A supply-side giffen good?

The Oregonian reports that farmers face a choice to grow grass and wheat and they chose to grow more wheat.  The problem? Wheat prices have been falling and are currently at their lowest. Doesn’t that seem a bit odd? Some say it is only a phenomena found in the Willamette Valley.  Farmer’s say that they want to increase output in order to provide more cash flow. So, as wheat prices are falling, they are increasing their supply.  This is obviously backwards.  Supply curves are supposed to be upward sloping where if the price increases, producers will increase quantity.

This reminds me of that weird theory called Giffen goods that always got tacked on when learning about demand curves in economics class.  Giffen goods, although only observed on the demand side, experience an upward sloping demand curve (price goes up, quantity demanded goes up) which is contrary to the law of demand that says it is downward sloping (price goes up, quantity demanded goes down).

Using the same logic of the Giffen good with the farming example, you can say this is sort of a supply-side Giffen good.   Instead of an upward sloping supply curve, (price goes down, quantity supplied goes down) the farming example has a downward sloping supply curve (price goes down, quantity supplied goes up).   Some fancy econometrics would need to prove it but I think I can explain intuitively why the farmers are doing it.

1) They are constrained by their ability to produce. They can either produce wheat or grass, but nothing else, and not both.

2) They are constrained by their income and don’t have enough cash to invest in alternatives.

3) They haven’t reached the shutdown point where their variable costs exceed their fixed costs. Since they are price takers, they have no choice.

So given their choices, the only way to profit maximize is to produce wheat at a lower price since grass fetches for even lower.

I could be wrong about this, so please comment if I am mixing up my economics.  I am assuming that this is a long-run behavior.  The farmers are given enough time to make a decision regarding falling wheat prices. I am aware of the assumptions in the short-run.  So that maybe what the debate, at least in economics, would be about.  Nevertheless it is an interesting exercise in understanding perfectly competitive markets and how it influences producers behavior.

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2 responses to “A supply-side giffen good?

  1. That’s wrong because if farmers really did have downward sloping supply curves, they would produce less as the price went up.

  2. I think Taylor is right that farmers do indeed have an upward sloping supply curve but the supply curve has limitations attached to it. You must assume cetrus parapus (that all other factors remain the same). In this example cash flow is causing the farmers to increase production and so this could be seen as the supply curve shifting right due to this external factor “cash flow”. If there was to be an increase in demand it would indeed cause an increase in price causing an extension in supply and the price to rise.

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