Academic journal article Contemporary Economic Policy

Experimental Work on Subsidies, Moral Hazard, and Market Power in Agricultural Markets

Academic journal article Contemporary Economic Policy

Experimental Work on Subsidies, Moral Hazard, and Market Power in Agricultural Markets

Article excerpt

I. INTRODUCTION

Agricultural price support programs have existed as U. S. federal policy since the 1933 Agricultural Adjustment Act and most recently have been continued in the 2008 Farm Bill (USDA/ERS 2008). (1) Through the years one goal has been consistent: maintain the income of growers. Besides commodity-specific price supports, programs instituting supply controls, conservation programs, and marketing loans have been introduced in a succession of U.S. farm bills (Dimitri, Effland, and Conklin 2005). For decades, however, price supports have been the primary method of subsidization for commodity producers. These "coupled" subsidies, which are tied to price and production levels, are being scrutinized because of their potential trade-distorting impacts, resulting in an increased interest in new subsidies which are "decoupled" from production.

In this paper, laboratory markets are used to study both coupled and decoupled payment programs for agricultural commodities. We create a very simple and stylized subsidy environment that mimics how growers are subsidized in the United States. A target-price program guarantees every seller a price for each unit of a commodity brought to market. The guaranteed price is a promise that producers will receive no less than the target price for their output. Operationally, producers sell their output in the open market at an acceptable price. If the average market price is below the target price, the producer is given a deficiency payment equal to the difference between the target and the average market price for each unit sold. If the average market price is above the target or floor, the producer does not receive a subsidy. In addition to this coupled subsidy program, two decoupled payment schemes are also studied in this paper. One consists of a lump-sum payment made before there is any commodity production (2) and the other is a periodic payment made at the beginning of each new planting season. Each of the subsidy plans is not directly tied to price or production.

We construct two distinct market environments to study the impact of coupled and decoupled subsidies for agricultural commodities. Both are a two-stage game involving a production decision and then exchange. One market environment puts sellers in a competitive market, where they individually make production decisions. Collective production quantities then sell at a price (based on a demand schedule) that clears the market. The experimenter serves as auctioneer and buyer in this case. We refer to this as a "seller-only" institution. This experiment isolates the impact of subsidies on production decisions and ultimately market supply. In a perfectly competitive market, we would expect sellers to continue producing until marginal cost is just equal to the target price or the market price, whichever is higher.

The second market environment is more complicated. As in the previous market design, a production decision is made by individual sellers. But then their collective production is sold to buyers in a posted-bid auction. Sellers accept bids for offered prices and quantities until all units are sold. This environment is designed to capture potential impacts of buyer and seller interaction in price discovery along with production impacts of subsidies.

In all of our experimental sessions there are many trading periods or seasons. During each trading period there is a production decision followed by exchange. We conduct a baseline treatment without a subsidy, two treatments with generous and not-so-generous target-price supports, and two decoupled subsidy treatments with equivalent lump-sum and periodic payments.

If exchange is conducted through a posted-bid auction, a type of auction commonly used in agricultural markets, we show that generous or high price supports, as defined below, give buyers substantial market power. The program effectively results in helping commodity buyers get their bids accepted at low prices. …

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