Archive for the 'Law of Supply' Category

Apr 11 2008

“Agflation”, conservation, and the loss of wildlands in America

How does a growing Chinese middle class threaten duck populations in the American Midwest? Here’s the story:

As Prices Rise, Farmers Spurn Conservation Program – New York Times

“You can’t pay me NOT to farm this land!”

This is the view being expressed by more and more American farmers today. Since 1985 the US government has paid hundreds of thousands of farmers around $50 per acre of land per year to NOT grow food. In other words, if you were a farmer with 1,000 acres, you could earn $50,000 a year for not doing anything with it at all, just letting it sit idle.

What is the logic of such a program? In the mid-80’s food prices were so low that farmers working their tails off to cultivate and harvest their lands often found themselves losing money when they went to sell their crops. The traditional farming lifestyle was in jeopardy as farmers experienced year after year of economic losses. Improvements in farm equipment, along with the widespread use of chemical fertilizers, pesticides and herbicides had increased farm yields to levels never before achievable in human history. What increases productivity for all farmers, however, also increases total supply of crops, driving prices to historic lows. All this meant farmers could barely get by in the American heartland.

Enter the government:

…the Conservation Reserve was conceived as part of the 1985 Farm Bill. Participants bid to put their land in the program during special sign-ups, with the government selecting the acres most at risk environmentally. Average annual payments are $51 an acre. Contracts run for at least a decade and are nearly impossible to break — not that anyone wanted to until recently.

Things were great for the farmers. Output fell as millions of acres went into disuse, while farm incomes rose due to rising prices for their outputs and transfer payments from the American taxpayers. Farmers now had to work less to earn more money.

Today, however, farmers are putting millions of idle acres back into cultivation. They are choosing to work harder and farm more land in order to take advantage of the rising world food prices caused by the increasing demand for meat among the world’s emerging middle class and the rising price of grains due to the push to promote ethanol as a renewable energy.

The farmers’ behavior today is a perfect demonstration of the law of supply, which acknowledges the direct relationship between a product’s price and the quantity that producers will bring to market. There are actually two markets at work here: the market for cropland, and the market for wildlands. Farmers face a tradeoff in their decision of whether to farm their land or let it lay fallow. In 1985, the government made the decision that not enough land was lain fallow, so it subsidized farmers who set lands aside for conservation. Since subsidies are a determinant of supply, the supply of idle land increased while the supply of cultivated land decreased, driving up food prices.

In addition to the law of supply, this article also encompasses the concept of market failure. The Farm Bill of 1985 inadvertently corrected a market failure relating to “merit goods”, or those that create positive externalities or spillover benefits for society. In the case of farmland, the less land was used for farming, the healthier the wildlife populations on the now idle lands of the American Midwest. Hunters, environmentalists, and conservation groups had much to cheer about:

,,,hunters had more land to roam and more wildlife to seek out, with the Agriculture Department estimating that the duck population alone rose by two million; and environmentalists were pleased, too. No one disputes that there are real environmental benefits from the program, especially on land most prone to erosion.

At its peak the “Conservation Reserve”, as it was known, saw more than 36 million acres set aside for wildlife. Today, however, farmers are choosing to put this land back into cultivation.

Markets are complicated things. Markets do a fantastic job of assigning values to easily tradeable commodities like corn, soybeans, sunflower seed oil, and wheat, which happen to be some of the crops most commonly grown on the millions of acres set aside for conservation since 1985. What market fail to do, however, is to assign adequate values to the non-tradeable goods in our society. The biodiversity of a wild grassland, the health of a water fowl population, the carbon-sequestration capacity of a standing forest, and the joy a hunter gets from roaming a fenceless wild land.

As food prices continue to rise in response to the shift towards bio-fuels and the growing demand for meat among developing countries’ consumers, there will be more and more pressure for farmers in the industrialized world to take their lands out of conservation and put them into cultivation. This is not only a rich world phenomenon either. In Brazil, farmers are responding to rising sugar prices by cutting down ever growing chunks of the Amazon, one of the world’s last great rainforests, sometimes called “earth’s lungs” because of its ability to trap carbon from the atmosphere.

If balance between conservation and cultivation is to be achieved, it requires a market system that puts a tangible, tradeable value on the sometimes intangible “goods” relating to the environment. For now, a short-term solution might be a new Farm Bill that offers farmers a more substantial payment for keeping lands idle. Such an interventionist approach may stem the loss of wild lands, but does little to address the bigger problem of market failure underlying the degradation of the world’s remaining natural environments.

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Mar 04 2008

“Fair Trade” coffee and economic development

In recent years coffee consumers may have noticed more and more cafes are offering “fair trade” coffee as an option. Usually, for an extra 10 or 20 cents per cup, you can get a beverage made from beans that were grown by farmers earning living wages and working in safe and sustainable environments. In some cases, “fair trade” coffee is of higher standards, representing a higher quality product. The premium paid by consumers, in theory, will eventually result in better standards of living for coffee farmers and their families.

Mike Munger, chair of Duke University’s economics department, argues that “fair trade” products, while they may represent good intentions, probably don’t do much to help poor farmers. While the full podcast offers even more reasons, the clip below presents one clear explanation of why “fair trade” may actually make poor farmers worse off.

Another interesting point Munger goes on to make relates to one of the models of economic growth we have been studying in IB Economics: the Lewis dual-sector model of structural change. According to the model, the path towards economic growth, which should create conditions that lead to economic development, requires the transition of workers from the low-productivity agricultural sector to the capital-intensive, high productivity manufacturing sector.Lewis Model of Growth

China, in its own economic growth, has demonstrated the success of this model, which involved rural to urban migration, employment of surplus labor from the farming sector in the industrial sector, giving workers access to capital, increasing productivity, output, income, saving, and investment, putting an economy on a path towards growth and development.

According to Munger, “fair trade” premiums paid to poor farmers create a disincentive for a farmer to migrate to the higher productivity industrial sector that may be emerging in his country. In essence, coffee drinkers in the rich world are offering a subsidy to farmers in the poor world aimed at keeping them poor. If the path to wealth and prosperity requires the transition to a capital-intensive industrial economy, then subsidies to poor farmers are only reducing the likelihood that they’ll achieve significant increases in income and savings.

Munger’s views are compelling, if a bit hard for a socially conscious, well-intentioned coffee lover like myself to swallow. I like to think that I’m helping farmers in the developing world when I drink “fair trade” coffee. If anything, Munger has at least made me think a bit harder about the true impact of the premium I pay when I choose “fair trade” next time I walk into Starbucks.

For the full podcast, click here: Munger on Fair Trade and Free Trade – EconTalk with Russ Roberts

8 responses so far

Nov 01 2007

Beijing caves in to the indisputable power of the MARKET!

Well, not exactly, but that’s kind of a dramatic headline, isn’t it? The other day I blogged about the shortages experienced in the petrol market in eastern provinces, evidenced by the long queues at gas stations around Shanghai last weekend.

Petrol stations resorted to rationing their product in small doses (between 20 and 40 litres) as the price of oil hit $92 and Chinese refiners scaled back production due to rising costs that they were unable to pass on to their customers. Beijing had previously imposed a price ceiling on fuel in an attempt to keep inflation low and Chinese consumers content; the actual impact of this price control was predictable: not enough fuel to go around as the quantity demanded exceeded the quantity supplied, leading to shortages and rationing at the pump.

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Sep 06 2007

A supply and demand mystery… to be solved by you!

Demand Down, but Rents Up –

Alright, AP students… you are economics detectives and you’ve been assigned your first case. The mystery is thus: how can decreasing demand cause prices to go up? In chapter three, we are reading about product markets, the interaction of supply and demand, and market equilibrium price and quantity. You’ve read that prices are affected by the interaction of supply and demand. Clearly, if demand for a product rises, prices should go up unless supply increases a certain amount. On the other hand, if demand falls, then prices should fall unless supply falls at the same time.

So what’s happening in the article above? The headlines seems to proclaim an economic impossibility is occurring: as demand falls, prices rise! How is this possible? Is it? Is the market for apartments in the D.C. area defying the laws of demand and supply? Read the article and see if you can solve this economic mystery!

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Aug 09 2007

Return to Shanghai, and a supply/demand paradox

While students and teachers across America settle into their summer routine and look forward to three more weeks of summer vacation, the first week of August marks an unseen exodus of thousands of international students and teachers in countries on every continent. For some reason, international schools all seem to start about two weeks earlier than the post-Labor day start date enjoyed by most public school in the US. Here at Shanghai American school, teachers arrive in droves around the 7th and 8th of August, just in time for our first work day on the 9th.
Shanghai then
My wife and I returned to 95 degree heat from the pleasant 70’s of Seattle last night to begin preparing for our second year at Shanghai American School. In a week SAS will welcome around 2900 students, making it one of the largest international schools in the world. As part of our orientation this morning, our director, Dr. Dennis Larkin, shared a bit of SAS’s 95 year history with the faculty, enlightening many of us to the school’s storied past stretching back to the concession era of Shanghai’s “golden age” when thousands of Westerners made their settlements in the city’s center. 100 years ago Shanghai underwent a renaissance unseen in China’s thousands of years of history. European influence brought the city into the 20th century architecturally, culturally, economically, and perhaps more notoriously in the realm of criminal activity as gangsters took over the city through much of the 20’s and 30’s.

With the large Western presence came a demand for Western schools, thus in 1912 Shanghai American School welcomed its first class of 12 students. By the 20’s enrollment rose to 600, and by the 30’s it approached 1,000. In 1937 China was invaded by Japan, and foreign firms and embassies began nervously moving their people out of Shanghai. By 1939 Shanghai had fallen to the Japanese and the school grounds were occupied by Japanese troops. But with the surrender of the Japanese in 1945, the school was back in operation, albeit for only a short time as a civil war between the Chinese Communist Party and the US backed Nationalists brought violence to the streets of Shanghai once more. By 1950 Beijing had fallen to Mao and the Communists, and SAS was shut down “for good”. Its doors would remained closed for 30 years until 1980, when Mao had died and Deng Xiaoping had ushered in the era of “Reform and Opening”, a euphemism for westernization. Once again SAS opened for business.Shanghai American School now

In the 27 years since the school’s rebirth, the student body has grown from the seven children of American diplomats to 2,900 students from over 50 countries. In the last five years alone the student body has nearly doubled in size, as the school has added a second campus and countless new buildings to serve the growing population of foreigners in Shanghai. Over the same 27 years, around ten other international schools have opened in Shanghai, some with two or three campuses spread across the vast city, several serving over 1000 students also from scores of foreign countries. What impact has the opening and expansion of SAS and other international schools had on tuition paid by foreign students in Shanghai? You may think that with so many schools competing to attract students, each school would have to lower its fees in order to attract students away from its competitors. Well, you’d be wrong. SAS increased its tuition fees by 10% this year, bringing a year’s tuition to around $22,000. Its competitors charge something in the same ballpark, meaning a year of schooling at any of Shanghai’s international schools will cost a family more than a year’s tuition at most state universities in the US.

Discussion Questions:

So, what does all this history and data have to do with economics? Here’s a simple supply and demand question for you. In 1980, international schools in Shanghai had room for, let’s say 20 students total. I am not sure, but I’d guess tuition in 1980 probably ran around $2,000. Today, there are somewhere around 10 international schools with room for probably around 10,000 students, and the average tuition is somewhere in the realm of $20,000.

  1. How would an economist explain the 1,000% increase in tuition over the last 27 years, given the fact that today international schools in Shanghai have the capacity to serve 500 times as many students as they could in 1980?
  2. Could you draw a supply and demand diagram illustrating the changes that have occurred since 1980 in the market for international education in Shanghai?
  3. Let’s be honest, $22,000 is a lot of money for a year of school. What would have to happen in the market for international education in Shanghai for the tuition fees to go down? Identify two scenarios that would result in a tuition decrease. Illustrate these scenarios on your diagram.

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