Subsidizing the price of milk or other agricultural products is not very expensive considering how many consumers there are in the United States. Therefore, there is little harmful effect from such subsidies

Subsidizing the price of milk or other agricultural products is not very expensive considering how many consumers there are in the United States. Therefore, there is little harmful effect from such subsidies

Case Study 16.1: Farm Subsidies

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This is a more detailed look at farm subsidies than the similar material in Chapter 16 of the text]
The Agricultural Marketing Agreement Act became law in 1937 to prevent what was viewed as “ruinous competi-
tion” among farmers. At the time, one in four Americans lived on a farm. In the years since, the government intro-
duced a variety of policies that set fl oor prices for a wide range of farm products. Now, only one in fi fty Americans
lives on a farm, but this program is still with us. Subsidies in the 2008 Farm Act cost U.S. taxpayers $15.4 billion
in 2009. Worse still, the U.S. government often sells surplus crops overseas for lower prices. That sounds altruistic,
but U.S. exports put some poor farmers around the world out of business. U.S. farm subsidies continue to be a sticking point in
negotiating
freer international trade agreements.
Let’s see how price supports work in the dairy industry, using a simplified example. The exhibit below presents the market for
milk. Without
government intervention, suppose the market price of milk would average $1.50 per gallon for a market quantity of 100 million g
allons per
month. In long-run equilibrium, dairy farmers would earn a normal profi t in this competitive industry. Consumer surplus is show
n by the blue-
shaded area. Recall that consumer surplus is the difference between the most that
consumers would be willing to pay for that quantity and the amount they actually pay.
Now suppose the dairy lobby persuades Congress that milk should not sell for
less than $2.50 per gallon. The higher price encourages farmers to increase their
quantity supplied to 150 million gallons per month. Consumers, however, reduce their
quantity demanded to 75 million gallons. To make the fl oor price of $2.50 stick, the
government every month must buy the 75 million gallons of surplus milk generated
by the fl oor price or somehow get dairy farmers to cut output to only 75 million gal-
lons. For example, to reduce supply, the government spent about $1 billion on milk
products in 2009 under one federal program.
Consumers end up paying dearly to subsidize farmers. First, the price consumers
pay increases, in this example by $1 per gallon. Second, as taxpayers, consumers
must also pay for the surplus milk or otherwise pay farmers not to produce that milk.
And third, if the government buys the surplus, taxpayers must then pay for storage.
So consumers pay $2.50 for each gallon they buy on the market, pay another $2.50 in higher taxes for each surplus gallon the go
vernment
must buy. Instead of paying a freemarket price of just $1.50 for each gallon consumed, the typical consumer-taxpayer in effect
pays $5.00 for
each gallon actually consumed.
How do farmers make out? Each receives an extra $1 per gallon in revenue compared to the free-market price. As farmers increase
their
quantity supplied in response to the higher price, however, their marginal cost of production increases. At the margin, the hig
her price just offsets
the higher marginal cost of production. The government subsidy also bids up the price of specialized resources, such as cows an
d especially
pasture land. Anyone who owned these resources when the subsidy was introduced would benefi t. Farmers who purchased them after
that (and,
hence, after resource prices increased) earn only a normal rate of return on their investment. Because farm subsidies were orig
inally introduced
more than half a century ago, most farmers today earn just a normal return on their investment, despite the billions spent annu
ally on subsidies.
If the extra $1 per gallon that farmers receive for milk were pure profi t, farm profi t would increase by $150 million per month
under the
government program. But total outlays by consumer-taxpayer jumped from $150 million per month for 100 million gallons to $375 m
illion per
month for 75 million gallons. Thus, cost to consumer-taxpayers increases by $225 million, though they drink 25 million fewer ga
llons. Like
other special-interest legislation, farm subsidies have a negative impact on the economy, as the losses outweigh the gains. The
real winners
are those who owned specialized resources when the subsidy was fi rst introduced. Young farmers must pay more to get into a posi
tion to reap
the subsidies. Ironically, subsidies aimed at preserving the family farm raise the costs of farming.
SOURCES:
Barratt Kirwan, “The Incidence of U.S. Agricultural Subsidies on Farmland Rental Rates,”
Journal of Political Economies
, 117 (February 2009): 138–164; Ani Katchova,
“A Comparison of Economic Well-Being of Farm and Nonfarm Households,”
American Journal of Agricultural Economics
, 90 (August 2008): 733–747; Bill Egbert, “Councilman
Eric Gioia Having a Cow Over Milk Prices: $6 A Gallon Is Too High, He Says,”
New York Daily News,
5 July 2009; Calitza Jimenez, “USDA Pulls Plug on Some Farm Subsidy Data,”
Center for Public Integrity, 21 May 2010, at http://www.publicintegrity.org/data_mine/entry/2100/; and Joseph Glauber, “Stateme
nt Before the Senate Judiciary Committee,” 19
September 2009, at http://www.usda.gov/oce/newsroom/archives/testimony/2009/VermontDairy.pdf.
QUESTIONS
1. “Subsidizing the price of milk or other agricultural products is not very expensive considering how many consumers there ar
e in the
United States. Therefore, there is little harmful effect from such subsidies.” Evaluate this statement.
2. Subsidy programs are likely to have a number of secondary effects in addition to the direct effect on dairy prices. What im
pact do you sup-
pose farm subsidies are likely to have on the following?
a. Housing prices
b. Technological change in the dairy industry
c. The price of dairy product substitutes
16
S
Millions of
gallons per month
$2.50
1.50
0 75 100 150
Excess quantity supplied
Dollars per gallon
D
Effects of Milk Price Supports

Case Study 16.2: Campaign Finance Reform

Critics have long argued that American politics is awash in special-interest money. Most Americans seem to agree. Two-thirds of
those
surveyed support public fi nancing of campaigns if it eliminates funding from large private donations and organized interest gro
ups. Since the
1970s, presidential campaigns, but not congressional races, have been in part publicly funded. Candidates who accept public fun
ds must abide
by campaign spending limits. But by rejecting public funds, candidates can ignore spending limits.
Senators John McCain and Russ Feingold proposed a ban on so-called soft-money contributions to national parties.
Soft money
allows
political parties to raise unlimited amounts from individuals, corporations, and labor unions and to spend it freely on party-b
uilding activities,
such as get-out-the-vote efforts, but not on direct support for candidates.
Hard money
is the cash parties raise under rules that limit individual
contributions and require public disclosure of donors. The McCain-Feingold measure was approved as the Bipartisan Campaign Refo
rm Act
of 2002. The act bans the solicitation of soft money by federal candidates and prohibits political advertising by special inter
est groups in the
weeks just before an election. The contribution limit is $2,300 for the primary and $2,300 for the general election, or a combi
ned $4,600 for
both.
Limits on special-interest contributions may reduce their infl uence in the political process, but such caps also increase the a
dvantage of
incumbents. Although there was anti-incumbent sentiment in the 2010 congressional election, historically about 95 percent of co
ngressional
incumbents usually get reelected. Incumbents benefi t from a taxpayer-funded staff and free mailing privileges; these mailings o
ften amount to
campaign literature masquerading as offi cial communications. Limits on campaign spending also magnify the advantages of incumbe
ncy by re-
ducing a challenger’s ability to appeal directly to voters. Some liberal and conservative thinkers agree that the supply of pol
itical money should
be increased, not decreased. As Curtis Gans, director of the Committee for the Study of the American Electorate argued, “The ov
erwhelming
body of scholarly research . . . indicates that low spending limits will undermine political competition by enhancing the exist
ing advantages of
incumbency.”
Money matters more to challengers
because the public knows less about them. Challengers must be able to spend enough to get
their message out. One study found a positive relationship between spending by challengers and their election success but found
no relation-
ship between spending by incumbents and their reelection success. So campaign spending limits favor incumbents.
The U.S. Supreme Court in 2010 ruled that the federal government may not ban certain types of political spending by corporation
s and
labor unions, ruling that: “When governments seek to use its full power, including the criminal law, to command where a person
may get his or
her information, . . . it uses censorship to control thought.”
Barack Obama and John McCain together spent a little more than $1 billion in the 2008 presidential race (with most of that spen
t by
Obama). More than a billion dollars sounds like a lot of money, but Coke spends at least twice that on advertising each year. T
he point is that
even well-meaning legislation often has unintended consequences. Efforts to limit campaign spending may or may not reduce the i
nfl uence of
specialinterest groups, but by
reducing a challenger’s ability to reach the voters, spending limits increase the advantage of incumbency, thus
reducing political competition
.
SOURCES:
Michael Ensley, “Individual Campaign Contributions and Candidate Ideology,”
Public Choice
, 138 (January 2009): 229–238; Jess Bravin, “Supreme Court Reverses
Limits on Campaign Spending,”
Wall Street Journal
, 21 January 2010; Jonathan Salant, “Spending Doubled as Obama Led Billion-Dollar Campaign,”
Bloomberg News
, 27
December 2008, at http://www.bloomberg.com/apps/news?pid=20601087&sid=apxzrZEHqU1o&refer=home#; the Federal Election Commission
at http://www.fec.gov/; and
Common Cause at http://www.commoncause.org.
QUESTION
1. The motivation behind campaign fi nance reform was to limit the infl uence of special interests. In what sense could that leg
islation have the
opposite effe