Agriculture often appears to be one of the most difficult industries, frequently leading to some form of market failure. In the EU, agriculture is the most heavily subsidised industry, yet despite the cost of the subsidy it fails to address many issues relating to agriculture.
Types of market failure in agriculture
- Volatile Prices / volatile supply
- Low and volatile income for farmers
- Environmental costs of intensive farming (negative externalities)
- Agriculture key component of rural life (positive externalities)
- Monopsony power of food purchasers.
Volatile Prices in Agriculture
Prices in agricultural markets are often much more volatile than other industries. This is because:
- Supply is price inelastic in short term. (It takes a year to grow most crops)
- Demand is price inelastic. (Food is essential and people are not usually put off by higher prices)
- Supply can vary due to climatic conditions.
This diagram shows that a ‘good’ harvest leads to an increase in supply. This leads to a significant fall in price (P1 to P2). See also volatile food prices
The problem of volatile prices is that:
- A sharp drop in price leads to a fall in revenue for farmers. Farmers could easily go out of business if their is a glut in supply because prices can plummet below cost.
- Cobweb Theory. The cobweb theory suggests prices can become stuck in a cycle of ever-increasing volatility. E.g. if prices fall like in the above example. Many farmers will go out of business. Next year supply will fall. This causes price to increase. However, this higher price acts as incentive for greater supply. Therefore, next year supply increases and prices plummet again!.
- In some years, consumers can be faced with rapid increase in food prices which reduces their disposable income.
2. Low income for farmers
Often farmers don’t share the same benefits of economic growth. As the economy expands, firms don’t see a similar increase in income. Food has a low income elasticity of demand. As incomes rise, people don’t spend more on food. Also, technological advances can lead to falling prices rather than rising incomes. Many developed economies feel it is necessary to subsidise farmers to protect their incomes.
For a developing economy, their current comparative advantage may lie in producing primary products. However, these may have a low income elasticity of demand. With global growth the demand for agricultural products doesn’t increase as much as manufacturing. Therefore, relying on agriculture can lead to lower rates of economic growth.
3. Environmental costs of intensive farming
Modern technology has enabled increased crop yields. However, this often requires chemical fertilizers which cause pollution. As farming becomes more competitive there is a greater pressure to produce more leading to increased use of chemicals. However, artificial fertilizers have diminishing returns, so it becomes more expensive and greater environmental cost for little benefit. Many farming methods have led to deforestation and cutting down trees. This can upset the eco-balance making regions more susceptible to flooding.
4. Positive externalities of farming
You could argue farming communities play an integral role in rural life. If farmers go out of business it has adverse consequences for rural communities and the environment they live in. This is often a justification for subsidising farmers (e.g. the social benefit of subsidising sheep farmers in the Lake District)
Supermarkets can have monopsony buying power over local farmers. This means farmers may see their profit margins squeezed by the big supermarkets who have substantial buying power. If farmers don’t sell to the big supermarkets they can’t sell their products, this is why it puts them in a difficult position.
Government intervention in agriculture
- Buffer stocks - to help stabilise prices though having minimum and maximum prices
- Minimum prices – to guarantee farmers basic income by subsidising food prices. However, minimum prices may encourage oversupply and lead to wasted food production.
- Subsidies for farmers who follow more environmentally friendly methods.
- Tariffs on imports. This increases the domestic price of agricultural produce, but leads to lower trade.
Problems of government intervention in agriculture
- Cost of subsidising agriculture in developed world It is estimated support to agricultural producers in advanced countries was $245 billion in 2000, five times total development assistance. In the members of OECD as a whole, a third of farm income came from government mandated support in 2000. (Martin Wolf, Financial Times, 21 November 2001) (problems of Agriculture)
- Subsidies have often been given to farmers with large amounts of land and with little incentive to follow more environmentally friendly procedures.
- Minimum prices have led to over-supply
- Tariffs on agriculture have led to lower income for food exporters in the developing world and have been a big stumbling block to trade.
Photo: A field in the Cotswolds by Tejvan