Chapter 11: "Government Intervention in Agriculture" Textbook Questions:

1. Using a graph, show how an inelastic demand affects farm revenue (prices) when there is a "bumper crop" (page 203). Explain what is meant by and "inelastic demand". What is a "bumper crop"??
2. What is the "farm problem"? What are the 2 symptoms of the problem and what are the "real roots" of the farm problem.
3. Discuss the following characteristics of agricultural operations:
   1. Lack of Market Power
   2. Interest Sensitivity
   3. Asset Fixity
4. Discuss the following "Forms of Government Intervention":
   1. Adjusting Production to Market Demand
   2. Price and Income Support Payments
   3. Foreign Trade Enhancements
   4. Subsidized Loans and Crop Insurance
5. Using a graph, show how "set-aside" programs affect market supply and farm prices. What is a "set-aside" program and what is its purpose?
6. What is meant by a "Demand Expansion" program? Give several examples. Using a graph, show how demand expansion programs affect farm prices and quantity demanded.
7. List and discuss the 4 "Consumer Issues" related to government intervention in agriculture.
8. Identify and discuss commodities that are typically NOT covered by "Government support programs" such as the set-aside program, CRP or target pricing.

222 CHAPTER ELEVEN GOVERNMENT INTERVENTION IN AGRICULTURE last part of this book will focus on international trade and the role governments play in the global marketplace. The focus in this chapter is on government intervention in the farm sector and in the delivery of a safe and nutritious product to consumers. The rationale typically advanced for government intervention in the agricul- tural sector of an economy is the need to: support and protect an infant industry, curb market powers of imperfect competitors when necessary to promote social good, provide for food security, "provide for consumer health and safety, and "provide for environmental quality. The U.S. food and fiber industry clearly no longer qualifies as an infant industry. The farm sector is characterized by a large number of highly capitalized farming oper- ations that produce crop and livestock products. It comes the closest of any sector in most economies to meeting the conditions we discussed in the first part of the book. Other sectors in the U.S. food and fiber industry, on the other hand, are more closely characterized as imperfect competitors, a small number of firms selling a dif- ferentiated product and a small number of firms buying production from the farm sector. The government, for example, has taken action against what it perceived as imperfect competitive behavior by U.S. breakfast cereal manufacturers. The Federal Trade Commission (FTC), an agency of the federal government, is charged with the responsibility of prohibiting companies from acting in concert to increase their mar- ket control using false and deceptive trade practices. Many nations intervene in their food and fiber industry to ensure an adequate food supply from domestic sources. Sometimes this is done with uncertainties asso- ciated with imported food supplies and prices, and the drain on the country's for- ign exchange reserves. Although the U.S. secretary of agriculture watches stocks of specific commodities when conducting federal commodity programs, food security reasons are rarely cited as a rationale for federal government intervention in the food and fiber industry, Jamie L Whitten Building main entrance, headquarters of the U.S. Department of Agriculture in Washington, DC. Credit Mesut Dogan/Shutterstock. hpGOVERNMENT INTERVENTION IN AGRICULTURE CHAPTER ELEVEN 223 The food and fiber industry is one of the most highly regulated industries in the United States. Regulations that govern the use of inputs to produce crops and livestock, regulations that govern the processing and manufacturing of food and fiber products, and regulations that govern the markets in which these products are traded are just a few examples of how the government controls the food and fiber industry. Government regulations cover everything from the regulation of chemical use in crop production to the inspection of crops and livestock products before they reach the retail grocery store shelves. Finally, we know from Chapter 10 that government agencies are charged with the responsibility of monitoring the use of U.S. resources, including land (soil ero- sion), water (pollution), labor (occupational safety), and air (pollution). Thus, the farm sector and the rest of U.S. food and fiber industry are heavily influenced by government intervention. The purpose of this chapter is to broadly discuss the issues associated with the production of farm products in the United States and related federal programs- FARM ECONOMIC ISSUES Politicians often debate the federal government's practice of making payments to farmers in an effort to support their farm incomes. This debate, which often pits rural politicians with their urban counterparts, has increased in intensity as the farm sector's relative contribution to national output has declined steadily over the post-World War II period. We will examine the nature of the issues involved and introduce the various ways in which the federal government intervenes to alter farm economic conditions. Historical Perspective on the Farm Problem What is the farm problem? Two symptoms typically associated with the farm prob- lem are illustrated in Figure 11-1: (1) output fluctuations from one year to the next due to weather patterns, disease, and technological change, and (2) low net farm incomes. The inelastic nature of the own-price elasticity of demand for agricultural products, the lack of market power by farmers and ranchers, the interest sensitivity of the sector, and the fixity of farm assets and chronic excess capacity represent the Effects of Inelastic De Figure 11-1 This figure illustrates what happens to the total revenue received by farmers facing an inelastic demand for their products if the supply curve were to shift to the right. Total revenue would fall because area OPIE,O, is greater than Quantity per unit of time\f226 / 433 87% to influence the market equilibrium price. Therefore, if Walt Wheaties suffers a sharp decline in wheat yields and does not have crop insurance, his revenue from wheat production will fall markedly, unless a large number of other wheat farmers experi- ence the same decline in yields, and the sector supply curve shifts to the left. Interest Sensitivity The farm sector is one of the most highly capitalized sectors in the U.S. economy. There is more capital invested per worker than for the rest of the busi- ness sectors as a whole. Farmers must borrow substantial amounts of money through short-, intermediate-, and long-term loans to purchase variable and fixed inputs. Thus, an increase in interest rates will increase farmers' interest expenses and, hence, their total production expenses. The high interest rates during a financial crisis in the farm sector in the early 1980s caused interest payments to reach over 20% of total variable production expenses, as compared to approximately 6% over 2008-2012. Higher pro- duction expenses will lower net farm income, all other things constant- In addition to their effects on farm production expenses, higher interest rates in the U.S. economy vis-a-vis the rest of the world raise the value of the dollar in foreign exchange markets. The higher exchange rate between the dollar and other currencies will make it more expensive for other nations to import U.S. farm products. This will lower the demand for U.S. farm products, which will cause farm prices for products such as wheat and corn to drop, lowering farm revenue. Asset Fixity and Excess Capacity Another major problem facing farmers and Asset fixity refers to the ranchers is the notion of asset fixity and excess capacity. Asset fixity refers to the fact that many production difficulty that farmers have in disposing of tractors, plows, and silos when downsiz- assets employed in ing or shutting down the business. These assets have little or no alternative uses and agriculture have little use in often sell for pennies on the dollar during hard times in the sector like the early and other sectors fi.e., a cotton picker). Furthermore, land, mid-1980s. They would have experienced a similar fate in the late 1990s to mid early buildings, and machinery. 2000s were it not for substantial government subsidies. Excess capacity refers to the all of which are fixed assets fact that the sector often produces more than it can sell domestically, leading to ris- and have little liquidity ing stocks of surplus storable commodities if export demand is weak. Technological value, dominate farm change, which shifts the sector's supply curve to the right, can lead to excess capacity. balance sheets. The combination of excess capacity and asset fixity can lead to a decline in farm asset values in times of market surplus. Forms of Government Intervention Government intervention in agriculture, required to improve farm economic and environmental conditions, has taken many forms. Chapter 10 covered the role of government in resources and the environment. We will discuss four additional forms in this chapter. Adjusting Production to Market Demand One approach to improving farm eco- nomic conditions is to reduce the number of resources employed to produce a prod- act plagued by surplus conditions. This is achieved by the government's renting whole farms or by paying farmers not to produce the product by requiring them to set aside part of the land normally used to plant this crop in order to qualify for farm program benefits. With less land planted to this crop, supply will decline and market prices will rise, If the demand curve is inelastic, farm revenue will increase. Consider the opposite of the bumper crop case illustrated in Figure 11-1. Assume the original supply curve was $2 and that policies that restrict resource use shift the supply curve back to S . Market equilibrium will now occur at E instead of . Because prices rise by a greater percentage (from Pa to Pi) than quantity declines from Q, to Q,), total revenue represented by area OPIE Q, will be greater than the total revenue represented by area OP2 Ez Q2.226 CHAPTER ELEVEN GOVERNMENT INTERVENTION IN AGRICULTURE Price and Income Support Payments|Another general approach by government to improve farm economic conditions is to directly support farm prices and incomes, which can be achieved by establishing a price floor supported through government purchases of surplus commodities. If the level of production rises during the year, the government can step in and buy (and store) excess supply at the announced price floor. This would prevent farm revenue from falling below minimum desired lev- els. An alternative approach is to support farm incomes through direct transfer pay ments from the government to farmers. The FAIR Act, passed in 1996, for example called for a number of efforts to help producers manage their exposure to risk. This included the establishment of the Risk Management Agency within the USDA and the implementation of pilot programs designed to provide revenue insurance. Thus, the nature of programs employed in the past to support pricing and/or income has taken several different forms. Since most payments under the 1996 FAIR Act were fixed, farm income could fluctuate more from one year to the next as market condi- ions change. In response to the low commodity prices in the late 1990s, Congress passed a new farm bill in 2002 that returned a safety net concept to supporting farm prices and incomes. The 2008 Farm Bill continued this practice. The impact of the growth in demand for renewable fuels is discussed in the section titled Domestic Demand Expansion Programs. The 2012 bill approved by the U.S. Senate intro- duced a major shift in farm policy if adopted. These programs will be discussed in more detail later in this chapter. Foreign Trade Enhancements A third approach to improving farm economic con- ditions involves the link between agriculture and foreign markets. There are essen- tially two general ways in which such enhancements can improve farm economic conditions in the United States. First, the government can institute tariffs, or a tax on imports, which make imported agricultural products more expensive to domestic consumers, or institute quotas, which limit the quantity of a particular good that can be imported. Both actions protect producers in the domestic agricultural sector. Quality restrictions on imports that grade imports or specify their sanitary conditions (pesticide and other chemical residues) can also effectively prohibit imports. These actions have the effect of limiting the supply coming into the market and raising the farm revenues of domestic producers. For example, a higher quota would shift the supply curve to the left and thus, like production controls, have the opposite effect of the bumper crop example illustrated in Figure 11-1. Prices will increase by a greater percentage (from P2 to P ) than will the decline in quantity (from Q, to Q,), and farm revenue will increase from area Of2520, to area OPE Q,- Second, the government can enhance the attractiveness of U.S.-produced agri- cultural products in foreign markets by subsidizing their purchase, thereby stimulat- ing the export demand for U.S. agricultural products. Export credits help potential buyers finance the purchase of U.S. agricultural products. Subsidies are grants given by the government to private businesses to assist enterprises deemed advantageous to the public. Commodity assistance programs, such as PL. 480, promote exports under direct food aid or subsidized concessionary sales. These actions have the effect of shifting the demand curve to the right, and they increase farm revenue129 those individuals deemed by local health officials to be at nutritional risk due to their inadequate income and existing nutrition. Participants are given a voucher redeem- able for specified foods at participating retail food stores. There are other programs that also provide food assistance to eligible individuals and households. HISTORICAL SUPPORT MECHANISMS We made the point earlier in this chapter that the low own price of elasticity of demand for farm products, coupled with an increase in supply, can cause farm rev- enue to fall sharply. The historical problem of low returns to resources in agricul- cure has been dealt with in different ways over time by the federal government. The approach taken has depended in part on the nature of the conditions that existed at the time. The federal government has been involved in altering free market condi- tions in agriculture for almost 80 years. The roots of the price and income support mechanisms discussed in this section can be traced back to the federal legislation enacted in the 1930s and 1940s. There are many excellent summaries of the history of federal government programs for agriculture." Instead of reviewing the labyrinth of farm programs for the last 60 years, we will focus on four key features of more recent farm programs: (1) loan rate mechanism, (2) set-aside mechanism, (3) target price mechanism, and (4) conservation reserve mechanism. Loan Rate Mechanism The U.S. Department of Agriculture has used the commodity loan rate mechanism since the early 1930s to support prices for commodities such as wheat, corn, and cot- ton. The loan rate essentially serves as a floor to farm prices for participating farmers. Loan rate The loan rate Market Level Effects To see how this mechanism works at the sector or market mechanism has long been a level, look at the market demand and supply curves for wheat in Figure 11-3. If com- means of providing a price petitive market forces were free to work, the market clearing price would be P, and floor for selected program commodities like com and the quantity marketed would be Qp. Assume that the federal government wished to wheat. Market-Level Effects of Loan Rates Figure 11-3 To achieve support prices of D+COOKa Po, the federal government would purchase the Exces SUKI surplus or excess supply supply Welfare effects marketed by farmers at the announced support price Producer surplus level. Farmers would be in a Before policy - 1 + 2 better position economically After policy = 1 + 2 + 3 + 4 + 5 by the amount that area 4 Gain = 3 - 4 - 5 exceeds area 2. Consumers Consumer surplus would be in a worse position economically by the sum of Before policy - 3 + 4 + 6 areas 3 and 4. They would After policy = 6 be paying a higher price (Pa) Loss - 3 + 4 and consuming less (O_). Qa For example, see Knutson. Penn, Flinchbaugh, and Outlaw (2006). hp\fThe government spent more than $1 million a day for storage costs. These charges eventually reached several million dollars a day, which was big money at that time. In addition, because price supports aid farmers in direct proportion to their level of production, the owners of large farming operations receive the bulk of the program's benefits. The value of expected future benefits from the loan rate mecha- nism is capitalized into the market value of farmland, resulting in an additional ben- efit to large landowners. Set-Aside Mechanism To combat the growing size and cost of government-held stocks, federal government Set-asides The set- policymakers adopted set-aside requirements in the Food, Agriculture, Conserva- aside mechanism required tion, and Trade (FACT) Act of 1990 to support farm prices. The set-aside mechanism participating farmers to constrains the annual production levels of any single crop and thus avoids accumulate idle a fraction of their farm land in exchange for ing larger surplus stocks, which depress farm prices. Set-aside requirements call for government subsidies. farmers to remove a certain percentage of cropland from production as a condition While this lowered the for receiving farm program benefits. Set-aside requirements were used for most major quantity coming onto the food and feed grains as a means of reducing production of surplus crops such as corn market, it became extremely and wheat. A major problem with the set-aside mechanism is that farmers will idle unpopular with farmers as their poorest land first and crop their remaining acres more intensively, which can well as input suppliers. result in slippage or larger supply and lower prices than desired by policymakers.? The Acreage Reduction Program (ARP) percentages spelling out these set- The ARP rates were the aside requirements were determined in part by the expected ratio of ending stocks percentage of land that to total use. There were individual ARP percentages set for corn, wheat, cotton, and had to be idled to receive other specific commodities that often varied dramatically from one year to the next subsidies under the set- depending upon demand and supply factors. The 1996 FAIR Act eliminated the aside policy mechanism. authority for this program, taking the USDA out of the commodity-level supply management game. Market Level Effects To illustrate how set-aside requirements work, study Figure 11-5. 5Mir represents the market supply curve for a commodity before acre- age restrictions are implemented. The market would have cleared at equilibrium Ey where price equaled Pr and quantity equaled Qp. Assume that the government wants to support prices above Ry. At price Pe, the quantity demanded would be equal to Qc, and the quantity supplied would be Qs if farmers were free to produce all they desired. We know from the previous discussion of the commodity acquisition approach that this would have resulted in additional surpluses equal to Qs - Qc. The CCC, in the absence of set-aside requirements, would have had to accumulate these additional stocks if it wished to maintain the market price at Po- Firm-Level Effects The provision for set-aside requirements in the 1990 FACT Act and earlier legislation restricted the amount of land the participating farmer can plant to a particular crop. This would result in a new firm-level supply curve SFIRM for this crop that lies to the left of its original supply curve (its true marginal cost curve), as we see in Figure 11-6. The individual farmer operating under the set aside mecha- aisms would produce go, where the backward-bent firm supply curve for this crop equals marginal revenue (PG). This quantity is less than the quantity produced under free market conditions g, and the quantity produced under the commodity acquisi- tion approach (45). Other production control mechanisms used ither currently or since the end of World War II include acreage alloc ments, marketing quotas, land retirement programs, and paid land diversion programs. Farm programs calling for acreage allotments continue today for peanuts and tobacco. Marketing quotas have traditionally been implemented only if two thirds of the farmers approve them in a referendum. The Soil Bank Program utilized in the 1950s led to whole farms being retired from production, even raximately 30 million acres. hp