Agricultural Price Supports

Most of the time, you can walk into your local grocery store and can grab most of the products on your grocery list without thinking. It can be easy to forget that someone somewhere had to wake up early to plant and harvest the wheat that goes into our bread, cereal, and crackers. There is a dairy farmer out there bringing his cattle into the barn for milking twice a day so that we can have our yogurt, cheese, and mango-flavored probiotic drink.

But how do they keep their operations going when markets fluctuate and prices are unreliable? Well, the U.S. government provides agricultural price support via several methods. If you want more answers, you'll have to keep reading!

Agricultural Price Support Definition

Agricultural price support programs were put into place by the U.S. government to make sure that farmers received a minimum price for their goods. The agricultural price support programs are meant to help farmers maintain a profit from their land. There are several types of agricultural price support programs that approach the same issue from different angles. These agricultural price support programs aim to address the fluctuation of prices and stabilize the market for agricultural produce.

Agricultural price support applies to farmers who produce crops like corn, wheat, and sugar that are staples in our diets. Ranchers who raise livestock such as cattle and dairy farmers are also eligible for these government price support programs since they are also affected by constant price fluctuations in the agricultural market.

Agricultural Price Support Programs

During the Great Depression in the 1930s, prices for agricultural products such as corn and milk fell so low that it was becoming difficult for farmers to afford to grow their crops.¹ This happened because food demand is inelastic, meaning that regardless of the price, people will still purchase more or less the same amount of food because they only need so much of it.² The supply of food is also inelastic. During this time, farmers had a very good harvest, which put food prices at risk of falling even lower. The government stepped in and created the Commodity Credit Corporation (CCC) under the Department of Agriculture to stabilize crop prices.

Since then, the agricultural price support programs in the U.S. have evolved over time. Let's go over the 3 main forms of agricultural price support programs that the U.S. government has come up with to help stabilize food prices:

• Loan Supports
• Deficiency Payments
• Land Banks

Target Prices

The government uses target prices to guide its agricultural price support programs. Target prices are price floors set by the U.S. government for agricultural products. A price floor is a lower limit that the price of a good or service cannot fall below. To be effective, the price floor must be set above the market equilibrium. Otherwise, there is not much use to it.

Loan Supports

Loan support is a price support program established by the CCC that uses target prices to calculate the size of the loan. These loans are typically in the form of non-recourse loans, which are loans where the farmer is not punished if they are not paid back. These loans work by holding the farmer's crop as a security for the loan.

A farmer will go to the CCC and take out a loan to have the money to grow their crops. The CCC will calculate how much crop the farmer could produce and give them the loan according to the target price. When the time comes for the crop to be harvested and sold, the farmer has the option to sell the crop at the market price or give the harvest to the CCC. If they choose to sell the harvest at the market price, the farmer has to pay back the loan to the CCC.

This form of agricultural price support was great for the farmers because it took away the risk of having to pay back the loan when the agricultural prices dropped significantly, but it posed some problems for the government. The issue with the non-recourse loans was that the government was taking possession of so much food that they were not able to use them all and were having to store them in various spaces. Storing the food became so expensive that the CCC had to come up with a new plan.

Deficiency Payments

Deficiency payments came as a solution to the problem of storing excess food caused by the non-recourse loans. Deficiency payments became a way for the government to find a medium between making sure farmers were able to make enough money and solving the issue of storing surplus food. Farmers were to sell their goods on the market for the highest price they could get. If that price was lower than the target price set by the CCC, the government would cut them a check for the difference. That way, farmers were not losing money in the market, and the government was not collecting these massive stockpiles of surplus food.

Land Banks

Land banks were and still are a method that the U.S. government uses to reduce surplus food production in the United States. Land banks are fields that are used to produce crops, but the farmers who own them are being paid to not farm the land. The U.S. Department of Agriculture wants to reduce the amount of farming production without having to lower prices. The solution is to pay farmers not to farm the land since they paid farmers deficiency payments anyways, but now they do not have to deal with the surplus crops.

The Main Argument for Agricultural Price Support

The main argument for agricultural price support is that it stabilizes the agricultural market. It does it by limiting the amount that prices can fall. It is important for the prices of agricultural goods to be stable because it ensures that food production will continue and keeps prices more consistent for both farmers and consumers.

Having price support also means that production levels will be more consistent since farmers have a secure source of income to pay for planting, maintaining, and harvesting their crops. Farmers are generally in favor of agricultural price support because it means that they have a guaranteed income.

Figure 1 shows a shift of the supply curve to the right and the effect it should have on price. When the supply of a crop increases, the supply curve shifts from S to S₁, and the equilibrium price would be at P₁. However, the agricultural price support programs essentially provide a price floor at P₀ and protect farmers from the income shock that a price decrease would bring.

Fig. 1 - A shift of the supply curve to the right

The Main Argument Against Agricultural Price Support

An argument against agricultural price support can be made by pointing out that price support can exacerbate the oversupply of agricultural goods because farmers get paid to produce more.³ If you were told that you would get paid an above-market wage for every good you produce regardless of price fluctuations, you would be encouraged to produce as much as possible.

In agriculture, the farmers who receive these subsidies will produce as many crops as they can to maximize profits since they do not have to worry about the market demand. This floods the market with goods, but the prices of the goods do not respond in the typical fashion where the supply curve shifts to the right and the equilibrium price falls.

Agricultural Price Support Based on Per-bushel Production

When agricultural price support is based on per bushel production, it means that farmers get compensated for each bushel of corn, wheat, soy, or whichever good is in question. This means that the more bushels the farmer can produce, the more money they will receive from the Commodity Credit Corporation. Therefore, larger farms with thousands of acres profit the most from these price supports since their production capacity is larger than the farmers who only have a few dozen. This creates an equity issue as big farming corporations can benefit a lot more from the price support than small farmers. It's the small farmers who are in need of income protection.

Agricultural Price Support: Price Floor

Agricultural price support programs provide a price floor because they prevent prices from falling below a certain point, regardless of the actual market equilibrium. If a price floor is set by the government, the market for the good cannot reach equilibrium. A price floor is only effective if it is set above the market equilibrium.

The target price set by the Commodity Credit Corporation acts as a price floor in that it prevents farmers from having to accept lower market prices. Farmers do not have to accept the market prices since the government will pay the farmers for their crops at the target price.

Fig.2 - Price Floor

Figure 2 shows the price floor set at the normal market equilibrium. This prevents the price of agricultural goods from falling below the normal market price in the case of an oversupply. In this situation, the price floor is appropriately set, and there is no extra supply of goods that would cause a surplus. In figure 3 below, the effects of a price floor set above market equilibrium will become apparent.

Fig. 3 - The effect of a price floor

Figure 3 models the effect of a price floor when the supply of an agricultural good increases unexpectedly. The supply curve shifts out to S₁, so the new market price in equilibrium would be at P₁ without the price floor. Now, the price floor at P₀ is above the would-be equilibrium (E₁). This exacerbates the oversupply problem. The farmers are supplying a quantity of Q₂, which is more than the quantity demanded Q₀ at the price of P₀.