Sep 28 2012

Bad crop equals higher incomes for farmers – what’s up with that?

Despite Record Drought, Farmers Expect Banner Year

Listen to the story above. According to the report, farmers in the American Midwest have seen their incomes reach new highs this year, despite the terrible harvest resulting from a nationwide drought.

This is curious. The drought starved crops of water, forcing farmers to harvest in the middle of the growing season, essentially destroying much of their harvest for the year. So the question is, how does a BAD harvest result in GOOD incomes for farmers?

Believe it or not, the answer to this riddle requires an understanding of elasticity; specifically, price elasticity of demand (PED). PED measures the responsiveness of consumers to a change in the price of a good. The PED for a good can be measured between two prices by using a simple formula:

  • PED = the percentage change in the quantity of a good demanded divided by the percentage change in the good’s price.

The result of this calculation, which is known as the PED coefficient, will always be a negative number. Why will the PED coefficient be negative? Think back to the law of demand, which states that there is always an INVERSE relationship between price and quantity demanded of a good. Since PED measures how much the quantity demanded changes in response to a particular change in price, the coefficient of PED must be negative, since price and quantity always change in the opposite direction.

So back to our farmers who are enjoying high incomes despite the terrible harvest. What does this have to do with PED? Well, that’s what I want you to figure out. In the comments below, explain how an understanding of price elasticity of demand can help us understand why farmers whose crops were largely destroyed by drought ended up earning higher incomes than they expected.

 


About the author:  Jason Welker teaches International Baccalaureate and Advanced Placement Economics at Zurich International School in Switzerland. In addition to publishing various online resources for economics students and teachers, Jason developed the online version of the Economics course for the IB and is has authored two Economics textbooks: Pearson Baccalaureate’s Economics for the IB Diploma and REA’s AP Macroeconomics Crash Course. Jason is a native of the Pacific Northwest of the United States, and is a passionate adventurer, who considers himself a skier / mountain biker who teaches Economics in his free time. He and his wife keep a ski chalet in the mountains of Northern Idaho, which now that they live in the Swiss Alps gets far too little use. Read more posts by this author


8 responses so far

8 Responses to “Bad crop equals higher incomes for farmers – what’s up with that?”

  1. Alice Forsython 28 Sep 2012 at 11:04 am

    The price elasticity of demand relates to the responsiveness of consumers to price change. If there is an increase in the price of a good and the demand decreases dramatically, that good is considered to be an elastic good. If there is an increase in the price of a good and the demand for that good does not change much, that good is then considered to be inelastic.

    For this question, we must understand if the farmers crops are an elastic or inelastic good. In order to do this, the total revenues of the farmers income can be calculated by multiplying the price by the quantity sold.

    If the farmers' crops were an elastic good, the demand curve will be close to horizontal, indicating that the change in price will lead to a large change in the quantity demanded. The supply curve shifts to the left due to the drought which causes a large decrease in the demand for the crops and also a decrease in the total revenues for the farmers.

    If we then assume that the farmers' crops are an inelastic good, the demand curve will be close to vertical, indicating that the change in price will lead to little change in the quantity demanded. The supply curve shifts to the left due to the drought which causes a very small decrease in the demand for the crops in comparison to the price change. This will cause the total revenues for the farmers to increase.

    Therefore, we can see that the farmers' crops are an inelastic good because the total revenues for the farmers has increased due to the drought and a decrease in the supply.

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  2. Rebecca Bon 28 Sep 2012 at 11:28 am

    First we must distinguish that the farmer's total income is referring to their total revenue. The drought caused most of the farmer's crops to be ruined, so the rash conclusion would be that the shortage of crops would increase the price of the crops supplied and consequently decrease the quantity demanded by the consumers. However, an important point to consider is that the crops are food, which is a necessity for consumers. We learnt in class that the more a good is necessary, the less responsive (or more inelastic) the consumers are to a price change. So if we take this brain-teaser and represent it on a supply and demand curve, the supply curve will shift to the left – displaying a change in supply due to the drought – and will automatically cause the price of the crops to increase. Then, because demand for the food crops is almost completely inelastic, (which would be an almost vertical line on a diagram), the price increase will cause almost no change in quantity demanded. Therefore, the farmer's total revenue, and thus income, has now increased from their original price of the crops before the drought to the increased price of the crops after the drought, with practically no sacrifice on their part for increasing the price because the demand has stayed the same.

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  3. Gabrielle Ciemnyon 30 Sep 2012 at 5:19 pm

    It may sound surprising that a bad harvest can result in a good income for farmers, but the reason this is possible is because crops are an inelastic good.

    An inelastic good is a good that is a necessity. Meaning that people have to have them and will buy them no matter the price. This means that the price can increase or decrease and the demand will pretty much stay the same (constant).

    Therefore, in the case of the farmers, even though they had fewer crops and increased the price in order to make enough income, consumers were still willing to buy them.

    It may be easier to imagine this question in terms of a supply and demand curve. In most cases (if the good is elastic) a decrease in supply and and increase in price will result in a decrease in demand. Causing farmers to not make enough income. However, because crops are an inelastic, the demand curve will almost be vertical. The supply curve will shift to the left as a result of the drought, but the demand still stays almost the same because the crops are an inelastic good.

    Since crops are an inelastic good, farmers were able to make a good income despite of the drought.

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  4. Matt Stringeron 30 Sep 2012 at 5:37 pm

    To fully understand the phenomenon at hand, we must first look into what crops were effected by this summer's droughts. The mid-west is known for its corn and wheat farming. Understanding that these farms provide essential goods for the public to consume in their everyday life can show us why farmers had record incomes in the midst of a drought.
    The PED coefficient for the wheat and corn markets (coming from farmers in the mid-west) must be a very large number, while being negative. It is interesting to think that it was actually beneficial to farmers throughout the American mid-west to lose so much of their harvest this year. The elasticity for wheat and corn in these markets show that, even though the price increased due to the drought, the demand barely changed. This happened because of the necessity of wheat and corn. The public were still willing and able to purchase the products despite their increase in price. Because they are used in so many products essential for every day life such as bread, flour, corn syrup etc., the demand is not going to change as dramatically in response to price changes. In this situation, the increase in price outweighed the amount of sales lost because of the price increase.

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  5. Charlotte Manzoneon 30 Sep 2012 at 9:39 pm

    Why would a bad harvest lead to a greater income for farmers? Necessity goods such as wheat and corn (from the example) are considered inelastic. It is if the percentage change in quantity demanded is less than the percentage change in price.
    When facing an inelastic demand, the best way to bring up more revenue (while selling fewer units) is to raise the price of the good.
    Since the goods are inelastic, the price of the goods will not play a major role in the consumer’s responsiveness’ to the price changes because they are essential to their daily lives.

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  6. Cameron Won 01 Oct 2012 at 8:16 am

    Price elasticity of demand is a measure to show the responsiveness, or elasticity, of the quantity demanded of a good or service to a change in its price. With the understanding of price elasticity, we can see that the crops the farmers were producing were highly inelastic as the goods produced by the crop were highly demanded and necessary, so when the price rose because of the drought consumers were unresponsive to the change as they needed and demanded the crop despite the price. The higher incomes of the farmers were unexpected because they did not take into account the elasticity of their crop. When the price rose, they expected a decrease in demand, when in fact, the increase in price did not waver the demand of the consumers, and the farmers were able to sell at a much higher price, leading to higher incomes.

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  7. Abbie Salteron 01 Oct 2012 at 8:22 am

    PED describes the responsiveness of consumers to a change in the price of a good. It can be assumed the harvest crops are fairly inelastic, meaning consumers respond very little to a change in price. Furthermore, despite a horrible crop season where the quantity of the crops decreases and the prices go up in order to combat the bad price, the farmers still prospered. The high price should drive down demand, but because crops don't have substitutes, they're a necessity, they are a small proportion of total income, and there wasn't enough time for a change the demand remained higher. So just as many people were buying the crops, and the higher price lead to the farmers earning more income. This made the drop in quantity not greatly effect the farmers income.

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  8. Faizanon 29 Jun 2014 at 2:48 pm

    why cant farmers destroy their crops in absence of drought, to raise their revenues?

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