Microeconomics Issues and Their Effect on US Agricultural Industry - Case Study Sample

According to a report published by the United States Department of Agriculture, several microeconomic developments have greater and direct consequences to the agricultural industry which contributes significantly to the US economy. In 2015, it contributed to around $992 billion to US Gross Domestic Product (GDP), providing employment to 11% of US citizens and accounts to 12.5% of American households expenditure. The microeconomic issues stated in this report which affects agricultural sector include interest rates, foreign and domestic income, employment, exchange rates, international trade, and energy prices. These developments can impact on agricultural production, consumption, prices and trade (Economic Research Magazine, 2017).

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Interest Rates

According to this report, the Federal Reserve have come up with ways of lowering the interest rates so that farmers can be able to qualify for loans and in the long run reducing farm borrowing costs. Low-interest rates increase the demand for agricultural commodities and thus the farmers will benefit from good prices for their product and ultimately leading to growth in both US and world economy. Low-interest rates result in higher farm incomes since it lowers production costs thus giving farmers incentive to expand production which makes the country to be food secure and possibilities of creating employment in the agriculture industry. The low-interest rates also improve investment in agricultural sector since investors will be given an incentive to invest due to possible high return on investment and also it encourages research and development which in future will affect productivity growth positively. Therefore, this report recommended that the US government should stabilize bank rates, prime rates, and market rates so that so that it will reduce production costs, improve investment and regulate interest rate risk in agri-business sector.

Foreign and Domestic Income

As analyzed in the USDA report, the US agricultural sector is primarily driven by the income growth outside the country. When income grows abroad, the demand for agricultural products increases thus the consumers will enhance their expenditure in food costs which makes the country to export more products. The global recession, on the other hand, leads to falling in incomes thus reducing demand for agricultural commodities. Income elasticity is reported to be the primary factor which relates changes to income growth to agricultural import demand. Trade between US and countries like Japan and other high-income countries who have low-income elasticities of demand for agricultural products have a little response to changes in income. China and India who are low-income income countries have high-income elasticities of demand meaning that they have an enormous impact on US agricultural trade due to changing wages. The report further stated that falling incomes would reduce consumer demand for foodstuffs, but the real effect will be felt in the application for nonfood items because they will reduce their expenditure faster than on food items. Countries who are poor will increase their demand for inferior goods in case their incomes drop and thus their government should be recommended to balance agricultural trade by reducing imports and subsequently increasing exports so as to increase domestic demand for products.

Employment

The report dealt extensively with the importance of the agricultural sector for employment and prosperity. It noted that in the world about 1.3 billion people work in the agricultural industry of which 97% of them are found in developing countries. Farming generates income to many households since locals engage themselves in retail trade, food processing and transportation of agricultural products. Employment in agriculture sector is enormous since each additional dollar earned in agricultural sector generates another 30 to 80 cents outside agriculture industry as indicated by the International Fund for Agricultural Development (IFAD). World Bank also determined that in areas with export-oriented agriculture, an increase in farmers income leads to the emergence of more paid jobs within and outside the agricultural sector. The report noted several arising matters which affects employment in this sector. Climate changes, increasingly scarce resources e.g. water and challenge of the need to create millions of jobs for increasing population are some of the problems which need to be addressed adequately. The report recommended that the agricultural sector sustainability growth will be of great importance in creating additional jobs and to take advantage of rising global demand for oils and fibers, food, and medicinal plants.

Exchange Rates

Exchange rates mean the price at which one country converts to another. This changes in exchange rates affect the value of currencies, therefore, changing prices of both imports and exports. An example is that US can export agricultural products expensively to a country like the UK whose exchange rates have fallen because the reduced exchange rate will raise producer and consumer prices for imported foodstuffs. This report found that exchange rates changes lead to changes in prices of domestic food products. Transmission elasticity which varies by country is the primary factor which determines the degree to which prices change due to exchange rate change. A country will reduce food import demand from another country if her exchange rates depreciate because of increasing domestic prices. Depreciating currency will change agricultural producers terms of trade. Improvement regarding trade improves production while worsening trade leads to poor output production. For a devaluing country, its domestic terms of trade are improving because primary factors of land and labor don't affect prices due to currency depreciation. Governments in respective countries should control exchange rates since currency depreciation can worsen terms of trade thus causing the decline of outputs in the country.

International Trade

Globalization in agriculture is characterized by a revolution in communication and information technology which reduces distortions to agricultural production, consumption, and trade. Effective international trade has led to decline in costs of cross-border trade in agricultural products. This report has touched on free trade which has benefited most of US farmers. Through trade liberalization in the international market, tariffs have been lowered and the introduction of non-tariff barriers to trade in agricultural products. According to US Department of Agriculture, the US farmers and other agricultural firms depend on export markets to sustain their revenues and prices since their agricultural productivity is growing faster than food and fiber demand. The agricultural exports have generated more than $190.6 billion in economic activity and over 1 million jobs in 2014 according to USDAs Economic Research Service. General Agreement on Tariffs and Trade (GATT) and North America Free Trade Agreement are some of the US trade agreements which have contributed to growth in US farm exports. World trade organization has also immensely benefited US agricultural sector through trade liberalization commitments like dispute settlement system between different countries.

Energy Prices

This report has put down four main reasons why energy prices are important for US agricultural sector. First, energy-related inputs like fertilizer, electricity and diesel fuel comprised of over 30% of expenses the farmers pay. Production of nitrogen-based fertilizer used in farm production depend on the price of natural gas which is influenced by crude oil. In a case of soaring natural gas prices, the costs of fertilizers rise. Electricity prices, on the other hand, can move up with oil prices over the long term. Secondly, energy prices have improved growth of countries who are customers for US food exports. They mostly depend on oil to manufacture their products thus lower energy prices creates a positive impact. Thirdly, energy prices influence US economic growth by driving domestic demand for food and fiber. Low energy prices lower inflation and lead to high growth and in turn increasing food demand which supports farm cash receipts. Lastly, US agriculture itself has become a supplier of energy due to the expansion of biofuel production from corn.

Acute trade contraction, especially in commodity trade, is a major concern in global trade due to shrinkage of growth rates in industrialized economies. A recent estimate by WTO showing only four percent growth rate of global trade has impacted negatively on US agriculture sector since demand for food products has reduced causing an imbalance between supply and demand thus giving rise to declining farm prices. The banking crisis is another microeconomic issue which has been touched in the report. This mainly involves exposure of banks to risks which make them restrain credit to agricultural companies. This has led to declining in American agricultural incomes, high feedstock costs, and shrinkage of American agro-food surplus and decline in agricultural production. Economic research and extension have supplied useful information to farmers through disseminating information on animal and crops, management practices, and modern techniques to use so as to increase their production. US government has funded agricultural sector using public extension which has impacted on agricultural productivity, and private sector involvement in extension activities has brought additional assistance to the industry.

Market failures is another major issue in US agricultural industry as analyzed in the report. Market failures include volatile prices, monopsony power of consumers, low-income to farmers and other positive and negative externalities. Price volatility is brought about by nature of agricultural products which is price inelastic in short term because it takes long to harvest. Also, their demand is price inelastic, and its supply can vary due to climatic conditions. Monopsony effects here occurs when farmers profit margins are squeezed by retailers like supermarkets who uses their buying power over local farmers. Farmers also receive low incomes because agricultural products demand doesnt increase as much as in manufacturing sector in case of global growth due to the low-income elasticity of demand for food. Negative externalities in US agricultural sector arises due to pollution brought about by chemical fertilizers. Positive externalities occur when farming improves the environment and improves rural economy. The government should employ buffer stocks to stabilize prices, set minimum prices to protect farmers from manipulation and set tariffs on imports to increase domestic prices.

Labor unions and government bodies involvement in the agricultural sector is another microeconomic issue currently faced. United Nation body of International Labor Organization (ILO) has played a pivotal role in improving farmers wages and transforming workers rights. United Farm Workers (UFW) have assisted farmers to fight for better wages and better working condition. Various Acts have been instituted by the labor unions so as to prohibit wage discrimination against women, prevent child labor, improve the health status of farmers and set higher wage floors. The government, on the other hand, has improved farmers in agriculture sector through reducing taxes for agricultural products, encouraging equal pay for farmers, setting a minimum wage and providing farm subsidies. The agricultural subsidies influence the cost and supply of agricultural goods and supplements the farmers income. By setting a minimum wage and encouraging equal pay for means that they improv...