the recovery of quota in the late 1980=s and early 1990=s. Several policy options for the current program situation are presented below. In evaluating these options, it is important to understand the potential effect of changes in farm level tobacco prices on the quantity of tobacco demanded by domestic and foreign cigarette manufacturers.
Potential effects of price changes on quantity demanded (sold)
Data from the 1950=s through the 1970=s indicated that for a 1 percent decline in U.S. flue-cured price, unmanufactured exports would expand by 2 to 2.5 percent. The results of the price support reduction in 1985 seem to bear this out since exports rebounded from around 350 million pounds to over 400 million pounds over a 5 year period. Demand by U.S. cigarette manufacturers is much less responsive to changes in price than is the export market. Research indicates for a 1 percent decline in U.S. flue-cured price, the quantity demanded has historically increased around 0.9 percent and for a 1 percent decline in burley price, quantity demanded has increased only about 0.1 percent. These relationships change over time and undoubtedly are substantially different today than 15 years ago. As closer substitutes for U.S. tobacco have been developed, purchasers are more sensitive to changes in U.S. tobacco prices since they can more easily switch to tobacco produced elsewhere. One possible exception to this generalization is unmanufactured flue-cured tobacco exports. U.S. flue-cured exports may be very price sensitive at much lower prices, for example prices near those of Zimbabwe or Brazil. But at the higher prices under the U.S. program many Aprice sensitive@ foreign buyers may have already abandoned the U.S. market, leaving less price sensitive foreign buyers. These Aprice sensitive@ buyers may be hard to lure back without large price declines. Sufficient data (enough years of data) to conduct analyses that could confirm or refute these suspicions are difficult to obtain at present.
When price is lowered, a lower return to quota is experienced. The rental rate for quota is the market=s value for the return to the right to sell tobacco. Quota owners that rent their quota to growers earn this return. It is also appropriate to think of growers (most of whom own quota as well as rent quota from non-growing quota owners) as earning the rental rate as a return to their own quota. When price is reduced the return (rental rate) on quota falls reducing income from quota ownership to both growing and non-growing quota owners.
At the same time, if reducing price results in more tobacco being sold, then growers earn larger returns on their management, labor, and fixed assets. Low quotas, especially unexpected quota declines (as has been the case in recent years), dramatically reduce grower earnings. Earnings on specialized assets for tobacco production (greenhouses, curing barns, etc.) may be eliminated completely by declining quotas.
In light of these price/quantity relationships and their effects, the following options are presented.
1. Maintain the current tobacco program without changes in support prices. Unmanufactured exports would continue their downward trend. Eventually, the quota could decline to a level that reflected mostly domestic purchases. Domestic purchases may recover from their current very low levels as manufacturers lower inventories to desired levels. For flue-cured tobacco this could eventually imply a quota of between 400 and 500 million pounds. Political intervention likely would be required if periods of high stabilization stocks occur. Interruptions in foreign supplies, such as caused by weather, unexpected change in exchange rates, or political unrest could slow or interrupt the trend to lower quota levels. Quota return per pound (rental rates) will increase resulting in total quota returns falling less than in the case of a price reduction. Grower earnings on management and fixed assets continue to decline with most specialized tobacco assets having a near zero value.
2. Lower price supports while keeping the curr