If there is one profession that requires a firm understanding of profit-maximization, it's farming. Farmers must respond
Question:
If there is one profession that requires a firm understanding of profit-maximization, it's farming. Farmers must respond to constantly fluctuating prices for their output, as well as constantly changing input prices. Furthermore, the farming industry satisfies the condition of a competitive market because it is composed of thousands of individual price-taking farmers.
For a good illustration of farmers' economic acumen we can look at the recent history of American crop and farmland prices for the years 2003 to 2013. During this decade, prices for corn and soybeans rose steadily, reaching an all-time high in 2012 and 2013 as corn prices quadrupled and soybean prices tripled.
This long-term rise was mainly due to two demand-based factors. First, corn prices benefited from a congressional mandate (2005 Energy Policy Act) to increase the use of corn-based ethanol, a biofuel that is blended into gasoline, as a means of reducing American dependency on imported oil. Second, crop prices were pushed upward by rapidly rising exports to China and other developing countries.
Being smart profit-maximizers, farmers responded by farming their land more intensivelyusing more fertilizer, for example and by increasing their acreage. By 2013, fertilizer prices had doubled compared to 2005. And over the decade from 2003 to 2013, the average price of farmland tripled, with some farmland selling for 10 times its 2003 price.
Doing this made complete economic sense, as each farmer moved up his or her individual supply curve. And because the individual supply curve is the marginal cost curve, each farmer's marginal cost also went up as more inputs were employed to produce more output.
By 2016, crop prices fell by more than 50% from their 2012 high as the oil boom from fracking pushed down the price of ethanol and a strong U.S. dollar reduced the demand by foreign buyers for American crops. On the supply side, bumper harvests in 2014 sharply depressed crop prices.
Thinking like economists, farmers responded by moving back down their supply curve, withdrawing from production the most expensive lands to cultivate and reducing their demand for additional acreage. As a result, the average price of Iowa farmland fell by 12% from 2012 to 2015, and unsurprisingly, the price of fertilizer fell significantly as well.
1. How did farmers respond to increases in the price of corn as a result of the 2005 Energy Policy Act?
2. In the long run, how did the Energy Policy Act affect individual farmers' costs and profits?