Cost price squeeze is increasing of costs when market pressures like competition make it hard to increase commodity prices in order to cover for the escalating costs. In agriculture it involves increasing costs of inputs like seeds and fertilizers and the decrease of crop prices. The farmers end up paying more than they get due to the squeeze between prices and costs. Increase of costs in upstream can be caused by energy costs fluctuation, consolidation, and inflation. When fertilizer and seed companies consolidate, there are no low cost inputs for farmers to buy. Prices on the downstream can decline or stabilize due to consolidation and over production. With consolidation on the downstream side, there are few places for farmers to sell their produce and they have to sell at the price dictated by buyers. This makes farmers to be takers of prices and cannot pass on the costs increment to consumers (Moss, 1992).
Cost price squeeze can be explained through macroeconomics theories. Neoclassical, classical, and monetarist theories see money with no effect that is real. It is considered a veil which determines the level of prices in aggregation but does not change the equilibrium. It does not go into functions of production, satisfy utility or even overcome fixities. Production relationships underlying equilibrium would not be changed by inflation due to monetary shocks. This would result to no change in relative prices making the cost price squeeze impossible. Neo Keynesian and Keynesian theories argue that since money is a useful factor in stimulating aggregate demand, a monetary authority mechanism is provided for management of the economy. Keynesian theory states that a mechanism for overcoming fixed wages is provided for by money. Money increase leads to increase in price level aggregate, reduction in wage rate, and increase in aggregate income. Impacts of the cost price squeeze are felt on implications of money on price levels versus aggregate income. Keynesian theory assumes that market pressures like wage rigidities can be outdone by increasing price levels (Moss, 1992).
Nature of agricultural markets
When prices of farm commodities fall and production cost rise, farmers are caught up in a fix. Price cost squeeze is caused by the cyclical nature of markets in agriculture. This cycles which are often short term is weather. For example, good weather yields a lot of produce that force prices to go down while droughts lead to low yields that push the prices up. When prices remain on the higher side, producers are encouraged to increase their inputs for more yields but once this is done prices definitely go down. Likewise if the profitability becomes negative, farmers lose the will to produce much cutting back on inputs. Eventually prices go high, profits are back to normal and the cycle repeats (Gardner, 1981). To avoid some farmers going out of business during the low cycle some policies have been put up as a protective measure.
Increasing productivity is a major contribution to agricultural market cycles. This production is attributed to increased technology; biological and mechanical and better management approaches. Farmers use fewer inputs due to these technologies. Market prices there fall with the additional produce in supply. In US large economies of scale in agriculture are encouraged to expand operations for the purposes of spreading fixed costs in more acreage. They are also encouraged to utilize the improved technology while purchasing in bulk in order to reduce input costs per unit. This however only works best for large scale and against the small scale farmers who are not able to take advantage (Shields, 2009).
Cost price squeeze measurement
Farms are different in a state and a simple form of measuring and gauging the cost price squeeze is necessary for the policy makers especially due to the rapid changes of market conditions. The simplest method of measuring this cost price squeeze is through comparing prices by farmers and input prices directly. This method compares the relationship between the prices and is only appropriate for short periods since there is a likelihood of financial fortunes reversing. The comparison becomes irrelevant with time when there are efficiency gains and technological changes. Cost price squeeze is expressed through a ratio which describes the amount of input that can be bought with a pound of output (Tweeten, 1980). The higher the number, the more profitable a relationship is for the farmers. For example if milk costs 0.12 dollars and the feeds cost 0.06 dollars, the ratio is 2:1 which means that two units of feed can be bought with one unit of milk.
Policy makers monitor the economic condition of farmers in the US monthly. In 2009 cost price squeeze was evident in dairy. Prices of producers fell below recorded levels in 2007 and 2008 while the costs of feeds went up high and were slow to recede (Commerce, 2008). For example the prices of soybeans and corn rose to great heights. There are other factors that are in support of foreign demand like global income growth, and weak dollar rate of exchange. This made the prices of milk, poultry, and livestock to be left behind by prices of feed and grains. Milk feed prices remained high compared to milk prices. The ratio went to 2:1 in 2008 when demand weakened and prices of milk fell. In 2009 there was greater production of milk but the demand remained low which created financial stress for farmers. Crop prices on the other hand in US have been rising steadily.
Effects of cost price squeeze
If the prices of farm products cannot pace with the prices of inputs, farmers are left with the obligation of making decisions which are business related and affecting the output of the farm. This decision collectively by all farmers results to a supply response across the sector which assists in directing the prices of farmers produce for the months in future. Agriculture in the US is governed by federal policies that also play a role in markets and production decisions made by farmers. Farmers are forced to depend on other sources of income to help them save their households through the financial distress (Jessi, 2012).
When farmers are faced with declining returns, costs and revenues of their operations are their main focus just like any other business. Since they are price takers, the selling price of their commodity is determined by its market, they emphasize on selling their produce in methods that avoid and maximize seasonal lows and potential revenues respectively. This is done through forward pricing. This is when a buyer is willing to pay an amount of premium to put his future needs to security. Marketing companies and brokers also provide a variety of marketing options as their work entails market monitoring, marketing plans establishment, and execution of these plans intending to get higher prices per unit than when the crop is sold at harvest time by the farmer. Farmers seek changes in cost for the sake of bottom lines improvement (Coetzee, 2012). They can opt to cut back on inputs like fertilizer for crops and hay for dairy, delay the upgrade of equipment and investment or sell assets of lower productivity like old beef. These actions are meant to save the farmer some money which he does through reducing costs proportionately than revenue. Farmers are advised to pay more attention to ratios of efficiency when making this decision.
Adverse market signals encourage farmers to alter their production plans. This alteration is seen in supplies of lower sectors. For example in crops it may mean that a farmer would shift from growing cotton to soybeans as cotton prices decline. A positive impact of the price for reduced supplies is seen as soon as traders suspect a decline in supplies. Livestock farmers tend to send their livestock to slaughter or give them less expensive feeds.
Policies assisting farmers
There are a number of programs provided by the federal government to farmers for their aid. Most of these policies however put their focus on specific crops which have been supported by the federal government for a long time. These crops include rice, corn, wheat, cotton and several others which get payment and support through the 2008 bill whose legislation has roots in 1930s and 1940s. Land owners who are participants are given program payments and other payments depending on the situation of farm prices. Sugar industry receives its support through import barriers and control of domestic supply. Program support for vegetables, horticultural crops, and fruits is limited to disaster assistance, marketing, research funding, promotion projects, and crop insurance. Livestock do not have an extensive policy support either except for milk that has pricing regulations (Fred, 2000). It has been noted in the past years by researchers that subsidies on crops have encouraged production of grains which has benefited livestock farmers in terms of low costs for feeds.
Federal policies may be counterproductive in their efforts to stabilize markets through support provision to producers. Changing or overriding signals in the market can alter production incentives originating from customers. This results to a disconnection between the consumers’ wants and the farmers’ produce which may lead to low prices due to surplus production. Government programs are criticized to keeping resources that are inefficient and working against natural forces brought about by economies of scale and technology which are useful in agricultural production. Government is needed to store surplus produce, give away unwanted produce in the market, and subsidize exports to get the product out of domestic market (for dairy). Government support is given to farmers in proportion to what they produce (Don, 1982). Large operations continue to get payments even when not needed for economic survival. This makes some firms to become large operations for survival purposes or reduce in size for management purposes. This however does not favor small scale farmers.
Markets are so volatile and can destroy farms that benefit the society unnecessarily with or without government intervention. It is argued that government operations in support of agriculture in particular to small scale farmers are of high costs which make the farmers susceptible to losses. This intervention should therefore be based on conservation measures since they aim at production of land for long term. During a period of cost price squeeze farmers can survive on income from off farm activities. Since labor requirements have been reduced by advancement in technology, farmers can seek part time employment or even full time jobs to supplement the income of the household. The nature of production being seasonal gives a farmer adequate time for employment during winter. Farm policies have changed since they were first made as agriculture has gained more significance both in rural and urban settings. Farm policies are sometimes seen to accelerate or reinforce trends in farm structures through intensifying the cost price squeeze effect of some farmers. Government assistance is still essential in market price controls.
Coetzee, K 2012, April 13, Beating the Cost Price Squeeze, Farmers Weekly, p. 12.
Commerce, UD 2008, Business Statistics, Government Printing Office, Washington DC.
Don, P 1982, The Scarcity Syndrome, American Journal of Agricultural Economics, 64(1), 110-114.
Fred, G 2000, Farmings Role in the Rural Economy, US Department of Agriculture, Washington DC.
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Jessi, M 2012, March 30, Cost Price Squeeze. Retrieved April 4, 2013, from http://foodglossary.pbworks.com/w/page/48854993/Cost%20Price%20Squeeze
Moss, CB 1992, The Cost Price Squeeze in Agriculture: An Application of Cointegration, Review of Agricultural Economics 14, 205-213.
Shields, DA 2009, The Farm Price Cost Squeeze and US Farm Policy, Congressional Research Service, Washington DC.
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