Agricultural economics

409 Pages·3.475 MB·English

by  Drummond, Harold Evan, Goodwin, John W

AGRICULTURAL
ECONOMICS
THIRD EDITION
H. Evan Drummond
University of Florida
John W. Goodwin
Oklahoma Panhandle State University
Prentice Hall
Boston Columbus Indianapolis New York San Francisco Upper Saddle River
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Library of Congress Cataloging-in-Publication Data
Drummond, H. Evan (Harold Evan)
Agricultural economics / H. Evan Drummond, John W. Goodwin.—3rd ed.
p. cm.
Includes bibliographical references and index.
ISBN-13: 978-0-13-607192-1
ISBN-10: 0-13-607192-9
1. Agriculture—Economic aspects. 2. Agriculture—Economic aspects—United States.
I. Goodwin, John W. II. Title.
HD1433.D78 2011
338.1—dc22
2009052979
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Paper bound ISBN-13: 978-0-13-607192-1
ISBN-10: 0-13-607192-9
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contents
Preface ix Basic Skills of the Agricultural Economist 18
New to This Edition xii Economic Models 18
Acknowledgments xiii Ceteris Paribus 19
Opportunity Cost 19
part one
Diminishing Returns 20
Foundations
Marginality 21
Logical Fallacies 22
1
Facts, Beliefs, and Values 24
Words 24
The Food Industry 2
Summary 25
Major Sectors—An Overview 2 Key Terms 25
Farm Service Sector 2 Problems and Discussion Questions 26
Producers 3 Sources 26
Processors 3
Appendix: Expressing Relationships 27
Marketers 4
Relationships 27
Contemporary Issues in the Food Industry 4
Reading Graphs 29
Farm Structure 4
Slope of a Line 31
Concentration 6
Globalization 6 Slope of a Curve 33
Coordination 7 Special Cases 34
Alternative Energy Sources 8
Key Terms 34
Summary 10
Key Terms 10
3
Problems and Discussion Questions 11
Sources 11
Introduction to Market Price
Determination 35
2
Markets 35
Demand and Supply 36
Introduction to Agricultural
Demand 36
Economics 13
Supply 38
Agricultural Economics 13
Price Determination 39
Basis for Economics 14
Changes in Supply and Demand 41
Basic Economic Decisions 14 Demand Shifters 44
Economic Systems 14 Supply Shifters 45
Supply or Demand 45
Levels of Economic Activity 15
Summary 46
Microeconomics 16
Market Economics 16 Key Terms 46
Macroeconomics 17 Problems and Discussion Questions 46
iii
iv contents
part two 6
Microeconomics
Supply, Market Adjustments,
4
and Input Demand 84
Supply Curve of the Firm 84
The Firm as a Production Unit 50
Market Supply 85
Perfectly Competitive Markets 50
Market Adjustments 86
The Perfectly Competitive Firm 51 Dynamic Relationship Between the Firm
Objective of the Perfectly Competitive Firm 51 and the Market 86
Conditions of Perfect Competition 52 Cost Structure and Price Variability 88
Behavior of the Perfectly Competitive Firm 53
Profit-Maximizing Input Use 89
Production 53 Value of the Marginal Product 90
Fixed and Variable Inputs 54 Profit Maximization 90
Length of Run 54 Input Demand of the Firm 92
Returns to Scale 54 Input Demand Shifters 92
The Production Function 55 Summary 92
The Total Product 56 Key Terms 93
Diminishing Marginal Product 57 Problems and Discussion Questions 93
Summary 58
Key Terms 59
7
Problems and Discussion Questions 59
Imperfect Competition and Government
5
Regulation 94
Market Structure 94
Costs and Optimal Output Levels 60
Perfect Competition 95
Environment of the Firm 60 Structure 95
Optimal Output Level 61 Conduct 95
Costs of the Firm 61 Pure Monopoly 96
Revenue of the Firm 66 Structure 96
Profit Maximization 67 Barriers to Entry 97
Behavior of the Loss-Minimizing Firm 70 Conduct of the Monopoly Firm 98
Summary 72 Unprofitable Monopolies 99
Key Terms 72 Performance 100
Problems and Discussion Questions 73 Monopolistic Competition 101
Appendix I: Factor-Factor Model 74 Structure 101
Local Cost Minimization 75 Conduct of the Monopolistically
Competitive Firm 102
Constant Output 76
Performance 104
Local Profit Maximization 76
Oligopoly 104
Graphical Solution 76
Structure 104
Expansion Path 78 Conduct 105
Key Terms 79 Game Theory 105
Appendix II: Product-Product Model 80 Government Regulation 106
Local Revenue Maximization 80 Railroads 106
Standard Oil 107
Graphical Solution 81
Antitrust 107
Generalization 83
Natural Monopolies 107
Key Terms 83
Marketing Orders in Agriculture 108
contents v
Summary 108 part three
Key Terms 109 Macroeconomics
Problems and Discussion Questions 110
10
8
Money and Financial Intermediaries 146
The Theory of Consumer
Behavior 111 What Is Money? 146
Money as a Medium of Exchange 146
The Law of Demand 111
Money as a Store of Wealth 148
Real Income and Substitution Effects 111
Money as a Basis for Keeping Records 148
Substitution Effect 112
What Backs Money? 148
Real Income Effect 112
Legal Tender 149
Market Demand and Individual
Money and Prices 149
Demand 112
The Money “Supply” 149
Utility Analysis 113
M1 150
Assumptions about the Utility Model 113
Near-Monies 150
Deriving the Demand Curve 117
Credit and Debit Cards 151
The Market Demand Function 118
Financial Markets 151
Summary 118
The Commercial Banking System 151
Key Terms 119 Financial Failures 154
Problems and Discussion Questions 119 Banks in the New Millennium 159
Appendix: Indifference Curve Analysis 120 Summary 160
Utility Maximization 122 Key Terms 160
The Impact of Changes in Ceteris Paribus Problems and Discussion Questions 161
Conditions 124 Sources 161
Substitutes and Complements 126
Derivation of the Individual Demand 11
Curve 128
Summary 130
The Circular Flow of Income 162
Key Terms 130
Final Goods 163
Problems and Discussion Questions 130
Production 163
Consumption 164
9
The Circular Flow 165
The Physical Flow 165
The Concept of Elasticity 131 The Economic Flow 166
The Basic Principle 167
Elasticity of Demand 132
Elasticity of Demand Related to Gross Domestic Product and National Income 169
Total Revenue 135 The Gross Domestic Product 169
Factors Affecting Demand Elasticity 136 National Income 170
Measurement Difficulties 170
Cross-Price Elasticity 138
The Price Level and GDP 171
Income Elasticity 139
The Circular Flow by Economic Sector 175
Elasticity of Supply 140
Households 175
Price Discrimination 141
Business Firms 175
Summary 142 Governments 176
Key Terms 143 The Foreign Sector 176
Problems and Discussion Questions 143 The Total System 177
vi contents
The Role of Financial Intermediaries 178 Exports 210
Summary 180 Imports 211
Key Terms 180 Why Do Nations Trade? 212
Problems and Discussion Questions 181 The Basis for Trade 213
Sources 181 Excess Supply/Demand 214
A Simple Trade Model 215
12 Gains from Trade 216
Restraints to Trade 218
Tariffs 218
Monetary Policy 182
Quotas 220
The Money Supply and Economic Activity 183
Restrict Domestic Demand 221
Objectives of Macroeconomic Policy 183
Foreign Exchange Markets 222
How Monetary Policy May Affect These
Objectives 184 Trade Agreements 226
General Agreement on Tariffs and Trade 226
Implementing Monetary Policy 188
North American Free Trade Agreement 226
Federal Reserve System 188
Money Creation 189 Summary 227
Instruments of Monetary Policy 190 Key Terms 227
Problems and Discussion Questions 228
Summary of Monetary Policy 194
Sources 229
Summary 194
Key Terms 195
15
Problems and Discussion Questions 195
Sources 195
Agricultural Policy 230
13 The Perfect Food System 231
The Economic Environment of Agricultural Policy
Fiscal Policy 196 Issues 231
Agricultural Price Support Policies 232
Debt and Deficits 197
Agricultural Income Support Policies 236
The Classical School 198 Current Price/Income Support Policies 236
Say’s Law 198 Average Crop Revenue Election—A New
Classical Macroeconomic Policy 199 Alternative 239
The Keynesian Revolution 200 Conservation Reserve Program 240
The Great Depression 200
U.S. Farm Policy in a Global Context 240
The Keynesian Contribution 201
Summary 241
Fiscal Policy in the 1930s 204
Key Terms 242
Summary 206
Problems and Discussion Questions 242
Key Terms 206
Sources 242
Problems and Discussion Questions 207
Sources 207 part four
Advanced Topics
14
16
International Trade 208
Changing U.S. Trade Patterns 208 Food Marketing: From Stable
Role of Trade in the U.S. Economy 208 to Table 244
From Creditor to Debtor 209
Food Marketing Defined 245
The Importance of World Trade to U.S.
Food Marketing Creates Utility 245
Agriculture 210
The Four Utilities of Food Marketing 245
contents vii
Why Do Food Marketing Firms Produce Utility? 246 Problems and Discussion Questions 285
Choices 246 Sources 287
The Food Bill 247
Away from Home Share 247 18
The Food Marketing Bill 248
Size and Composition 248
Financial Markets 288
By Commodity 249
How Firms Obtain Funds 288
Farm Service Marketing Bill 251
Stock 289
Food Market Levels 252
Newly Issued Stock 289
Assemblers 252
Previously Issued Stock 292
Commodity Processors 252
Stock Price Determinants 293
Food Processors 253
Reading Stock Reports 294
Distributors 253
Stock Splits 296
Retailers 253
Classes of Stock 297
Vertical Integration 254
Types of Stocks 297
Industrialization 254
Market Indicators 298
Market Functions 255
Investors and Speculators 299
Primary Functions 255
Summary—What Makes Stock Prices Go Up
Facilitating Functions 255
and Down? 300
Marketing Margins 256
Bonds 301
Derived Demand 256
Characteristics of Bonds 301
Derived Supply 257
Trading of Bonds 304
Market Equilibrium 258
Bond Prices 305
Dynamic Adjustment 258
Bond Price Quotations 306
Gains from Marketing Efficiency 259
Other Bond Features 308
Elasticity by Market Level 261
Mutual Funds 309
Food Market Regulations 262
How a Mutual Fund Works 310
Summary 263 Managers and Advisors 311
Key Terms 264 Types of Funds 312
Problems and Discussion Questions 264 How to Read Mutual Fund Quotations 313
Sources 264 Closed-End Funds 314
Summary 315
Key Terms 315
17
Problems and Discussion Questions 316
Sources 317
Futures Markets 266
Risk Management 266
19
Futures Markets 267
Exchanges 268
Investment Analysis 318
Futures Contracts 269
Futures Contract Prices 272 Typical Life of an Investment 319
Basis of Futures Contracts 273
Economic Profitability of an Investment 319
Speculators 274
Present Value 319
Hedgers 275
Net Present Value 322
Options 280 Internal Rate of Return 323
A Final Word 283 Evaluating Alternatives 324
Summary 284 Summary 324
Key Terms 285 Key Terms 325
viii contents
Problems and Discussion Questions 325 Information Asymmetries 355
Sources 325 Used Cars 355
Baseball’s Free Agents 356
20 Problems in Dealing with Market Failure 356
Information Failure 357
Economic Efficiency Considerations 357
Farm Service Sector 326
Equity Considerations 357
Purchased Inputs 326 Summary 358
Direct Sales 326 Key Terms 359
Franchise Agents 326
Problems and Discussion Questions 359
General Store 327
Sources 360
Cooperatives 327
Insurance 331
22
Crop Insurance 331
Revenue Insurance 331
The Malthusian Dilemma 361
Credit 332
Types of Credit 332 The Neo-Malthusians 362
Sources of Credit 332
The Non-Malthusians 363
Farm Labor 334
The Demographic Transition 365
Tenant Labor 334
Traditional 365
Labor Contractors 335
Developing 366
Custom Hire 335
Developed 367
Consultants 335
Land 368
Summary 336
Summary 369
Key Terms 336
Key Terms 369
Problems and Discussion Questions 337
Problems and Discussion Questions 369
Sources 337
Sources 369
21
23
The Economics of Market Failure 338
Economic Development and Food 370
Advantages of Markets 338
Quantity of Food 371
Coordination 338
For Want of Food 371
Prices Driven to Minimum Cost 339
Who Is Hungry? 372
Disequilibria Are Self-Correcting 339
Why Hunger? 374
No Coercion 339
Food Demand During Development 375
Types of Market Failure 339
Quantity 375
Poorly Defined Property Rights 340
Quality 375
Public Goods 342
Processing and Marketing 376
Common Property Goods 343
Summary 376
Externalities Cause Market Failure 345
Key Terms 376
Externalities Defined 346
Problems and Discussion Questions 377
Private and Social Costs/Benefits 346
Pesticide Use—An Example of Externalities 346 Sources 377
Higher Education—Another Example of
Externalities 347
Glossary 378
Optimal Level of Pollution 349
Index 390
Benefit-Cost Analyses 351
Policy Alternatives 352
Preface
This text is designed for a one-semester (or two-quarter sequence) introductory
course in agricultural and environmental economics. Many texts view agricultural
economics in a rather narrow context of the profit-maximizing farm business. We pre-
fer a broad view of the food system that emphasizes linkages between and among
financial institutions, the macroeconomy, world markets, government programs,
farms, agribusinesses, food marketing, and the environment. The objective of this text
is to cover many topics lightly rather than any one or two topics in depth. The text is
designed to allow for and encourage a maximum of “skipping around” rather than
requiring a strict sequential ordering of the chapters.
Economics is about decision making. It deals with how decisions are made
under varied conditions and situations. It also deals with the evaluation or implica-
tions of alternative decisions for a given situation. Since decisions are a fact of every-
day life, economics is with us in most of what we do. Even monastic monks who sell
fruitcakes to support their spiritual endeavors make economic decisions when they
decide which ingredients to buy and what price to ask for their product.
You, the college student, are surrounded by economic decisions as you pursue
academic success at the institution of your choice. Several of the economic decisions
you must make will be discussed to briefly introduce you to six economic concepts
that will recur throughout this book. These concepts form the foundation of how
economists approach decision making.
SUPPLY AND DEMAND
There is probably no better-known (and more poorly understood) concept in eco-
nomics than supply and demand. Supply and demand are the central nervous system
of the economic system—they are the key to price determination. One decision that
each college or university student must make is “What am I going to major in?” The
specific answer to that question depends upon the criterion used by the individual
student to make a choice.
A student who bases his or her choice of a major on potential income is certainly
into the use of supply and demand. In today’s market, we all know that computer
engineers, on average, earn more than high school teachers. Why is that? It is a simple
matter of supply and demand in the determination of the price (i.e., wage) for com-
puter engineers and for high school teachers. In Chapter 3, the basic foundations of
supply and demand will be examined in detail.
OPPORTUNITY COST
A second fundamental concept of economics is the concept of opportunity cost.
Whenever a resource is employed in one activity, that means it can’t be used in
another. Something must be given up to do something else. That is, if you are attend-
ing class, you can’t be earning money by flipping hamburgers at the same time. The
value of what is foregone is the opportunity cost of doing something else.
A relevant economic question that each college student should ask is “What
does it cost for me to attend the university?” Most students will think of “costs” as
tuition, residence hall fees, meals, and so on. From the economist’s point of view,
probably the single biggest cost (if you are in a public university) is the opportunity
ix