lecture 4: common agricultural policy based on sloman chapter 3.4 and chapter 8, swann lecture 4:...
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Lecture 4: Common Agricultural Policy
Based on Sloman Chapter 3.4 and Chapter 8, Swann
Lecture 4: Common Agricultural Policy
Based on Sloman Chapter 3.4 and Chapter 8, Swann
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CAP- The Common Agricultural policyCAP- The Common Agricultural policy
• Massively complex, massively expensive Massively complex, massively expensive policy.policy.
• Hard to understand without seeing how it Hard to understand without seeing how it developed.developed.
• CAP started as simple price support policy CAP started as simple price support policy in 1962.in 1962.
• Objective: To stabilise prices Objective: To stabilise prices • AND provide income support for AND provide income support for
social reasonssocial reasons
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Farm Size Distribution in EU(1987)Farm Size Distribution in EU(1987)Very skewed ownership:
• biggest 7 per cent of farmers owned ½ of the land• smallest 50 per cent of farmers owned only 7 per cent of the land.
Source: Baldwin & Wyplosz
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Changes in Farm size 1970-1987Changes in Farm size 1970-1987
Source: Baldwin & Wyplosz
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AGRICULTURE AND AGRICULTURAL POLICYAGRICULTURE AND AGRICULTURAL POLICY
• AgricultureAgriculture– Many producers, all price takersMany producers, all price takers– Many consumers, all price takersMany consumers, all price takers– ‘‘free’ entry and exitfree’ entry and exit– As close to perfect competition as could As close to perfect competition as could
imagineimagine
• So why intervene in Agriculture sector?So why intervene in Agriculture sector?
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AGRICULTURE AND AGRICULTURAL POLICYAGRICULTURE AND AGRICULTURAL POLICY
• Why governments intervene in agricultureWhy governments intervene in agriculture– to reduce price fluctuationsto reduce price fluctuations– to raise farm incomesto raise farm incomes– to protect rural communitiesto protect rural communities– to encourage greater self-sufficiency in foodto encourage greater self-sufficiency in food
• Causes of short-term price fluctuationsCauses of short-term price fluctuations– fluctuations in demand & instabilityfluctuations in demand & instability– fluctuations in the harvestfluctuations in the harvest
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fig
Suppose we have a crop which takes a year to grow and is grown only
once year,
DA
P1
Q1
P
Q O
a
SAe.g. Hops for Beer
Suppose now that demand were to rise but supply
cannot respond immediately
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fig
What will happen to Price?
Suppose we have a crop which takes a year to grow and is grown only
once year,
DA
P1
Q1
P
Q O
a
SAe.g. Hops for Beer
Suppose now that demand were to rise but supply
cannot respond immediately
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fig
So price rises to P2
Since supply is fixed, the price is determined by the available supply at Q1.
DA
P1
Q1
P
Q O
a
DB
P2
SA
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• But next period farmers observe that the price of hops was very high
• So now they all want to grow hops
• At P2, what will the supply be?
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fig
DA
P1
Q1
P
Q O
a
DB
P2
At P2, the following year
supply increases to Q3
Q3
SA
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fig
DA
P1
Q1
P
Q O
a
DB
P2
But now Supply exceeds demand so price must fall to P3
Q3
P3
SA
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fig
DA
P1
Q1
P
Q O
a
DB
P2
Q3
P3
Q4
But next period farmers see lower price and decide to supply less: Q4
SA
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fig
DA
P1
Q1
P
Q O
a
DB
P2
Q3
P3
Q4
Notice here that we are spiraling through time to an equilibrium
This is a stable Cobweb
SA
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fig
Suppose instead that the supply curve was very flat.
DA
P1
Q1
P
Q O
a
SA
Now what will happen to Price?
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fig
Suppose instead that the supply curve was very flat.
DA
P1
Q1
P
Q O
a
SA
Now what will happen to Price?
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fig
Since supply is fixed, again the price must rise to P2
P1
Q1
P
Q O
a
DA
DB
SA
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fig
Since supply is still fixed at Q1, again the price must rise to P2
P1
Q1
P
Q O
a
DA
DB
SAP2
But next period farmers observe that the price of hops was
very high
So now they all want to grow hops
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fig
DA
P1
Q1
P
Q O
a
DB
P2
Now Supply Increases to Q5
Q5
SA
At P2, what will the supply be in this case?
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fig
DA
P1
Q1
P
Q O
a
DB
P2
Q5
SA
But again Supply exceeds demand so price must fall to
P5
P5
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fig
DA
P1
Q1
P
Q O
a
DB
P2
Q5
SA
But at P5 next period farmers
decide to supply Q6
P5
Q6
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fig
DA
P1
Q1
P6
Q O
a
DB
P2
Q5
SA
But if only Q6 is supplied demand will exceed supply
and price will rise to P6
P5
Q6
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fig
DA
P1
Q1
P6
Q O
a
DB
P2
Q5
SA
P5
Q6
But Now the price and quantity are gradually spiraling away from equilibrium.
This is an unstable cobweb.
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Summary of Cobweb Effects
• With a demand SHIFT and supply fixed yearly, a sudden rise in demand will see a big increase in income.
• The lagged response next year can generate cyclical fluctuations in prices over the next few years.
• When Q goes up and P fall, income PxQ can also fluctuate.
• Not all cobwebs are stable
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fig
Supply Side Shock
D
PE
QE
P
Q O
e
LRS
LRS is the long-run supply curve.
SRSE is the expected supply this year.
SRSE
PA
QA
SRSA
SRSA is the actual supply this year. e.g. Bad harvest
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fig
Supply Side Shock
D
PE
QE
P
Q O
LRS
So price rises, what about income?
PEeQEO=ab is expected income
SRSE
PA
QA
SRSA
ac= actual income
Overall depends on size of c relative to b
e
a
b
c
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fig
Supply Side Shock
D
PE
QE
P
Q O
LRS
If demand is more inelastic, c>b and income rises.
SRSEPA
QA
SRSA
ac= actual income
Overall depends on size of c relative to b
e
a
b
c
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fig
Supply Side Shock
D
PE
QE
P
Q O
LRS
But if it is a good crop and demand is inelastic,
SRSE
PA
QA
SRSA
c < b and income falls
So variability in incomes leads to pressure for government intervention
e
a
b
c
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REASONS FOR INTERVENTIONREASONS FOR INTERVENTION
• Causes of short-term price (and income?) Causes of short-term price (and income?) fluctuationsfluctuations– fluctuations in demand fluctuations in demand – fluctuations in the harvest (supply)fluctuations in the harvest (supply)
• Causes of declining farm incomesCauses of declining farm incomes– low income elasticity of demandlow income elasticity of demand– increases in supplyincreases in supply
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Decline in farm incomes over time 1Decline in farm incomes over time 1
P
Q O
P1
D1
S1
Q1
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P
Q O
P1
P2
D1
S1
S2
Q1 Q2
An improvement
in farm efficiency!
But with inelastic demand,
income will fall as before
Decline in farm incomes over time 1Decline in farm incomes over time 1
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P
Q O
P1
P2
D1
S1
S2
D2
Q1 Q2
How might farmers gain?
Need an increase in
demand due to rising
income in other sectors.
But if demand does not move out much there may be no
income gain
Decline in farm incomes over time 2Decline in farm incomes over time 2
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P
Q O
P1
P2
D1
S1
S2
D2
Q1 Q2
If income elasticity of demand is low, the D curve only
moves out a little and
there may be no income
gain
Decline in farm incomes over time 3Decline in farm incomes over time 3
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Evidence on Income elasticities of demand for Evidence on Income elasticities of demand for various foodstuffsvarious foodstuffs
Note NEGATIVE values imply these are inferior goods so demand falls as income rises
Source: Sloman from; National Food Survey 2000 (National Statistics, 2001), extracted from Tables 6.1, 6.3, 6.4 and 6.5
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RECAP on REASONS FOR INTERVENTION in RECAP on REASONS FOR INTERVENTION in Competitive marketCompetitive market
• Causes of short-term price fluctuationsCauses of short-term price fluctuations– fluctuations in demand fluctuations in demand – fluctuations in the harvest (supply)fluctuations in the harvest (supply)
• Causes of declining farm incomesCauses of declining farm incomes– increases in supplyincreases in supply– low or negative income elasticity of demandlow or negative income elasticity of demand
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AGRICULTURE AND AGRICULTURAL POLICYAGRICULTURE AND AGRICULTURAL POLICY
• Types of government intervention in Types of government intervention in agricultureagriculture– buffer stocksbuffer stocks
– subsidiessubsidies
– high fixed priceshigh fixed prices
– reducing supplyreducing supply
– structural policiesstructural policies
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Buffer stocks to stabilise pricesBuffer stocks to stabilise prices
P
Q O
Pg
D
Q1
Existed in all six original member
states
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Buffer stocks to stabilise prices 1Buffer stocks to stabilise prices 1
P
Q O
Pg
D
Sa1
Qs1Q1
Bought into buffer stock
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Buffer stocks to stabilise prices 2Buffer stocks to stabilise prices 2
P
Q O
Pg
D
Sa2
Qs2
Released from buffer stock
Q1
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Buffer stocks to stabilise prices 3Buffer stocks to stabilise prices 3
P
Q O
Pg
D
Sa2
Qs2
But income still fluctuating, now worse
Extra income in good timesIncome
in Bad Times N
orm
al
Q1
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AGRICULTURE AND AGRICULTURAL POLICYAGRICULTURE AND AGRICULTURAL POLICY
• Buffer stocksBuffer stocks– buffer stocks to stabilise pricesbuffer stocks to stabilise prices
– buffer stocks to stabilise farm incomesbuffer stocks to stabilise farm incomes
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Recall Elasticity FormulaRecall Elasticity Formula
0
01
0
01
Dp
PPP
QQQ
Pd
If elasticity equals 1 it means the percentage increase in quantity is
the same as the percentage fall in prices
So if the percentage price and income change is the
same then income stays the same
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Buffer stocks to stabilise incomesBuffer stocks to stabilise incomes
P
Q O
D
aP1
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P
Q O
D
Y
aP1
Pd = 1
Buffer stocks to stabilise incomesBuffer stocks to stabilise incomes
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P
Q O
D
Sa2
Q2Q1
Sa1
Y
aP1
Buffer stocks to stabilise incomes 1Buffer stocks to stabilise incomes 1
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P
Q O
D
Sa2
Q2Q1
Sa1
Y
aP1
P2
Buffer stocks to stabilise incomesBuffer stocks to stabilise incomes
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P
Q O
D
Sa2
Q2Q1
Sa1
Q2
Y
ab
c
P1
P2
P2
Bought into buffer stock
Buffer stocks to stabilise incomesBuffer stocks to stabilise incomes
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P
Q O
D
Sa3
Q3 Q1
Sa1
Y
aP1
Buffer stocks to stabilise incomes 2Buffer stocks to stabilise incomes 2
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P
Q O
D
Sa3
Q3 Q1
Sa1
Y
aP1
P3
Buffer stocks to stabilise incomesBuffer stocks to stabilise incomes
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P
Q O
D
Sa3
Q3 Q1
Sa1
Q3
Y
a
de
P1
P3
P3
Released from buffer stock
Buffer stocks to stabilise incomesBuffer stocks to stabilise incomes
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AGRICULTURE AND AGRICULTURAL POLICYAGRICULTURE AND AGRICULTURAL POLICY
• SubsidiesSubsidies
– effects on price and outputeffects on price and output
– the incidence of a subsidythe incidence of a subsidy
– Subsidy is an amount paid for every unit Subsidy is an amount paid for every unit
produced. It reduces the cost to the farmer of produced. It reduces the cost to the farmer of
supplying the good and moves the supply supplying the good and moves the supply
curve down and out.curve down and out.
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Effect of subsidies on foodstuffs in which the country is self-sufficient Effect of subsidies on foodstuffs in which the country is self-sufficient 11
P
Q O
D
Qe
Pe
S
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Effect of subsidies on foodstuffs in which the country is self-sufficientEffect of subsidies on foodstuffs in which the country is self-sufficient
P
Q O
D
Qe
Pe
S + subsidy
S
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Effect of subsidies on foodstuffs in which the country is self-sufficientEffect of subsidies on foodstuffs in which the country is self-sufficient
P
Q O
D
Q1Qe
Pe
P1
S + subsidy
S Note at Pe farmers willing to supply Q2,
But then Supply exceeds demand
Q2
so price must fall to P1
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Effect of subsidies on foodstuffs in which the country is self-sufficient Effect of subsidies on foodstuffs in which the country is self-sufficient 22
P
Q O
D
Q1Qe
Pe
Pg
P1
S + subsidy
S
Sub
sidy
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Effect of subsidies on foodstuffs in which the country is self-sufficientEffect of subsidies on foodstuffs in which the country is self-sufficient
P
Q O
D
Q1Qe
Pe
Pg
P1
S + subsidy
S
Sub
sidy Note two parts to the subsidy
in this example:
1. Getting higher price Pg
2. But also selling more, S1
Depends on pD
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Effect of subsidies on foodstuffs which are partly importedEffect of subsidies on foodstuffs which are partly imported
P
Q O
D
Pw
SEU
Sworld
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Effect of subsidies on foodstuffs which are partly importedEffect of subsidies on foodstuffs which are partly imported
P
Q O
D
Qd
Pw
SEU
Sworld
QS1Imports
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Effect of subsidies on foodstuffs which are partly importedEffect of subsidies on foodstuffs which are partly imported
P
Q O
D
Qd
Pw
S + subsidy
SEU
Sworld
QS1
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Effect of subsidies on foodstuffs which are partly importedEffect of subsidies on foodstuffs which are partly imported
P
Q O
D
QS2Qd
Pw
S + subsidy
SEU
Sworld
QS1Imports
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P
Q O
D
QS2Qd
Pw
Pg
S + subsidy
SEU
Sworld
QS1
Effect of subsidies on foodstuffs which are partly importedEffect of subsidies on foodstuffs which are partly imported
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P
Q O
D
QS2Qd
Pw
Pg
S + subsidy
SEU
Sworld
QS1
Effect of subsidies on foodstuffs which are partly importedEffect of subsidies on foodstuffs which are partly imported
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Problems of OversupplyProblems of Oversupply
• EU switches from net food import to exporter in EU switches from net food import to exporter in most products.most products.
Source: Baldwin & Wyplosz
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EU citizen Attitudes to the CAPEU citizen Attitudes to the CAP
• Support among those questioned for direct Support among those questioned for direct support to farmers was on average 62support to farmers was on average 62
• 42% - in the number of respondents who 42% - in the number of respondents who felt that the CAP ensured that agricultural felt that the CAP ensured that agricultural produce was safe to eat produce was safe to eat
• Lack of information continues to be a Lack of information continues to be a problem -'Don't know' answers in the poll problem -'Don't know' answers in the poll ranged from 24 - 35%.ranged from 24 - 35%.
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EU citizen attitudes to the OBJECTIVES of the CAPEU citizen attitudes to the OBJECTIVES of the CAP
Question New EU 15
Should the EU use its agricultural policy to….. Yes Yes
ensure that agricultural products are healthy and safe? 88% 90%
favour and improve life in the countryside? 88% 77%
ensure stable and adequate incomes for farmers? 86% 77%
promote the respect of the environment? 84% 87%
help farmers to adapt their production to consumers' expectations? 84% 80%
protect medium or small sized farms? 83% 81%
defend farmers' interests in their dealings with intermediaries and distributors ? 81% 69%
make European agriculture more competitive on world markets? 80% 77%
encourage the diversification of agricultural products and activities? 80% 73%
reduce development disparities between regions? 80% 72%
protect European agricultural products? 78% 73%
favour methods of organic production? 69% 72%