U.S. market price causes a corresponding rise in the AWP (thereby diminishing the supplemental
payment to farmers). If the relationship between the U.S. price and the world price is 1:1, then the rise in
the world price causes a decline in the supplemental payment that, from the producer’s perspective,
completely offsets the rise in the market price. In this case, there would be no net benefit of the demand
shift to producers.14 However, there are a number of reasons to expect that the U.S. market price and the
AWP do not move in parallel fashion. First of all, U.S. cotton is widely regarded to be of a superior
quality and not perfectly substitutable with cotton from elsewhere in the world (thus they are not exactly
the same commodity and may not receive the same price in the market). There are also transportation
costs to consider, which also keep U.S. prices from directly tracking the AWP. To test for this
empirically, we ran a price transmission regression of the AWP on the U.S. price and estimated a
statistically significant price transmission parameter of 0.3. This implies that a $1 change in the U.S.
price will lead to a 30 cent change in the world price. Thus, this feedback on the world price diminishes
the benefit to producers of positive demand shifts when the loan rate is binding, but not enough to wipe
out CRPP benefits entirely.
Panel (c) illustrates the effects of the Step 2 program. When the U.S. price is above the A Index
price by at least 1.25 cents per pound for 4 consecutive weeks, U.S. mills, marketers, and exporters
receive a supplemental payment to use U.S. cotton that is equal to the difference between the U.S. price
and the A Index. In this case, a CRPP-induced shift in U.S. demand raises the domestic market price. If
Step 2 is in effect, then demanders do not effectively pay the higher U.S. price; rather, they receive a
higher supplemental Step 2 payment from the government. By foregoing a negative demand response,
U.S. prices increase more than they would without Step 2. Therefore, this enhances the price benefits of
the cotton program to U.S. producers. The price transmission issue applies here as well. The size of the
Step 2 supplement is diminished in part by the corresponding rise in the world price. We adjust for that
using the price transmission parameter of 0.3 referenced above.
14We thank Dr. Henry Kinnucan for raising this point in his review of the first draft of a longer report on which this
paper is based.
12