Friday, June 13, 2014

Perfect Competition, Price Floors, VC's, FC's, Opportunity Costs, Farm Policy---this blog entry has it ALL!

I am going to attempt a layman's (VERY layman!) view of how farm policy, in terms of Price Floors, works in the US. I am using actual US Dept of Agriculture data to do my calculations.

Not claiming it is perfect and I am SURE I am leaving out some (a lot?) of details, but I think for the AP Microeconomics Unit on Perfectly Competitive firms AND Price Floors it will be instructional.  Any constructive criticisms are welcome.

First, here are the projected cost data (2014-15 growing season) for a typical farm growing either Corn, Soybeans or Wheat.

The costs are very conveniently divided up into "Variable Costs" (Operating Costs) and "Fixed Costs" (Allocated Overhead).

What make this a bonus for Economics teachers is the Fixed Costs include explicit money costs ("hired labor, taxes and insurance, general farm overhead") AND implicit "opportunity costs".  The opportunity costs are "Unpaid Labor, Rental Rate of Land and Capital".

This distinction will be important at the end of this lesson.

Source: USDA ERS
The USDA projects yields for each of these crops to be (in 2013-14):

   Corn: 165 bushels per acre.
   Soybean: 43 bushels per acre.
   Wheat: 47 bushels per acre.

If we divide these projected bushels per acre into the "TOTAL ALLOCATED COSTS" (Variable PLUS Fixed and Opportunity Costs) for each commodity we will arrive at a "Cost per Bushel" for growing each of these crops:

    Corn: $4.18
    Soybean: 11.10
    Wheat: $6.78

If we divide the projected bushels per acre into just the "TOTAL OPERATING COSTS", or ONLY the Variable Costs then the cost per bushel would be:

Corn: $2.19
Soybean: $4.27
Wheat: $2.77

The latest Farm Bill (2014), which dictates US farm policy through 2018, set Price Floors (called "Reference Prices") for these commodities at:

Corn: $3.70
Soybean: $8.40
Wheat: $5.50

The means that if the actual market price in any given year falls BELOW these floor/reference prices then the Federal government will compensate farmers for the difference between what they sell their crop for at market and the above reference price. In other words, the reference prices you see above are the guaranteed minimum per bushel the farmer will receive for their crop.  If the market price is ABOVE the reference price then the farmer receives that price and the reference price is "non-binding".

IMPORTANT POINT:  Notice how these Price Floor/Reference prices fall IN BETWEEN the two versions of costs I calculated above.

The Floor/Reference Price is higher than the farmers Variable Costs BUT lower than his/her TOTAL ECONOMIC COSTS.

So, the price floor guarantee helps the farmer cover ALL Variable Costs and some of their Fixed Costs, but not ALL of the Opportunity Costs of being a farmer.

Anyways, I think this is interesting and I have never seen it broken down like this before.

Makes me understand farm policy and the plight of the farmer a little bit better.

Again, any comments, corrections or guidance as to where I went wrong are welcome.

We are all fellow travelers on the road to knowledge.

NOTE: This particular aspect of the Farm Bill is called "Price Loss Coverage (PLC)".  There are other important programs that complement/substitute for the one I described above.  More on the PLC and these other programs can be found HERE.
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