quantity demanded is 10 billion bushels per year, by how many bushels would the
quantity demanded decrease in response to this tax?
Answers: (a) 2.5 percentage points, 5 percentage points

(b) The price of wheat would have to fall to $2 per bushel.
(c) The quantity demanded of corn would decrease by 1 percent; the quantity demanded
would decline by 100 million bushels.
Feedback: Consider the following example. Suppose that corn currently costs $4 per
bushel and that wheat currently costs $3 per bushel. Also assume that the price elasticity
of corn is .10 while the price elasticity of wheat is .15.
Part a:
If the price of corn fell by 25 percent to $3 per bushel, by what percentage would the
quantity demanded of corn increase? What if the price of corn fell by 50 percent to $2 per
bushel?
To find the percentage change in the quantity of corn demanded multiply the percentage
change in price by the elasticity. Note that the quantity direction is opposite of the price
movement.
When the price of corn falls by 25%, the percentage increase is quantity demanded equals
25% x 0.10 = 2.5%.
When the price of corn falls by 50%, the percentage increase is quantity demanded equals
50% x 0.10 = 5%.
Part b:
To what value would the price of wheat have to fall in order to induce consumers to
increase their purchases of wheat by 5 percent?
Here we can use the same formula as above (note the negative in front of the price
change. A fall in the price will be recorded as a negative percentage change
algebraically).
%Δ quantity = - %Δ price x elasticity
Rearranging, we have
- %Δ price = %Δ quantity / elasticity
Substituting the values given above, - %Δ price = 5% / 0.15 = -33.33%. Thus, a price
decrease of 33.33% will induce a 5% increase in the quantity of wheat demanded.
Since the original price of wheat was $3.00, a 33.33% decline in the price of wheat
results in a new price of $2.00 (=$3.00 - 0.3333 x $3.00)
19-7
whole or part.
Part c:
If the government imposes a $.40 per bushel tax on corn so that the price of corn rises by
ten percent to $4.40 per bushel, by what percentage would the quantity demanded of corn
decrease? If the initial quantity demanded is 10 billion bushels per year, by how many
bushels would the quantity demanded decrease in response to this tax?
Using the formula discussed in part a, an increase in the price of corn via the tax results
in a 1% decrease in the quantity of corn demanded (= 10% x 0.1).
Given the initial quantity demanded was 10 billion, a 1% decrease in quantity demanded
implies a fall of 100 million bushels demanded after the tax (= 0.01 x 10,000,000,000).
2. Suppose that both wheat and corn have an income elasticity of .1. LO1
a. If the average income in the economy increases by 2 percent each year, by how many
percentage points does the quantity demanded of wheat increase each year, holding all other
factors constant? Holding all other factors constant, if 10 billion bushels are demanded this year,
by how many bushels will the quantity demanded increase next year if incomes rise by 2 percent?
b. Given that average personal income doubles in the United States about every 30 years, by
about how many percentage points does the quantity demanded of corn increase every 30 years,
holding all other factors constant?
Answers: (a) The quantity demanded would increase by .2 percentage points; the quantity
demanded would increase by 20 million bushels (= .2 percentage points times 10 billion).
(b) By about 10 percentage points.
Feedback: Consider the following example. Suppose that both wheat and corn have an
income elasticity of .1.
Part a:
If the average income in the economy increases by 2 percent each year, by how many
percentage points does the quantity demanded of wheat increase each year, holding all
other factors constant? Holding all other factors constant, if 10 billion bushels are
demanded this year, by how many bushels will the quantity demanded increase next year
if incomes rise by 2 percent?
To calculate the percentage change in quantity demanded multiply the percentage change
in income by the income elasticity.
%Δ quantity = %Δ income x income elasticity
The increase in income by 2% per year results in an increase in quantity demanded for
wheat is 0.2% per year (= 2% x 0.10).
Given that 10 billion bushels were demanded last year, the 0.2% increase in demand
results in an increase of 20 million bushels demanded at each price this year.
Part b:
Given that average personal income doubles in the United States about every 30 years, by
about how many percentage points does the quantity demanded of corn increase every 30
years, holding all other factors constant?
19-8
whole or part.
Using the same formula as above, the doubling of income implies a 100% increase in
income every 30 years. This implies the demand for corn will increase by 10% over the
same 30 years (= 100% x 0.1).
3. Suppose that 10 workers were required in 2010 to produce 40,000 bushels of wheat on a 1000‐
acre farm. LO2
a. What is the average output per acre? Per worker?
b. If in 2020 only 8 workers produce 44,000 bushels of wheat on that same 1000‐ acre farm, what
will be the average output per acre? Per worker?
c. By how many percentage points does productivity (output per worker) increase over those ten
years? Over those ten years, what is the average annual percentage increase in productivity?
Answers: (a) Average output per acre will be 40 bushels per acre; average output per
worker will be 4000 bushels per worker.
(b) Average output per acre will be 44 bushels per acre; average output per worker will be
5500 bushels per worker.
(c) Productivity has increased by 37.5 percentage points; the average annual increase in
productivity was 3.75 percent per year.
Feedback: Consider the following example. Suppose that 10 workers were required in
2010 to produce 40,000 bushels of wheat on a 1000‐acre farm.
Part a:
What is the average output per acre? Per worker?
Average output per acre will be 40 bushels per acre (= 40,000 bushels divided by 1000
acres); average output per worker will be 4000 bushels per worker (= 40,000 bushels
divided by 10 workers).
Part b:
If in 2020 only 8 workers produce 44,000 bushels of wheat on that same 1000‐ acre farm,
what will be the average output per acre? Per worker?
Average output per acre will be 44 bushels per acre (= 44,000 bushels divided by 1000
acres); average output per worker will be 5500 bushels per worker (= 44,000 bushels
divided by 8 workers).
19-9
whole or part.
Part c:
By how many percentage points does productivity (output per worker) increase over
those ten years? Over those ten years, what is the average annual percentage increase in
productivity?
Productivity has increased by 37.5 percentage points [= 100 x (5500 - 4000)/4000]; the
average annual increase in productivity was 3.75 percent per year (= 37.5 percentage
points divided by 10).
4. In 2009, it was estimated that the total value of all corn‐production subsidies in the United
States totaled about $4 billion. The population of the United States was approximately 300
million people that year. LO3
a. On average, how much did corn subsides cost per person in the United States in
2009? (Hint: A billion is a 1 followed by nine zeros. A million is a 1 followed by six zeros.)
b. If each person in the United States is only willing to spend $.50 to support efforts to overturn
the corn subsidy, and if anti‐subsidy advocates can only raise funds from 10 percent of the
population, how much money will they be able to raise for their lobbying efforts?
c. If the recipients of corn subsidies donate just one percent of the total amount that they receive
in subsidies, how much could they raise to support lobbying efforts to continue the corn subsidy?
d. By how many dollars does the amount raised by the recipients of the corn subsidy exceed the
amount raised by the opponents of the corn subsidy?
Answers: (a) $13.33 (b) $15 million (c) $40 million (d) $25 million
Feedback: Consider the following example: In 2009, it was estimated that the total
value of all corn‐production subsidies in the United States totaled about $4 billion. The
population of the United States was approximately 300 million people that year.
Part a:
On average, how much did corn subsides cost per person in the United States in
2009?
$13.33 (= $4 billion divided by 300 million)
Part b:
If each person in the United States is only willing to spend $.50 to support efforts to
overturn the corn subsidy, and if anti‐subsidy advocates can only raise funds from 10
percent of the population, how much money will they be able to raise for their lobbying
efforts?
To find the answer to this question we first calculate the number of individuals willing to
fund the anti-subsidy advocates. Since only 10% of 300 million are willing to provide
funding, we have 30 million people providing funding (= 0.10 x 300 million). Each of
these individuals is only willing to provide $0.50. This results in a total funding of $15
million (=$0.50 x 30 million).
19-10
whole or part.
Part c:
If the recipients of corn subsidies donate just one percent of the total amount that they
receive in subsidies, how much could they raise to support lobbying efforts to continue
the corn subsidy?
Since the recipients of corn subsidies receive a total of $4 billion from the government,
1% of this amount is 40 million (= 0.01 x $4 billion).
Part d:
By how many dollars does the amount raised by the recipients of the corn subsidy exceed
the amount raised by the opponents of the corn subsidy?
$25 million (= $40 million - $15 million).
19-11
whole or part.

Supply) Relative To Fixed Inelastic Demand Curves Produce Large Changes in Equilibrium

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Supply) Relative To Fixed Inelastic Demand Curves Produce Large Changes in Equilibrium

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Chapter 19 - Agriculture: Economics and Policy

Chapter 19 Agriculture: Economics and Policy

Answer: Economic efficiency is only partly a matter of high productivity or low

Average allotments: decrease supply

There is an international misallocation of agricultural resources. Wherever there is a

Answers: (a) 2.5 percentage points, 5 percentage points

%Δ quantity = - %Δ price x elasticity

- %Δ price = %Δ quantity / elasticity

%Δ quantity = %Δ income x income elasticity

$13.33 (= $4 billion divided by 300 million)

$25 million (= $40 million - $15 million).

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