Samuel Allen 5/10/12 AREC 405 Final Paper

Wheat Production in the United States: Application of Production Economics Theories

In our current global economy, production of different types of wheat is widespread and prolific in many different parts of the world. Many countries including Canada, Australia, Pakistan and the United States depend on wheat production as a main export source as well as a great source of revenue. Typically, the type of wheat that is grown by these countries is common non-durum wheat (hard or soft) which is used to make flours for bread, pastry and cakes. Another type of wheat that can be produces is durum wheat which is typically hard and used to make products such as flat bread, macaroni and other pasta products. Wheat production demands several inputs that not only allow for its growth, but also the harvesting of the crop and its protection from disease/fungus. However, for the sake of applying economic theory only two inputs (land and fertilizer) will be examined. This paper will examine the production process of wheat and recent increases in input prices that are resulting in higher output prices set by producers in the U.S. as well as other historical trends/problems in American wheat production. Furthermore, several theories and concepts of production economics will be applied directly to the production of wheat by American farmers. In the context of this paper I will refer to the input set for production of wheat as V(y) (or just inputs as x) and I will be referring to the prices of two separate inputs that will make up the necessary input set. The two inputs that will be included are fertilizer and land. The input set is

defined as the collection of inputs that produce a given output in the technology. Thus, fertilizer and land are the necessary inputs that are used to produce the single output, wheat (denoted y). Volatility in the prices of inputs can result in various effects, including reduction in demand, higher output prices or changes in profit maximizing supply. According to the USDAs National Agricultural Statistics Service, the price of wheat spiked recently in the year 2008 due to a variety of factors, a main variable being an increase in the price of inputs, specifically the prices of fuel and fertilizer necessary to grow and harvest wheat (Ali et al. 2009). This has been shown to be the result of a rise in international energy prices and an increase in the price of natural gas used to produce ammonia necessary in fertilizer (Ali et al. 2009). Demand for fertilizer had increased in other areas of the world including China, India and Brazil which also accounts for the rise in input prices (Ali et al. 2009). The cost function which is defined as the value of the cheapest bundle of inputs (x) to produce a given output (y) given input prices (w) gives us some insight into the meaning of increasing input prices. A rise in the price of fertilizer used to grow wheat is shown to be a real price change, as it changes the proportion of fertilizer a firm would be willing to substitute for another input (such as land). Since cost is non-decreasing in input prices, the observed rise in fertilizer prices will result in a greater cost for a wheat producing firm (certeris paribus). This will result in a loss of profit for any firm that sells wheat considering cost (inputs * input prices) is subtracted from revenue (output * output prices), so the only reasonable behavior for producers (who are price takers in input prices) is to raise the price of their harvested wheat. This result is observed in USDA data as the average monthly price of wheat increased to almost $12 per bushel following input price increases in 2007-2008 (Ali et al. 2009).

Another alternative for a farmer trying to respond to an increase in fertilizer price is to try to substitute more land to decrease the amount of fertilizer he uses. This method will become less and less effective due to the law of substitutability which states that substitution becomes more ineffectual as more of one input is substituted for another. Thus an attempt to spread less fertilizer over a broader plot of land to produce wheat will not be productive in the long run. There are several other integral implications of a rise in the price of fertilizer can lead to. One of these results can be proved using Shepherds Lemma and the relationship between input price and cost minimizing demand. Based on the properties of the cost function, which when graphed against input prices is concave; a line is formed that is tangent to the given input price (in this case fertilizer) and its associated cost that represents the slope at the given point. The slope of the line at this point is considered the cost minimizing demand according to Shepherds Lemma. In this case the cost function is graphed against the price of fertilizer and the increase in price of fertilizer will cause the tangent line to move up along the concave cost function to a point that has a flatter slope and therefore a lower point of cost minimizing demand. Increases in fertilizer prices have affected cost minimizing firms in that demand for fertilizer is decreasing simultaneously. Wheat production in the U.S. has also been affected by a reduction in wheat planted areas in the 1980s, or land that is used for wheat production (Ali et al. 2009). This has been a result of the USDAs Acreage Reduction designed to reduce government stock of certain commodities. Despite a slight recovery in the amount of wheat area in the 1990s, the enactment of the 1996 Farm Act caused further reduction of wheat acreage in the U.S. This act created planting flexibility programs that allowed farmers to take land used for wheat out of production or allot land previously used for wheat to different higher yielding/profiting crops (Ali et al. 2009).

Large wheat-growing states such as North Dakota and Kansas have greatly reduced their wheat yield since the 1980s, in these states wheat area used to account for 80-90 percent of wheat, corn and soybean land. As of the year 2008 it is seen from figure 4 below that this is percentage is closer to 60 percent in both states.

This decrease in the amount of wheat planted area would have a profound effect on a firm that relies on wheat production. With government regulations limiting the amount of land allotted for wheat growth or encouraging firms to produce different crops, a wheat producing farmer (especially in Kansas or North Dakota) may see reduced revenue as a result. This can be explained by the theory of Free Disposability of Inputs and its implications on the revenue function. The revenue function (R(p,x)) defined as maximum revenue given the output (y) is in the output set (Y(x)). Free disposability of inputs implies that revenue increases with increased input (R(p,x) >= R(p,x) when x >= x), the inverse of this implication would suggest that revenue decreases with decreased input. As evidenced by the reduction in amount of land used for wheat production in Kansas and North Dakota, (in firms only producing wheat) reduction in

land can cause a decrease in revenue and subsequently a decrease in profits since (profit) = revenue cost. Wheat disease is another factor that affects yields produced by wheat farmers in the U.S. Farms in states such as North Dakota and Minnesota have experienced wheat fields infected with scab (a type of fungus) which have reduced the amount of harvestable wheat yielded from their farms. The presence of wheat disease has reduced crop yields significantly in North Dakota and will definitely have an effect on the production function of a farmer within the state. Since wheat disease can reduce the output of a certain farm after the crop is grown, it is conceivable that this could result in a violation of the theory of Free Disposability of Inputs. Suppose a farmer that is trying to increase his/her wheat yield (output) purchases 100 acres of land adjacent to his farm and another 100 pounds of fertilizer to grow more wheat (inputs). Free disposability of input implies that if the bundle (x,y) is in the technology, then (x,y) is also in the technology if x > x, thus the same output can always be produced given more input. This notion can easily be violated in a situation in which a farmer (in North Dakota, hypothetically) acquires a new piece of land that is infected with the scab fungus. The scab fungus proceeds to spread and infect not only the newly acquired land but the original planting area that the farmer previously owned, reducing his wheat output to a lower amount than he had previously produced with fewer inputs. While free disposability of inputs can be violated in that situation, the theory of free disposability of outputs will typically be satisfied in wheat production since a farmer should always be able to produce less wheat given the same input bundle, even if it is not economically prudent. Overall, wheat production in the U.S. is in a competitive position due to recent expansion of ethanol/corn production. Corn is replacing wheat in feeds for livestock resulting in greater demand for corn and a lower supply of wheat. The reallocation of wheat land for different

higher-profit crop production is a gleaming example of why the global U.S. wheat production share decreased from 2010 to 2011, down to 7.84% from 9.23% (USDA). While wheat will continue to be a useful crop that is universally utilized for its many uses, it is foreseeable that its status as a major cash crop in the U.S. will not last. If prices for fertilizers and other wheatproducing inputs continue to rise, many farmers will not be able to continue to profit in wheat production and will turn to more cost effective crops.

Works Cited
Ali, Mir, and Gary Vocke. "Consequences of Higher Input Costs and Wheat Prices for U.S. Wheat Producers." USDA Outlook (2009). U.S. Department of Agriculture. Web. 10 May 2012.

"Wheat Data: Yearbook Tables World and U.S. Wheat Production, Exports, and Ending Stocks." World and U.S. Wheat Production, Exports, and Ending Stocks. U.S. Department of Agriculture. Web. 10 May 2012. <http://www.ers.usda.gov/data/wheat/YBtable04.asp>.