Today's lesson is a two-fold lesson encompassing the concepts of economies of scale and the perfectly competitive firm structure. The first concept, economies of scale refers to the ability for larger firms to squeeze out additional units at lower and lower costs as they expand to the greatest marginal return. In other words, since fixed costs are highest at the first unit of output, the additional units spread out these costs over more and more units. This results in lower average cost per unit until diminishing returns set in. Diminishing returns means that for each unit past the minimum average cost level, the increase in marginal cost is greater than the benefit or revenue of the next unit.
For agriculture the fixed costs are quite high because land is thousands of dollars and acre, and the inputs for production such as tractors, feed, corrals, etc. are very expensive. As a result, the smaller farmer has to pay for the capital cost of their operation over a smaller number of units, so their average cost is higher than a corporate farm where the equipment and land costs are spread out of a factor of the smaller guy's operation. In other words, if farmer Joe and farmer Jim both raise cows in the same area, but farmer Joe has only ten acres and farmer Jim as a thousand, then farmer Jim has the ability(if his money allows) to purchase more cows than Joe possibly could, so the cost of the truck, trailer, feed will be spread out over however many units each one's land can produce efficiently.
A second consideration is the type of market structure an agricultural business exisists within. Since product differentiation between most agricultural products is pretty much nonexistent(ie one cannot tell apart milk from Joe's cows compared to milk from Jim's cows) and anyone who can buy land and cows can enter the market, and also that millions of little producers are creating milk at any given time result in a nearly perfectly competitive market. This has two important meanings economically: 1) that the homogenous nature of the product and number of sellers means nobody has the ability to control price or collude, and 2) that in the long run the economic profit is zero because firms can easily enter or exit the market depending on supply and demand conditions. As a result, the spot price for an agricultural good is the price anyone pays for it, so anything above that price will not sell at all. This creates a problem because the producers are reliant on say milk pricing being X, but then they fall and suddenly the smaller firm has the same costs but shrinking revenue. If the price rises, the smaller firm may be able to have a short term profit, but the price will go lower due to new firms producing the formerly profitable good.
Given how economically despairing the idea of being a small farmer is, so many people in this country still attempt it. The downfall of the family farm is an unfortunate side effect of the economic realization of the preceding lesson, in that the wages earned being a small farmer are more work and lower than what could be earned at a service job. If this were not the case, why would whole swathes of the nation see their children flee and towns become vacant as the last generations of farmer pass on?
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