25.11.11

OPPORTUNITY COSTS.

Put corn in the gas tank, that Angus Deluxe will command a de luxe price at the drive-through.
The amount of corn consumed by the ethanol industry combined with continued demand from overseas has cattle and hog farmers worried that if corn production drops because of drought or another natural disaster, the cost of feed could skyrocket, leaving them little choice but to reduce the size of their herds. A smaller supply could, in turn, mean higher meat prices and less selection at the grocery store.

The ethanol industry argues such scenarios are unlikely, but farmers have the backing of food manufacturers who also fear that a federal mandate to increase production of ethanol will protect that industry from any kind of rationing amid a corn shortage.

The subject of debate is the Renewable Fuel Standard, a 2005 law requiring the nation to produce 7.5 billion gallons of renewable fuel by 2012. The standard was changed in 2007 to gradually increase the requirement to 36 billion gallons by 2022.

While a $5-billion-a-year federal ethanol subsidy is scheduled to expire this year, the production requirement will remain.

That has other corn consumers worried that if production falls and rationing is needed, ethanol companies will be exempt. The U.S. Department of Agriculture recently reduced its estimate of this year’s corn crop because of flooding in the Midwest and drought in the southern plains, and corn reserves are expected to fall to a 20-day supply next year. A 30-day supply is considered healthy.
The talk about rationing (by something other than price) is at this time just talk, and three years ago there was similar talk.  Complete with, not surprisingly, bad economics.
Cattle feedlot operators are becoming less tolerant of record corn prices, and some feedlots are on the brink of putting themselves up for sale or going out of business, speakers said.

Gregg Doud, chief economist with the National Cattlemen’s Beef Association, explained in economic terms this is the result of an “inelastic demand function” where there’s no replacement for a good or commodity.

For the livestock industry, that commodity is corn.

“The producer picks up the tab,” he said. “The feedlot folks right now – their red ink will flow at some point into the laps of the cow-calf producers.”

Corn futures continue a big rally on the Chicago Board of Trade at more than $6.50 a bushel, heightened by excessive rainfall in the U.S. Corn Belt. By comparison, corn was trading at just over $4 a bushel a year ago.

There’s even concern there could be rationing of corn supplies for livestock if prices continue to escalate, Doud said.

“Can you imagine what will happen to the livestock industry?” he said, noting it would be the death blow.
Inelastic demand for an input is derived from inelastic demand for the finished product. That ought to give the cow-calf producers (doesn't that phrase just summon the echoes of pink-cheeked kids working on their 4-H projects) some bargaining power as buyers bid up the price.  Or is Mr Doud worried about McDonald's taking advantage of the situation to extract some quasi-monopsonistic rents?

Those ethanol subsidies, however, are having the effect any intermediate price theory student would expect.
Even if there’s no rationing, ethanol manufacturers generally have been better able to cope with high corn prices than livestock farmers because their business has bigger profit margins, said Darrel Good, an agricultural economist at the University of Illinois.

Randy Spronk, who raises corn and hogs in Edgerton, Minn., said farmers don’t want to attack the ethanol industry but they want a plan in place if the corn supply should drop significantly.

“We really don’t want to attack ethanol but wise people make plans,” he said.

Matt Hartwig, chief of staff for the Renewable Fuels Association, called the effort to rewrite the fuel standard law “little more than a Trojan horse effort” to weaken or even eliminate it. He said the farmers’ complaints were overblown and most livestock producers and meatpacking companies were making good profits.

Also, the ethanol industry now produces about 1 billion gallons of ethanol more than is required and if corn supplies fall short, it could cut back, he said.

The Environmental Protection Agency, which administers the fuel standard, said in a statement that states can already ask for a waiver “under certain circumstances, including inadequate domestic supply or harm to the economy or environment of a state.”
I wonder what rent-seeker put that provision into the standards.
Texas Gov. Rick Perry did this in 2008, claiming rising corn prices were hurting ranchers in his state. The EPA said it denied the request because the quota for renewable fuel wasn’t causing severe economic harm to the state.

Meyer said many farmers are skeptical about a process that leaves such decisions to the EPA administrator, who “many in agriculture believe won’t consider the best interest of livestock.”

Good, the University of Illinois farm economist, said meat supplies could tighten if competing demands force corn prices higher. He said it boils down to a simple choice: “We’re going to have to reduce our rate of increase in corn consumption or we’re going to have to produce more corn.”
So much for Governor Perry being consistent on limiting government's power. Pay close attention, though, dear reader to that "reduce our rate of increase in corn consumption." Doesn't the rightward shift of a demand curve (that's Professor Karlson-speak for what the principles texts call "increase in demand") provide an incentive for the production of additional corn?  Ultimately, it's not the best interest of livestock that matters, or the best interest of ethanol producers that matters.  It's the attempt of consumers to allocate their claims to goods among food and fuel that determines the use of the corn.  Whether the consumers can better achieve that allocation through political means or through their consumption decisions is left to the reader as an exercise.

7 comments:

Xerographica said...

As somebody who understands the opportunity cost concept...what do you think the outcome would be if taxpayers were allowed to directly allocate their individual taxes?

Stephen Karlson said...

There's another maxim to keep in mind: institutions evolve to conserve on transaction costs. Thus constitutional republics that derive their powers from the consent of the governed have elected delegates who determine the level of services and raise the revenues to pay for those services.

Here's a non-ideological analogy to use in thinking about the transaction costs of direct allocation of taxes. If you have any kind of disposable income, or any history of making charitable contributions, this time of year your mailbox is probably full of appeals. You can decide to send in nothing, or pick one charity, such as the Red Cross, and send a big contribution to it, or bestow your favors among agencies (a check to the Red Cross, a check to the animal shelter, a check to the USO). Or you might trust the judgement of your local United Fund.

Now multiply the list of supplicants by some power of ten: so much for schools, so much for police, so much for the army, so much for the air force, so much for the little tin box.

Yes, the prospect of confronting such a long list might provoke some voters to ask "why" for many of the entries, but the incremental benefit in evaluating voter preferences is probably smaller than the administrative costs.

Xerographica said...

What were the origins of congress though? Nearly 1000 years ago some Barons were unhappy with how the king was spending their money. The only reason that the king had power of the purse in the first place was because people believed he had "divine authority".

Would people truly consent to indirectly allocate their taxes if they understood how the invisible hand works?

In terms of transaction costs...why not just allow each and every taxpayer decide for themselves whether they indirectly or directly allocated their taxes?

Here are a couple analogies...would it make sense if America had to elect 535 personal shoppers to purchase Christmas gifts for everybody? Would it make sense if donors to the NRA and donors to PETA were forced to pool their donations and elect representatives to split the pool between the two organizations?

Stephen Karlson said...

Working backwards: when you have disagreement over how to split the donations, you either get compromise or gridlock. When you elect 535 (actually 538) personal shoppers, and those shoppers have little regard for the provisions of the Constitution, you solve the nasty issues of compromise or gridlock by buying something for everyone and giving the grandchildren the bill. You have the Constitution as an alternative to the divine right of kings.

Xerographica said...

But why would it make sense for you and I to pool our income and purchase the exact same set of private goods? How would that help us or the economy?

The constitution is clearly not even a tiny speed bump. What would be a significant speed bump is if people could only allocate their own individual hard earned taxes.

If you get a chance you should check out the comments on this guy's blog entry...Two ways of saying the same thing.

Stephen Karlson said...

What happens when you and I "pool our income" by purchasing memberships in the YMCA or a country club? In what way is the story different when you and I "pool our income" by hiring the same security service, or making friends with the same Godfather? Might it be more efficient to pay what we understand as taxes for our failure to civilize everybody? And on a larger scale, can you and I pool our income to purchase a guided missile cruiser to patrol the sea lanes for us?

Xerographica said...

Without choice then there's no way for opportunity costs to ensure the efficient allocation of scare resources. I agree that we shouldn't be able to choose whether we pay taxes...but without allowing taxpayers to consider the opportunity costs of their tax allocation decisions then there's no way of knowing whether we need more missiles or more computers for public schools.

Taxpayers should be allowed to consider the opportunity costs of war.