Lecture 4: Common Agricultural Policy Based on Sloman Chapter 3.4 and Chapter 8, Swann Lecture 4:...

Lecture 4: Common Agricultural Policy

Based on Sloman Chapter 3.4 and Chapter 8, Swann

Lecture 4: Common Agricultural Policy

Based on Sloman Chapter 3.4 and Chapter 8, Swann

CAP- The Common Agricultural policyCAP- The Common Agricultural policy

• Massively complex, massively expensive Massively complex, massively expensive policy.policy.

• Hard to understand without seeing how it Hard to understand without seeing how it developed.developed.

• CAP started as simple price support policy CAP started as simple price support policy in 1962.in 1962.

• Objective: To stabilise prices Objective: To stabilise prices • AND provide income support for AND provide income support for

social reasonssocial reasons

Farm Size Distribution in EU(1987)Farm Size Distribution in EU(1987)Very skewed ownership:

• biggest 7 per cent of farmers owned ½ of the land• smallest 50 per cent of farmers owned only 7 per cent of the land.

Source: Baldwin & Wyplosz

Changes in Farm size 1970-1987Changes in Farm size 1970-1987


AGRICULTURE AND AGRICULTURAL POLICYAGRICULTURE AND AGRICULTURAL POLICY

• AgricultureAgriculture– Many producers, all price takersMany producers, all price takers– Many consumers, all price takersMany consumers, all price takers– ‘‘free’ entry and exitfree’ entry and exit– As close to perfect competition as could As close to perfect competition as could

imagineimagine

• So why intervene in Agriculture sector?So why intervene in Agriculture sector?


• Why governments intervene in agricultureWhy governments intervene in agriculture– to reduce price fluctuationsto reduce price fluctuations– to raise farm incomesto raise farm incomes– to protect rural communitiesto protect rural communities– to encourage greater self-sufficiency in foodto encourage greater self-sufficiency in food

• Causes of short-term price fluctuationsCauses of short-term price fluctuations– fluctuations in demand & instabilityfluctuations in demand & instability– fluctuations in the harvestfluctuations in the harvest

fig

Suppose we have a crop which takes a year to grow and is grown only

once year,

DA

P1

Q1

P

Q O

a

SAe.g. Hops for Beer

Suppose now that demand were to rise but supply

cannot respond immediately

fig

What will happen to Price?

Suppose we have a crop which takes a year to grow and is grown only

once year,

DA

P1

Q1

P

Q O

a

SAe.g. Hops for Beer

Suppose now that demand were to rise but supply

cannot respond immediately

fig

So price rises to P2

Since supply is fixed, the price is determined by the available supply at Q1.

DA

P1

Q1

P

Q O

a

DB

P2

SA

• But next period farmers observe that the price of hops was very high

• So now they all want to grow hops

• At P2, what will the supply be?

fig

DA

P1

Q1

P

Q O

a

DB

P2

At P2, the following year

supply increases to Q3

Q3

SA

fig

DA

P1

Q1

P

Q O

a

DB

P2

But now Supply exceeds demand so price must fall to P3

Q3

P3

SA

fig

DA

P1

Q1

P

Q O

a

DB

P2

Q3

P3

Q4

But next period farmers see lower price and decide to supply less: Q4

SA

fig

DA

P1

Q1

P

Q O

a

DB

P2

Q3

P3

Q4

Notice here that we are spiraling through time to an equilibrium

This is a stable Cobweb

SA

fig

Suppose instead that the supply curve was very flat.

DA

P1

Q1

P

Q O

a

SA

Now what will happen to Price?

fig

Since supply is fixed, again the price must rise to P2

P1

Q1

P

Q O

a

DA

DB

SA

fig

Since supply is still fixed at Q1, again the price must rise to P2

P1

Q1

P

Q O

a

DA

DB

SAP2

But next period farmers observe that the price of hops was

very high

So now they all want to grow hops

fig

DA

P1

Q1

P

Q O

a

DB

P2

Now Supply Increases to Q5

Q5

SA

At P2, what will the supply be in this case?

fig

DA

P1

Q1

P

Q O

a

DB

P2

Q5

SA

But again Supply exceeds demand so price must fall to

P5

P5

fig

DA

P1

Q1

P

Q O

a

DB

P2

Q5

SA

But at P5 next period farmers

decide to supply Q6

P5

Q6

fig

DA

P1

Q1

P6

Q O

a

DB

P2

Q5

SA

But if only Q6 is supplied demand will exceed supply

and price will rise to P6

P5

Q6

fig

DA

P1

Q1

P6

Q O

a

DB

P2

Q5

SA

P5

Q6

But Now the price and quantity are gradually spiraling away from equilibrium.

This is an unstable cobweb.

Summary of Cobweb Effects

• With a demand SHIFT and supply fixed yearly, a sudden rise in demand will see a big increase in income.

• The lagged response next year can generate cyclical fluctuations in prices over the next few years.

• When Q goes up and P fall, income PxQ can also fluctuate.

• Not all cobwebs are stable

fig

Supply Side Shock

D

PE

QE

P

Q O

e

LRS

LRS is the long-run supply curve.

SRSE is the expected supply this year.

SRSE

PA

QA

SRSA

SRSA is the actual supply this year. e.g. Bad harvest

fig

Supply Side Shock

D

PE

QE

P

Q O

LRS

So price rises, what about income?

PEeQEO=ab is expected income

SRSE

PA

QA

SRSA

ac= actual income

Overall depends on size of c relative to b

e

a

b

c

fig

Supply Side Shock

D

PE

QE

P

Q O

LRS

If demand is more inelastic, c>b and income rises.

SRSEPA

QA

SRSA

ac= actual income

Overall depends on size of c relative to b

e

a

b

c

fig

Supply Side Shock

D

PE

QE

P

Q O

LRS

But if it is a good crop and demand is inelastic,

SRSE

PA

QA

SRSA

c < b and income falls

So variability in incomes leads to pressure for government intervention

e

a

b

c

REASONS FOR INTERVENTIONREASONS FOR INTERVENTION

• Causes of short-term price (and income?) Causes of short-term price (and income?) fluctuationsfluctuations– fluctuations in demand fluctuations in demand – fluctuations in the harvest (supply)fluctuations in the harvest (supply)

• Causes of declining farm incomesCauses of declining farm incomes– low income elasticity of demandlow income elasticity of demand– increases in supplyincreases in supply

Decline in farm incomes over time 1Decline in farm incomes over time 1

P

Q O

P1

D1

S1

Q1

P

Q O

P1

P2

D1

S1

S2

Q1 Q2

An improvement

in farm efficiency!

But with inelastic demand,

income will fall as before


P

Q O

P1

P2

D1

S1

S2

D2

Q1 Q2

How might farmers gain?

Need an increase in

demand due to rising

income in other sectors.

But if demand does not move out much there may be no

income gain


P

Q O

P1

P2

D1

S1

S2

D2

Q1 Q2

If income elasticity of demand is low, the D curve only

moves out a little and

there may be no income

gain


Evidence on Income elasticities of demand for Evidence on Income elasticities of demand for various foodstuffsvarious foodstuffs

Note NEGATIVE values imply these are inferior goods so demand falls as income rises

Source: Sloman from; National Food Survey 2000 (National Statistics, 2001), extracted from Tables 6.1, 6.3, 6.4 and 6.5

RECAP on REASONS FOR INTERVENTION in RECAP on REASONS FOR INTERVENTION in Competitive marketCompetitive market

• Causes of short-term price fluctuationsCauses of short-term price fluctuations– fluctuations in demand fluctuations in demand – fluctuations in the harvest (supply)fluctuations in the harvest (supply)

• Causes of declining farm incomesCauses of declining farm incomes– increases in supplyincreases in supply– low or negative income elasticity of demandlow or negative income elasticity of demand


• Types of government intervention in Types of government intervention in agricultureagriculture– buffer stocksbuffer stocks

– subsidiessubsidies

– high fixed priceshigh fixed prices

– reducing supplyreducing supply

– structural policiesstructural policies

Buffer stocks to stabilise pricesBuffer stocks to stabilise prices

P

Q O

Pg

D

Q1

Existed in all six original member

states

Buffer stocks to stabilise prices 1Buffer stocks to stabilise prices 1

P

Q O

Pg

D

Sa1

Qs1Q1

Bought into buffer stock


P

Q O

Pg

D

Sa2

Qs2

Released from buffer stock

Q1


P

Q O

Pg

D

Sa2

Qs2

But income still fluctuating, now worse

Extra income in good timesIncome

in Bad Times N

orm

al

Q1


• Buffer stocksBuffer stocks– buffer stocks to stabilise pricesbuffer stocks to stabilise prices

– buffer stocks to stabilise farm incomesbuffer stocks to stabilise farm incomes

Recall Elasticity FormulaRecall Elasticity Formula

0

01

0

01

Dp

PPP

QQQ

Pd

If elasticity equals 1 it means the percentage increase in quantity is

the same as the percentage fall in prices

So if the percentage price and income change is the

same then income stays the same

Buffer stocks to stabilise incomesBuffer stocks to stabilise incomes

P

Q O

D

aP1

P

Q O

D

Y

aP1

Pd = 1


P

Q O

D

Sa2

Q2Q1

Sa1

Y

aP1

Buffer stocks to stabilise incomes 1Buffer stocks to stabilise incomes 1

P

Q O

D

Sa2

Q2Q1

Sa1

Y

aP1

P2


P

Q O

D

Sa2

Q2Q1

Sa1

Q2

Y

ab

c

P1

P2

P2

Bought into buffer stock


P

Q O

D

Sa3

Q3 Q1

Sa1

Y

aP1

Buffer stocks to stabilise incomes 2Buffer stocks to stabilise incomes 2

P

Q O

D

Sa3

Q3 Q1

Sa1

Y

aP1

P3


P

Q O

D

Sa3

Q3 Q1

Sa1

Q3

Y

a

de

P1

P3

P3

Released from buffer stock



• SubsidiesSubsidies

– effects on price and outputeffects on price and output

– the incidence of a subsidythe incidence of a subsidy

– Subsidy is an amount paid for every unit Subsidy is an amount paid for every unit

produced. It reduces the cost to the farmer of produced. It reduces the cost to the farmer of

supplying the good and moves the supply supplying the good and moves the supply

curve down and out.curve down and out.

Effect of subsidies on foodstuffs in which the country is self-sufficient Effect of subsidies on foodstuffs in which the country is self-sufficient 11

P

Q O

D

Qe

Pe

S

Effect of subsidies on foodstuffs in which the country is self-sufficientEffect of subsidies on foodstuffs in which the country is self-sufficient

P

Q O

D

Qe

Pe

S + subsidy

S


P

Q O

D

Q1Qe

Pe

P1

S + subsidy

S Note at Pe farmers willing to supply Q2,

But then Supply exceeds demand

Q2

so price must fall to P1

Effect of subsidies on foodstuffs in which the country is self-sufficient Effect of subsidies on foodstuffs in which the country is self-sufficient 22

P

Q O

D

Q1Qe

Pe

Pg

P1

S + subsidy

S

Sub

sidy


P

Q O

D

Q1Qe

Pe

Pg

P1

S + subsidy

S

Sub

sidy Note two parts to the subsidy

in this example:

1. Getting higher price Pg

2. But also selling more, S1

Depends on pD

Effect of subsidies on foodstuffs which are partly importedEffect of subsidies on foodstuffs which are partly imported

P

Q O

D

Pw

SEU

Sworld


P

Q O

D

Qd

Pw

SEU

Sworld

QS1Imports


P

Q O

D

Qd

Pw

S + subsidy

SEU

Sworld

QS1


P

Q O

D

QS2Qd

Pw

S + subsidy

SEU

Sworld

QS1Imports

P

Q O

D

QS2Qd

Pw

Pg

S + subsidy

SEU

Sworld

QS1


Problems of OversupplyProblems of Oversupply

• EU switches from net food import to exporter in EU switches from net food import to exporter in most products.most products.


EU citizen Attitudes to the CAPEU citizen Attitudes to the CAP

• Support among those questioned for direct Support among those questioned for direct support to farmers was on average 62support to farmers was on average 62

• 42% - in the number of respondents who 42% - in the number of respondents who felt that the CAP ensured that agricultural felt that the CAP ensured that agricultural produce was safe to eat produce was safe to eat

• Lack of information continues to be a Lack of information continues to be a problem -'Don't know' answers in the poll problem -'Don't know' answers in the poll ranged from 24 - 35%.ranged from 24 - 35%.

EU citizen attitudes to the OBJECTIVES of the CAPEU citizen attitudes to the OBJECTIVES of the CAP

Question New EU 15

Should the EU use its agricultural policy to….. Yes Yes

ensure that agricultural products are healthy and safe? 88% 90%

favour and improve life in the countryside? 88% 77%

ensure stable and adequate incomes for farmers? 86% 77%

promote the respect of the environment? 84% 87%

help farmers to adapt their production to consumers' expectations? 84% 80%

protect medium or small sized farms? 83% 81%

defend farmers' interests in their dealings with intermediaries and distributors ? 81% 69%

make European agriculture more competitive on world markets? 80% 77%

encourage the diversification of agricultural products and activities? 80% 73%

reduce development disparities between regions? 80% 72%

protect European agricultural products? 78% 73%

favour methods of organic production? 69% 72%

Lecture 4: Common Agricultural Policy Based on Sloman Chapter 3.4 and Chapter 8, Swann Lecture 4:...

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