Can good news for farming be bad news for farmers?
Let’s now return to the question posed at the beginning of this chapter: what happens to wheat farmers and the market for wheat when university agronomists discover a new wheat hybrid that is more productive than existing varieties recall from chapter 4 that we answer such question in three steps. First, we examine whether the supply or demand curve shifts. Second, we consider which direction the curve shifts. Third, we use the supply-and-demand diagram to see how the market equilibrium changes.
In this case, the discovery of the new hybrid affects the supply curve. Because the hybrid increases the amount of wheat that can be produced on each acre of land, farmers are now willing to supply more wheat at any given price. In other words, the supply curve shifts to the right. The demand curve remains the same because consumers’ desire to buy wheat product at any given price is not affected by the introduction of a new hybrid. Figure 8 shows an example of such a change. When the supply curve shifts from S1 to S2, the quantity of wheat sold increases from 100 to 110, and the price of the wheat falls from $3 to $2.
But does this discovery make farmers better off? As a first cut to answering this question, consider what happens to the total revenue received by farmers. Farmer’s total revenue is PxQ, the price of the wheat times the quantity sold. The discovery affects farmers in two conflicting ways. The hybrid allows farmers to produce more wheat (Q rises), but now each bushel of wheat sells for less (P fall).
Whether total revenue rises or falls depends on the elasticity of demand. In practice, the demand for basic foodstuffs such as wheat is usually inelastic, for these items are relatively inexpensive and have few good substitutes. When the demand curve is inelastic, as it is in figure 8, a decrease in price causes total revenue to fall. You can see this in the figure: The price of wheat falls substantially, whereas the quantity of wheat sold rises only slightly. Total revenue falls from $300 to $220. Thus, the discovery of the new hybrid lowers the total revenue that farmers receive for the sale of their crops.
If farmers are made worse off by the discovery of this new hybrid, why do they adopt it? The answer to this question goes to the heart of how competitive markets work. Because each farmer is a small part of the market for wheat, he or she takes the price of wheat as given. For any given price of wheat. It is better to use the new hybrid in order to produce and sell more wheat. Yet when all farmers do this, the supply of wheat rises, the price falls, and farmers are worse off.
Although this example may at first seem only hypothetical, in fact it helps to explain a major change in the U.S. economy over the past century. Two hundred year ago, most Americans lived on farms. Knowledge about farm methods was sufficiently primitive that most of us had to be farmers to produce enough food. Yet, over time, advances in farm technology increase in food supply, together with inelastic food demand, caused farm revenues to fall, which in turn encouraged people to leave farming.
A few numbers show the magnitude of this historic change. As recently as 1950, there were 10 million people working on farms in the United States, representing 17 percent of the labor force. In 2000, fewer than 3 million people worked on farms, or 2 percent of the labor force. This change coincided with tremendous advances in farm productivity: Despite the 70 percent drop in the number of farmers, U.S. farms produced more than twice the output of crops and livestock in 2000 as they did in 1950.
This analysis of the market for farm products also helps to explain a seeming paradox of public policy: Certain farm programs try to help farmers by inducing them not to plant crops on all of their land. Why do these programs do this? Their purpose is to reduce the supply of farm products and thereby raise price. With inelastic demand for their products, farmers as a group receive greater total revenue if they supply a smaller crop to the market. No single farmer would choose to leave his land fallow on his on his own because each takes the market price as given. But if all farmers do so together, each of them can be better off.