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Table of Contents

1. Introduction.

2. Choice of organic crop.

3. Demand determinants for organic corn.

4. Price elasticity of demand and Demand curve.

5. Supply determinants for organic corn.

6. Price elasticity of supply and Supply curve.

7. Cost of switching to organic.

8. Recommendation.

References

1. Introduction

The subject of the supply and demand analysis of this paper is organic farming in the U.S. In the situation described in scenario D of the assignment, there is a farmer who is experienced in growing (non-organic) corn on his 100 acre field and who is interested in switching to presumably more profitable organic farming. The farmer wants to know what the best (most profitable) organic crop is and how much it will cost to become a certified organic farmer. This paper argues that the organic crop the farmer should be growing instead of regular corn is organic corn, evaluates demand and supply factors for organic corn, estimates demand and supply elasticities and assesses the cost of becoming a grower of organic corn.

2. Choice of organic crop

The key difference between the regular and organic crops is the use of pesticides and fertilizers. According to Kaiser and Ernst (2011), organic crops are the ones that are grown using production methods that are “intended to mimic natural processes”. Such methods include various cultural practices and natural inputs and exclude “most synthetic pesticides and standard commercial fertilizers”.

In our case, the farmer has extensive experience of growing corn and all necessary supplies, tools and equipment. Switching to growing a different crop would require a significant investment in learning about this new crop (and, inevitably, a learning curve) and buying new equipment and supplies. Given that our farmer does not work on a large scale – he only has 100 acres of land to work with – investing in self-education and new props may require a substantial investment outlay (and thus significant fixed costs) which may suppress profits at the initial stages. On the other hand, switching from regular to organic corn will not require a lot of additional investment.

Another reason to switch to organic corn (as opposed to some other organic crop) is that currently U.S. demand is not being met by local supply. There is generally not a lot of data on organic crops – for example, U.S. Department of Agriculture (USDA) only started collecting organic crops data in 2011 – but according to Brat (2015) sales of foods certified as free of synthetic chemicals or genetic engineering by the U.S. were up 11% in 2014 relative to 2013 and amounted to about 5.1% of U.S. grocery spending. The same article also states that the average annual growth of the organic sector was about 10% which is three times higher than that of the overall food sales, citing USDA and trade association data.

According to the data published on Mercaris Company website [4], as much as 24% of the organic corn sales during 7/2012-6/2013 was imported (and according to Brat (2015), with over 90% of U.S. corn being bioengineered, most organic corn comes from abroad – for example, the U.S. import of Romanian corn went up to $11.6 million in 2014 from $0.55 million a year before.)

Domestic organic corn has its advantages from the buyer’s perspective because it is easier to verify its organic status and it may be cheaper due to lower transportation costs. According to an expert cited in Brat (2015) , the problem with growing organic corn (and other crops) domestically is that in order to be certified organic there is a requirement that a farm must be free of anything non-organic (seeds, chemicals, etc.) for three years. During this time, the farmer sells the crops at regular, non-organic prices whereas the cost of non-chemical growing is higher. As a result, farmers lose profit for 3 years before realizing any price benefit from the organic product and until now this has been the main reason why U.S. farmers had little reason to switch. Lower crop and higher labor cost per acre and the three-year transition rule had been making organic products not worth the risk. However, most recently with changes in commodity prices and tightening of the farmers’ margins to the point of just breaking even, more farmers may choose to invest in switching to organic (Brat (2015)).

Finally, the three-year rule applies to all types of organic crop so it affects the choice to switch to organic but does not affect the choice of the crop type therefore it does not add to the argument in favor of organic corn.

3. Demand determinants for organic corn

USDA website states that consumer demand for organically produced goods has been growing at double-digit rates during most years since the 1990s and organic products sell at substantial premiums over conventional ones. It is reasonable to expect that with the overall trend towards higher consumption of organic foods, both types of demand will continue to experience steady growth.

According to Kaiser and Ernst (2011), organic white and yellow food grade corn is produced for human consumption (organic cereals, tortillas, corn chips, snack foods, cornmeal, and other corn-based processed products) and for animal feed (production of organic beef, dairy, poultry, and hog). Thus, demand for organic corn has two components – final consumer demand and animal feed demand.

In general, demand for a product is determined by consumer income, consumer tastes and preferences, prices of related goods, number of buyers and expectations for the future.

Consumer income. Organic corn is a normal good and if income goes down its demand will go down as well.

Consumer preferences. Although for most people organic goods are more desirable than conventional ones, many people still consider them to be a luxury good and there is some disagreement about just how significant are the health risks associated with consumption of conventional foods (the ones grown with pesticides, genetically modified, etc.) Future demand for organic corn will be affected by the change in attitudes about health risks of non-organic products. For example, if (as unlikely as it is) new scientific evidence suggested that conventional, non-organic foods present no health risks, the demand for organic goods would be negatively affected.

Price of substitutes. If relative price of substitutes - conventional foods – goes up (which could happen if, for example, some of the effective pesticides were banned), demand for organic goods would increase.

Number of buyers. If more people switch from consuming conventional to organic corn, the number of buyers will increase.

Expectations for the future. Some people might be incentivized to switch to organic if they believe that organic will become relatively cheaper in the future or if they anticipate that further evidence will be found about the health dangers of non-organic foods.

4. Price elasticity of demand and Demand curve

There is no consistent available data about organic corn prices and quantities demanded. I am going to assume that in 2014 the average price was $11 per bushel, and in 2015 it was $14, whereas the quantities sold were 30 and 28 million bushels, respectively. Then, using the midpoint formula, price elasticity of demand can be calculated as:

, which is -0.287. The slope of demand curve is a change in price divided by change in quantity, which is (14-11)/(28-30) = -1.5

5. Supply determinants

The supply of domestically grown organic corn is fairly stable in the short run because new, not recently farmed land (“organic land”) is prohibitively expensive for most U.S. farmers and because of the three-year transition rule for the previously farmed land. The supply of foreign organic corn, which constitutes about a quarter of organic corn sales in the U.S., has more variability in the short run.

Formally, supply of a product is determined by production costs, technology, sellers' expectations and number of sellers.

Production costs. Production costs include fixed and variable costs. According to Kaiser and Ernst (2011), fixed costs include cost of land, management, marketing and capital, and variable costs include land preparation (including seeding), purchase of seed, fertilizers, harvest and handling costs. Marginal cost is the cost of each additional bushel of corn.

Technology. Technology is unlikely to change dramatically – after all, the point of organic is that the crops are grown using the methods that are “intended to mimic natural processes” (Kaiser and Ernst (2011)).

Sellers’ expectations. Farmers’ expectations for future prices of organic goods are an important factor for their decision to switch to organic.

Number of sellers. Finally, number of farmers can increase over time if conventional crops farmers will be switching to organic (it is unlikely that the total number of farmers, organic and non-organic, will go up a lot unless some changes in U.S. legislation increase the attractiveness of farming business.)