NEWS for North Dakotans
Agriculture Communication, North Dakota State University
7 Morrill Hall, Fargo, ND 58105-5665
April 20, 2000
Global markets are currently awash in grain, thanks to at least four consecutive years of favorable growing conditions in many world's major crop production regions. And the teeter-totter effect of economic theory is playing out: when supplies go up, prices go down to stimulate demand.
So why are U.S. producers intending to plant as many acres to crop this year as they did last year? An agricultural economist at North Dakota State University says there is rational thinking behind this seemingly irrational behavior.
"It can be argued that producers respond to higher prices by producing more, and they respond to lower prices by also producing more," says Dwight Aakre, extension farm management specialist at NDSU. "The attempt to increase production when prices rise is rational because producers are attempting to maximize their profits. But it is also rational to increase production when prices fall because production agriculture is characterized by high fixed costs, which are those costs that do not change in the short run with changes in output."
A case in point: the NDSU Extension Service projected budgets for spring wheat in south central North Dakota show the total cost of production (excluding labor and management) to be $107.79 per acre. Of that total, $51.83 (48 percent) is variable, leaving $55.96, or 52 percent, as fixed costs. Labor and management are also fixed costs, Aakre explains. Under the same set of budgets (again, excluding labor and management), the total cost of production per bushel is $3.59, based on an expected wheat yield of 30 bushels per acre. With a projected price of $3.22, the return to labor and management is a negative $11.19 per acre, or a loss of 37 cents per bushel.
"But as long as the price is above the variable cost of $1.73 per bushel," Aakre says, "producers are better off producing because anything above $1.73 is available to help pay fixed costs. This explains why even in times of low prices there continues to be pressure to expand."
In the situation where a wheat producer in south central North Dakota is considering expanding by renting additional land, the land rent should be included in the variable costs rather than in the fixed costs, Aakre says. But even then, the price needed to cover variable costs is only $2.75 per bushel, which is well within the budgets' projected price.
"Expansion is a strategy to deal with low prices," Aakre says. "We continue to see strength in the land rental market in most of North Dakota. Demand for land in an era of low returns in agriculture is an attempt to spread the fixed costs of machinery and operator and family labor over more acres because each acre is contributing less. This same scenario holds true with livestock enterprises. That is why we are seeing an increase in large livestock operations and the gradual disappearance of small operations."
In contrast to this expansionist strategy, many agribusinesses routinely engage in supply management when prices decline. Aakre cites recent examples involving Illinois-based firms: Archer Daniels Midland closed three domestic oilseed crushing plants and reduced production at all its other plants, and Deere & Company has reduced its agricultural manufacturing operations on a worldwide scale.
"What these agricultural giants are doing is managing supply to meet demand and thereby preventing burdensome supplies that must be disposed of at unprofitable prices," Aakre says. "But when it comes to production agriculture, no single producer can influence price, and so producers may not cut back on production until price drops below variable costs or they are able to shift to a more profitable alternative crop. This distinction makes it difficult for this sector to reduce supply without government assistance."
And there are other factors affecting the production agriculture sector that do not influence other industries in similar ways, Aakre says. One is weather, which despite agronomic advances remains the biggest factor in determining the supply of major crops on a global scale. Another factor is inelastic demand for agricultural commodities, which means that a small change in supply results in a much larger change in price in the opposite direction.
"The biggest challenge producers face today is to perform a thorough analysis of the current production and financial characteristics of their farm business," Aakre concludes. "This needs to include an analysis of their present situation as well an objective analysis of where their business is heading. It is difficult to address these situations except through a one-on-one consultation with someone well-versed in management strategies."
###
Source: Dwight Aakre (701) 231-7378
Editor: Dean Hulse (701) 231-6136