Tuesday, December 10, 2013

Corn farmers are challenging the underlying theory of the market they operate in. Don't they understand basic microeconomics?

Well, yes, the average framer probably does and likely much more than even the best micro-economist.

Some farmers have provided a nice, real life scenario that gives me an opportunity to illustrate a basic economics concept: Supply and Demand.

The Wall Street Journal has a article on a how one of the determinants that shift a market supply curve, "Producer Expectations", is playing out down on the farm.

Farmers Hoard Corn as Prices Drop
"...Faced with the lowest corn prices in more than three years, many U.S. farmers are stashing away their grain in a bet on a rebound. 
The strategy is sending ripples through the corn belt—affecting everyone from grain buyers to storage-bin makers—and tempering the price declines in the $27 billion corn-futures market. 
By hoarding freshly harvested supplies, farmers are forcing livestock producers, ethanol companies and food makers to pay a premium over futures in some areas to secure corn, helping to buoy prices during what is expected to be a record U.S. harvest, traders and analysts say..." Wall Street Journal
 Let's go to the graphs!!

Here is the Market for Corn at some equilibrium at Pe and Qe-- Point "A"

 As the article suggests, farmers are with-holding corn and storing it in the belief that they will be able to receive a higher market price some time in the near future.  So, at the current market equilibrium price of "Pe" the Quantity Supplied of Corn is going to be LESS than it was before.  Assume this is at "Qs1" or Point "B".  The market now is in disequilibrium.

 What is true at "Pe" and "Qs1" is also going to be true at every other Price and Quantity Supplied combination along Supply Curve "Supply*".  This will shift the market supply curve to the LEFT, indicating a DECREASE in SUPPLY.

With the decrease in supply the market price is going to increase. When the market price increases then the Quantity Supplied increases (Law of Supply)  and the market moves ALONG the new Supply curve from Point "B" to Point "C". The Quantity Demanded decreases (Law of Demand) and the market moves along the same Demand curve from Point "A" to Point "C".  The market will reach a new equilibrium at the higher price of "P1" and a lower market quantity of "Q1" at Point "C".

For farmers to accomplish this for any extended period of time it will require massive cooperation because farmers, for the most part, operate in what is term a "Perfectly Competitive Market". This means that there are MANY individual producers producing an identical product and they have very little pricing power over what they can sell their corn for.

Good Luck to them!!

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