A Price Floor in the Produce Business

A Price Floor in the Produce Business

When faced with life’s unfairness we all ask ourselves why and what could be done to help. Although, lately, we only wonder what politicians would have to do to fix things for us.

In the years of low agricultural prices we realize how unfair the industry is. While some continue to earn (or lose little), farmers lose money and their livelihoods are at stake. Farmers feel helpless. They have done what they were supposed to do: cultivate a product with quality in a timely manner. And yet, they are not adequately compensated for their effort.

For many years, farmers, coworkers, journalists, activists and many friends have asked me:

  • If the problem is low prices, why governments do not set a legal minimum price?

And I usually answered the best I could while trying to be empathetic with the hardships and bitterness of the questioner:

  • Dear Friend. I wish we could solve complex problems with simple solutions. If we want to get paid a better price for our products, we will hardly get it with a governmental price control policy.
  • But why not? – My interlocutors used to insist.

And from that point on I was in trouble. Let’s see if I can provide a good simple answer.

The problem is not new. In fact, the case of agricultural prices is very old. I’m not going back to the seventeenth century to talk about Mr. King (If you want to know more, see this past article about Mr. King) but I’ll tell you that it has been a never-ending discussion topic ever since. And even the initial principles of the CAP (Common Agricultural Policy) of the EEC (European Economic Community) were built based on the control of agricultural prices to provide “abundant and cheap food while guaranteeing farmers’ incomes”.

So, what happened?

Let’s start with a bit of basic economic theory. “The market” is an abstraction that includes the purchasing decisions of all of us. We complain about the market but we are the market.

Consumers can generally share that it is an unfair that farmers do not receive enough money for their products, but at the moment of the purchase (in normal goods and especially in commodities) consumers buy at the cheapest possible price. Consumers (that is, all of us or the majority of us) are a lot more motivated to make ends meet, saving or paying less to have the opportunity buy other “valuable” things than in “helping the cause of agriculture”.

And being that way, we model markets (to understand them) with a few very simple rules. Offer (what we produce), Demand (what we buy), Price and Quantity. Where Supply meets (freely and without intervention) with the Demand an Equilibrium Price is set and so it is a Quantity. (See graph below)

But what happens when the public authorities intervene in the market by setting a minimum legal price. Here, the acclaimed economist Gregory Mankiw comes to the rescue with his book “Principles of Economics” to illustrate us about it.

Mankiw tells us that when a government establishes a minimum price, two scenarios are possible:

  • If the floor price is set bellow the equilibrium price is not binding and has no effect on the market outcome. So, nothing changes. It does not influence buyers and sellers.
  • If the equilibrium price is below the minimum price it becomes a binding constrain to the market. Now we see how.

The floor price control prevents supply and demand from reaching equilibrium at a lower price and a higher quantity. That is to say, when the market price reaches the minimum price, it cannot continue to fall and the consumption of that good is thus reduced, generating a surplus of supply in the short term. (See graph below)

Obviously, it is in the interest of farmers to receive a higher price than that given by the market equilibrium. And following this logic to aim that higher minimum price, I draw the previous graph (with a certain inclination-elasticity of the supply and demand lines) in which farmers clearly benefit from this price control (this is not always the case).

Even selling less, the income would be € 910 (new price of €14 X new quantity sold of 65 units) compared to the result of the free market equilibrium € 750 (Price of €10 x Quantity of 75 units).

Unfortunately, this has already been tested in the European CAP (especially in cereals and other agricultural commodities) and the following is a summary of the problems that were created with that price control policy:

Many more farmers were attracted to cultivate the products with these guaranteed minimum prices, generating even more production surplus and to avoid the escalation, the governments would subsequently establish a control of access to the cultivation of this product (for those familiar with the CAP: the famous historical “rights”).

– When, despite access control, the surplus of farmers with rights was found to be unmanageable, production quotas were introduced. That is, the minimum price will be only guaranteed for a certain maximum amount and even fines are delivered to whoever produces more. The world upside down: “If you are a good and efficient farmer, the system punishes you”.

– And what is to be done with the surplus? For the time being, compelling your consumers to buy the product from you. Market access must be closed to other producers outside the territory. But since we still cannot eat everything we produce, a system of export subsidies is put in place to compete in world markets and by doing this we sink the prices of farmers from the rest of the world.

And this is the reason why, in the successive rounds of the World Trade Organization, many of these practices have been limited, restricted and prohibited.

So it’s not going to happen. Let us stop useless debates that distract us from the main target. Raising the price paid for our products requires, above all, that we increase the value perceived by consumers of the product grown by farmers and also through increasing our bargaining power.

Even when, as in this news from France (see link), politicians advocate for a price control will be done in such way that the impact of the measure will be set below the current equilibrium price or directly be declared contrary to law. That is, it will never have any real effect on farmers’ income (or maybe a very negative one).

2018-12-11T15:41:29+00:00January 8, 2018|The Blog|0 Comments

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