KEY Exercise 9 ECON 460 Fall 1996 Kilkenny

re: Voluntary Supply Control

1. SLIPPAGE is the difference between the actual output reduction and the desired reduction in output following a restriction on acreage use associated with a voluntary income/price support program.

When price and/or income support programs increase the revenue per unit supplied, producers have incentives to increase production. If supplies were not contained in some way, surpluses would accumulate and the subsidy program could become impossible to sustain. Farmers who wish to receive subsidies also must agree to reduce acreage planted. Farmers who do not wish to reduce acreage planted will not be eligible for any direct subsidies, but they may benefit from higher market prices if price floor policies are binding.

Both types of farmers, participants and non-participants, thus have incentives to increase output when price support is available. Participants set-aside a portion of acreage, but this does NOT reduce output by the same portion. First, they set-aside their least productive land. Second, they may use seed, fertilizer, and other chemicals more intensively (substitutes for land). Nonparticipants may do the same on all their land in production, and they may also bring new acreas into cultivation. The increased yeilds per acre on the acres in production means that the acreage restriction results in less of an overall reduction in output than planned: SLIPPAGE.

SLIPPAGE is shown graphically by three supply curves in a S&D graph. The farthest out (rightmost) is the initial supply curve. The farthest left is the DESIRED supply as constrained by the voluntary acreage reduction assuming 100% participation. The one in the middle is what actually results, since not all farmers participate and since all farmers intensify input use. The middle one is 'slipping' back towards the initial supply inspite of the set-aside policy.

2. The right-side panel of graph 8.1 shows three sets of cost curves. The lower, larger set with no subscripts represents costs when there are no programs. The higher, smaller curves respresent participants and non-participants cost curves. Assume all farmers are originally the same. Those who participate do not use as much land so their output is lower than those who use all their land. This is illustrated by the participants' curves being on the left (lower quantity, same costs).

3. As discussed in (1), the policy induces both partipants and non-participants to use more inputs per acre. This raises costs of production per unit produced, which they do willingly since price supports are raising the revenue. Furthermore, we also know that income support ultimately causes land rents to rise, which also increases costs of production for everyone. So, the MC and AC curves for both types of farmers SHIFT UP with the policy.