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Agricultural economics PDF

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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 Amsterdam Cape Town Dubai London Madrid Milan Munich Paris Montreal Toronto Delhi Mexico City São Paulo Sydney Hong Kong Seoul Singapore Taipei Tokyo 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 Editor in Chief:Vernon Anthony Acquisitions Editor:Bill Lawrensen Editorial Assistant:Lara Dimmick Director of Marketing:David Gesell Campaign Marketing Manager:Leigh Ann Sims Curriculum Marketing Manager:Thomas Hayward Senior Marketing Coordinator:Alicia Wozniak Marketing Assistant:Les Roberts Production Editor:Holly Shufeldt Cover Art Director:Jayne Conte Cover Designer:Bruce Kenselaar Cover and chapter opener art:Istock Lead Media Project Manager:Karen Bretz Full-Service Project Management:Saraswathi Muralidhar, GGS Higher Education Resources Composition:GGS Higher Education Resources, A Division of PreMedia Global Inc. Printer/Binder:Edwards Brothers Cover Printer:Lehigh-Phoenix Color Corp. Credits and acknowledgments borrowed from other sources and reproduced, with permission, in this textbook appear on appropriate page within text. Copyright © 2011, 2004 Pearson Education, Inc., publishing as Prentice Hall, One Lake Street, Upper Saddle River, NJ 07458.All rights reserved. Manufactured in the United States of America. This publication is protected by Copyright, and permission should be obtained from the publisher prior to any prohibited reproduction, storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or likewise. To obtain permission(s) to use material from this work, please submit a written request to Pearson Education, Inc., Permissions Department, Prentice Hall, One Lake Street, Upper Saddle River, NJ 07458. Many of the designations by manufacturers and seller to distinguish their products are claimed as trademarks. Where those designations appear in this book, and the publisher was aware of a trademark claim, the designations have been printed in initial caps or all caps. 10 9 8 7 6 5 4 3 2 1 Paper bound ISBN-13: 978-0-13-607192-1 ISBN-10: 0-13-607192-9 Loose leaf ISBN-13: 978-0-13-506990-4 ISBN-10: 0-13-506990-5 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

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