October 30, 2010

Subsidies for WA wheat farmers; not a part of the "perfect mix"

This article, form the Spokesman, a Washington State news paper, discusses the prosperous wheat crop this year and the importance of the subsidies for farmers. They explain that farmers have the "perfect mix" this year, composed of good weather, higher prices, and subsidies. The article estimates that $70 million in federal subsidies will be given to Washington wheat farmers. This reminded me of our recent discussion about the pitfalls of setting a price floor. The author describes these as being both necessary and helpful, sating only convoluted reasoning for the subsidies, including the uncertainty of weather patterns and the fact that many Washington wheat farms are small family owned operations. The issues that the author stated are actually not relevant to the subsidies, which can hurt small farms by decreasing their market demand, increasing the number of firms without expanding demand, and decreasing their ability to compete with international markets.

Farm subsidies such as these are the result of the federal government imposing a price floor, which can be demonstrated in the following graph:

In the short run there is one major issue as seen in this graph, a price floor results in a surplus. In order to appease the farmers, who due to the policy, will not be able to sell all of the supply that they normally would, the government “buys back” crops in the way of subsidies. This means that the government is paying farmers to produce crops that they cannot sell instead of letting the market operate at equilibrium and allowing farmers to produce as much as demanded and selling their crops at the market price. In the long run there is another problem. Nothing is being bid up, as new firms enter the market, the. Thus the market for wheat (the market with the price floor) will never return to zero economic profit. This means that the market will not reach a long run equilibrium, and firms will continue to enter the market and increase the burden on consumers and tax revenue. Looking at the graph, if we assume P1 to be the price floor we can see that the market would be prevented from moving back to its equilibrium point.

No comments: