Common Agricultural Policy Part 2 - Declining Farm Incomes

The next thing the CAP aims to eradicate is declining farm incomes. These are mainly caused by two things: low income elasticity of demand and/or increases in supply. As usual, we'll display this diagrammatically. Lets suppose we have a fairly inelastic demand curve and at the same time farm efficiency has improved, we can expect the market to now look as follows:

We can see that prices have fallen from P1 to P2 and quantity has risen from Q1 to Q2. However, we can also see that this has caused a fall in income of area a and an additional income of area b for the farmers. Area a is clearly larger than area b, meaning the farmers income as a whole has fallen. The way for farmers to gain is for demand to shift out by a larger amount, as even a small shift in demand would leave farm incomes still falling. 

What the farmers need is a more elastic demand curve for any increases in supply efficiency to actually increase farmers income. However, demand for grown crops is generally more inelastic because it's a necessity and therefore a change in price really doesn't affect demand all that much. This is why the government needs to intervene with the CAP because else there would be no incentive for farmers to make their production mechanisms more efficient as they'd effectively be losing money due to it.

Now we have covered both reasons as to why the CAP is necessary; fluctuating crop prices and declining farm incomes. We will next cover how the EU uses it's policies to correct these issues. Stay tuned!

Sam.

Common Agricultural Policy Part 1 - Price Fluctuations

The Common Agricultural Policy is a massive deal in Europe and the European Union. It's a very expensive policy that started out back in 1962 as a simple price support policy. It has two key objectives: to stabilise prices and to provide income support for social reasons. If you look at the distribution of farms across Europe, it is clear to see why this is needed. The biggest 7% of farmers own roughly half the land, whilst the smallest 50% of farmers own only 7% of land. This is a massive inequality and could lead to monopoly powers, outlandish prices and other such problems if it went unregulated.

We'll first look at a few of the characteristics of the agricultural industry. There are many producers, all are price takes. There are also many consumers, all of which are also price takers. There is generally freedom of entry and exit into the industry. It's about as close to perfect competition as you could get in a realistic scenario. Governments need to intervene for many reasons:

• To reduce price fluctuations.
• Raise farm incomes.
• Protect rural communities.
• To encourage greater self-sufficiency.

Firstly, I'm going to focus on the price fluctuations. In the short term they are caused by instability and the fluctuations in the harvest (good or bad!). Let's assume that the demand for a crop were to rise one year, which would cause a shift to the right of the demand curve. Supply in the short term obviously cannot react to this because supply is fixed each year depending on what is planted. This demand rise will cause a rise from price P1 to P2. This is all shown on the diagram below.

The farmers observe this rise in price and then next year they increase their supply to the market. At P2 the farmers decide that Q2 is the correct quantity to supply to the market. However, at this amount supplied, demand is outstripped and therefore price must fall to P3. The year after, at price P3 a different amount is supplied by the farmers, but at this supply more is demanded and therefore price rises again. This will continue, as shown on the diagram below we can see that the market is slowly spiralling towards a point of equilibrium at which both consumers and producers would be happy. 

We call this concept a stable cobweb. This price fluctuations and changes are supply are making the market more and more stable as over time the fluctuations get smaller until equilibrium is finally met. In this case, the government wouldn't need to intervene in the agricultural industry. However, there is the opposite case. An unstable cobweb could appear. The case of this occurs when the supply of the crop is very elastic. Diagramatically, the supply curve will be much flatter. The same instance as above will occur, demand increases causing a price rise as supply is fixed. In the second term supply is increased due to this new price, but there is oversupply and price has to fall... and so on and so forth. Except, when the supply curve is elastic this doesn't spiral towards equilibrium, it spirals away from it as can be seen in the diagram below.

This shows one of the cases in which the government would need to intervene in the agricultural industry, hence the Common Agricultural Policy. The price fluctuations in this unstable cobweb would keep getting worse and worse if left to market forces. 

Next we'll move on too supply side shocks. This is when supply is affected, either for good or for bad, and therefore the supply of the crop isn't as expected. Once again, diagrams are an easier way of showing this. The first case will be a bad harvest, where supply of the crop is less than what was expected. The diagram below shows this. Supply of the crop has fallen from the expected level of Qe to the actual level of Qa. The area labelled 'b' is income that the farmer has lost, the area labelled 'c' is income gained from this supply side shock. The expected income for the farmer was area 'ab', but the actual income of the farmer is now area 'ac'. If area c is greater than area b then the farmer has gained, otherwise the farmer has lost out due to the bad harvest. Generally, the more inelastic demand is, the greater are 'c' is and therefore the more likely the farmer will benefit. 

I'll quickly go through the other supply side shock as well. As you can guess, this is when there is a better harvest than expected. This causes a shift to the right of actual supply from Qe to Qa. A fall in price is seen from Pe to Pa and once again the farmers income may be affected. Area 'c' is the income gain, area 'b' is the income loss and area 'a' is the income that has stayed constant. If area 'b' is bigger than area 'c' then the farmer has lost out. 

What we have achieved in this blog post is the causes of the fluctuations in prices of harvested goods. This is one of the things the Common Agricultural Policy aims to stop, as stable prices is an aim. In the next post we'll look at what is causing the decline of farmers income and then we'll move on to look at how the government intervenes in this policy to correct these issues.

Stay tuned guys, enjoy!

Sam.

Principles of Economics: Revenue (Microeconomics)

* Sorry about the delay with this post, I've had a busy week and have just got round to writing this up. But I'll have another one up tomorrow as well to make up for it. *

Right, today's post will be relating to revenue and more specifically a firms revenue. We'll start with a few of the basic bits of terminology that I'll be using throughout this post. Firstly, total revenue. This is fairly self-explanatory but I'll give a definition anyway. Total revenue is a firms total earnings in a period of time from the sale of a particular amount of goods, the formula is better known as price x quantity. Average revenue next and this is the amount a firm earns for each unit sold, the formula for this is (total revenue) / (quantity) which you may have noticed just equals price. Marginal revenue is the final term, this refers to the extra revenue gained from selling one more unit of a good. The formula for marginal revenue is (change in total revenue) / (change in quantity).

We'll first look at the revenue curves for a small firm. We'll be assuming this firm is in a perfectly competitive market (Will do a blog post on this later today/tomorrow). Basically, this means that the firms are generally too small to have any effect on the price of the good they are selling. If they raise their price no-one will buy from them, if they lower their price they will find an overwhelming demand and probably be charging less than the cost to produce the good. That being said, the market forces determine the price the firm has to charge.

As you can see here, the demand and supply have met in the market and this has created a price for the good. The firm, shown on the left has a demand curve of this price because consumers will only buy from the firm at this price. No matter the quantity, the price will remain the same. Another note on this, D = AR = MR because the price is constant. The average revenue and marginal revenue will always be the same because we are working with a constant price.  We can model the total revenue of a firm as well. This is simple, first we create a table with the quantity supplied, price and total revenue. We then plot this table. Simple.

Simple as that for a total revenue curve for a small firm. However, when it comes to larger firms and the price of the good does vary with output we are struck with a different scenario. The average revenue curve is still equal to the price and will be the demand curve, but this time it will be downward sloping as with the normal characteristic of demand. The marginal revenue curve will also be downward sloping, but at a faster rate than the average revenue curve and will more than likely reach negative values. This is due to the diminishing marginal rate of production, the marginal revenue falls with each additional good you produce up to a point where producing another good will generate no additional revenue and may even decrease revenue. Before the quantity where marginal revenue equals zero, the average revenue is elastic because an increase in quantity will lead to a rise in revenue. After this point, it's inelastic because a rise in quantity leads to a fall in total revenue. 

And all that's left to add to this is the shape of the total revenue curve when the price varies with output. I should note, this happens in larger firms when they can effect the market price. The total revenue curve would be somewhat hill shaped. It would slope up, reach a peak at some unknown point and then slop down again afterwards. You may be thinking "Ok, great... Why?"! Well, this will come in useful in the next posts when we look at profit maximisation of a firm. 

Thank you for reading again, keep watching for the next few posts which will relate and link to this one. Have a good day!

Sam. 

News Story - Scrapping Price Controls on Postage Stamps?

News today in an article in the Daily Mail suggest that current controls on the price of stamps could be scrapped, leaving Royal Mail to set their own prices without any challenge. Now, this post will be a discussion about whether this is beneficial to us, the consumers, and to Royal Mail itself.

The price of stamps are to rise on Monday anyway: first class stamps will rise by 12.2%ish and second class by 12.5%, meaning postage is getting more expensive anyway. But with the latest news, it could get worse. However, the real question is will this have any effect on consumers or on the Royal Mail itself?

A natural course of events should take place; price rises so demand will fall, probably at a lesser rate because stamps are currently still a necessity so the price of them will be very much inelastic. The families on lower incomes will be hit the hardest as it's a larger percentage of their income being spent on the stamps. But with  technology nowadays, the internet mainly, i question whether the price rises will be of any good to the Royal Mail. In 2010, 60% of adults accessed the internet every day - using the internet means access to e-mail, which means information can be sent in an alternative way to the mail... cutting out the need for letters to be sent. Plus, whats more, the internet can be seen as more reliable, quicker, easier and cheaper than the post anyway, leaving the Royal Mail in a sticky situation. I mean, come-on, if you have the choice out of sending an email (from the comfort of your own home, with no direct charge and knowing it will reach the destination almost instantly) or sending the same message in a letter (by leaving the house and heading to a post-box, paying directly for a stamp and knowing it will be at least a few days before it reaches the destination), it's not a hard choice.

Parcels and packages are where the Royal Mail might get lucky. As is fairly evident, you cannot send a parcel over the internet - for the not so bright ones out there. This means they have to be sent in the mail, 'ca-ching' for Royal Mail (you'd think)! Oh, but maybe not so lucky if you see the competition in this market.. plenty of other firms offer the package sending service cheaper and more efficiently than Royal Mail do. Ouch!

Last year, the Royal Mail lost £163 million on stamped mail, equivalent to 6.4p for every item handled, so therefore the price rises are justified. But from my point of view, it seems to be a dying industry... The internet is taking over and i feel that raising prices further will just encourage more people to seek alternative methods of communication and make the position of Royal Mail worse. What's more, they don't seem to do themselves any favors anyway - the service is still annoyingly adequate with mail going missing, late post and other such things. So, maybe if they sorted out  their current issues and restored the publics faith in the mail service first, they may have success increasing prices!

Full article at: dailymail.com... Got a view on this issue? Comment away. Thanks for reading.