When I saw the headline this week that crop conditions in the United States were good and those in Minnesota unprecedentedly favorable, my first reaction was sympathy for my friends and relatives who farm. ‘Well, that’s too bad,’ I thought.
It may seem paradoxical, but while high crop yields at an individual farm are always good news for that farmer, they often are bad for farmers as a group. Years with very high national yields seldom are ones with high farm incomes. Rural areas can certainly use some strong income right now. So the prospects of a bumper crop are not all positive.
This year may be different. Demand for Minnesota’s corn, soybeans and wheat is up, partly because of bad growing conditions elsewhere in the world. But farmers remain wary, for good reason.
Basic interactions of supply and demand often mean that high yields result in low incomes. For any given level of demand, a greater quantity supplied means a lower price. Under some conditions, the effect of the decrease in price outweighs that of the increase in quantity sold. Total revenue to the producer-seller actually falls. Farming often faces such conditions.
The problem is that both the supply of farm products and the demand for them are “inelastic.” So a small change in quantity is associated with a large change in price.
Supply is inelastic because many of the production costs in agriculture, including the land itself and the machinery needed to farm it, are fixed costs that must be paid regardless of farm product prices. The core idea of supply is that as prices rise, producers increase output and that as prices fall, output decreases. That still is true for crops, but because so many inputs are fixed costs, price has to drop a great deal to reduce output very much. That is what economists call “inelastic supply.”
Demand also is inelastic in that people don’t buy much less even when prices rise because farm products still are mostly food, and food is a necessity. If the prices of bowling or champagne rise, people buy much less of these goods because you don’t need to go bowling or drink champagne. But you do need to eat. People may shift from more expensive food items to thriftier ones and they may eat more at home rather than going out, but they don’t cut their total food consumption much. The flip side is that when food prices fall, people don’t necessarily buy a lot more.
Combine inelastic supply with inelastic demand, add a summer of favorable weather, and crop product prices can fall much below where they would be if growing conditions were not as good. Even multiplied by many more bushels, a lower price can mean so-so farm incomes.
If that sounds challenging, the picture is even more complicated for those who raise livestock. (Many Minnesota farmers raise both.) For those with livestock, high grain prices are not necessarily a blessing. It is the spread between the prices of feeds used and the milk or meat produced that is important. So lower feed costs from a bumper crop can increase profits for livestock-intensive farms.
Right now, crops generally are good across much of the United States, although Minnesota stands out, especially for corn and soybeans. But there are bad crop conditions in some other places in the world.
Indeed, news of adverse wheat-growing conditions in parts of Russia and Canada boosted prices for that crop last month. And economic growth in other parts of the world, especially China and the rest of Asia, foster higher total world food demand. So factors outside the United States may keep prices up even if total crop production is high.
Farmers know by experience that the worst possible situation is to have a bad crop, perhaps due to hail or localized drought, while the rest of the country has a good crop. You don’t have much quantity because of your local problems, and price is low because production was good elsewhere. Conversely, the best possible situation is to have a good crop locally while the rest of the nation or world has a bad one. You have much to sell and get a good price for it. Minnesota is edging toward that favorable end of the scale right now.
And one must also keep in mind that farmers are only part of the rural economy and only part of the food chain. Trucking grain and livestock; drying, storing and processing crops products, supplying inputs like LP gas for crop processing; and selling and fixing farm machinery all are important economic activities in farming areas. And, unlike crop production itself, this work is directly tied to crop volumes and not highly affected by crop prices. Corn has to be dried, stored and hauled whether the farmer is getting $2 per bushel or $6 per bushel. So for the hundreds of thousands of people who work in these sectors, a big crop is generally good news.
The one person not mentioned so far is the consumer. For most of human existence, the size of the crop was one of the most important variables for society. But in our country, the price of food has fallen so far, both in inflation-adjusted prices and as a proportion of household income, that the effects of a good or bad crop go completely unnoticed by most households. That is a blessing many don’t appreciate.
© 2010 Edward Lotterman
Chanarambie Consulting, Inc.