An ethanol article from the WSJ micro weekly review

I'm still at the EPA valuation workshop ... here is something to occupy my space until my head stops swimming:

Ethanol Creates a Pricing Puzzle for Corn Farmers
by Lauren Etter
Mar 29, 2007
Page: A1

TOPICS: Marginal Analysis, Risk and uncertainty, Supply and Demand

SUMMARY: The increased demand for corn-based ethanol has prompted several questions, ranging from the amount of corn seed to plant to the amount of crop insurance to purchase, that farmers must answer. "Plant too much corn, and you could help depress prices; plant too little, and you could miss a windfall. Buy too much insurance -- the price of which is also rising -- and risk shrinking your profit margin; buy too little and risk taking a hit if there is a soggy spring or a summer drought. With corn prices at near-record levels, it would be tough for growers to lose -- but they could easily fail to take advantage of what could be an once-in-a-lifetime opportunity." One interesting point in the article is about corn farmers who have invested in ethanol processing. In their roles as farmers, they prefer higher corn prices. However, in their roles as ethanol processors, they prefer lower input (i.e., corn) prices. By investing in both corn and ethanol, farmers reduce the risk of fluctuating corn prices.

QUESTIONS:

1.) How does the expected future price of corn affect the number of acres that farmers devote to corn production?

2.) A farmer has a fixed amount of land, and must decide how many acres to devote to soybeans and how many to corn. Use marginal analysis to characterize the farmer's optimal allocation of the land between the two crops.

3.) What is the effect to a farmer of that individual farmer planting "too much" corn? What is the effect on the market of the market suppliers planting "too much" corn? What is the effect to a farmer of that individual farmer planting "too little" corn? What is the effect on the market of the market suppliers planting "too little" corn?

4.) What is hedging? Why is a corn farmer's investment in an ethanol processing facility a form of hedging?

Reviewed By: James Dearden, Lehigh University