It is in these markets where prices are set most often by the forces of supply and demand.  However it also in these markets where there is the most government intervention.  The reasons for this include:

·        Agricultural prices are subject to considerable fluctuations – this can cause low incomes for farmers, or high prices for consumers and/or uncertainty which discourages investment.

·        Low incomes of farmers.

·        Protection of traditional rural ways.

·        Competition from abroad – farm may go out of business if the government doesn’t intervene due to cheap imports.

The reasons for large price fluctuations are:

·        Inelastic supply – it is difficult to expand production of foodstuffs in the short run.

·        Supply fluctuations – harvest are unpredictable affected as they are by weather, disease and pests. Therefore some years can se bumper harvests other can see poor harvests.

·        Inelastic demand – foodstuffs tend to be inelastic in demand because:

·        Many are considered basic necessities;

·        There are no close substitutes;

·        They account for a relatively small proportion of people’s incomes.

The effects of this are shown on the following diagram:

In the short term supply of foodstuffs is virtually perfectly inelastic as all harvest crops are always brought to market.  Since demand is relatively inelastic the price in a good year is significantly lower than price in a bad year.  This huge potential for fluctuation in price means the potential for high consumer prices one year and low farmer’s incomes the next year.  The government can intervene to help the situation in the following ways:

(A) BUFFER STOCKS

This is a way of stabilising prices by fixing at a price where long run demand and supply meet.  A suitable price will be P₃ in the following diagram:

When there is a good harvest (S_good) the government buys the surplus (Q_g – Q₃) and stores it to use if there is a bad harvest (S_bad) releasing Q₃ – Q_b.  Such solutions are only useful for non-perishable s like grain, wine, milk powder or food which can be frozen.

(B)       SUBSIDIES

This solution has been highlighted earlier.  The advantages of subsidies are a guaranteed income to the farmer and lower prices to the consumer.  The disadvantage of subsidies is the cost to the taxpayer/government.

(C)       MINIMUM PRICES

This solution has again been highlighted earlier.  In the European Union (EU) the Common Agricultural Policy (CAP) is an example of minimum prices the reasons for its existence include:

·        Assured food supplies.

·        Guaranteed incomes for farmers.

·        Growth in agricultural productivity.

·        Stable prices.

·        Reasonable prices for consumers.

Problems with the policy include:

·        Surpluses leading to large wine lakes, butter mountains etc.  Although for some agricultural products the introduction of quotas has reduced surpluses e.g. sugar and milk.

·        Costs to the taxpayer of purchasing these surpluses.

·        Tend to result in high prices to the consumer rather than reasonable prices. The McSharry reforms of 1992 went a little way towards achieving this.

·        Harms the environment because farmers are over-producing.

·        Surpluses are often ‘dumped’ on third world markets, this can damage the domestic agricultural industry in these places.

(D) COBWEB THEORY

These markets are also often dynamic in nature.  In the sense that supply decisions are often the result of prices in the previous periods.

The diagram shows the long run equilibrium of P_e and Q_e.  Assume that in year 1 a bad crop results in supply only being at Q₁.  This shortage will put up prices to P₁ (position a).  Since farmers knew they could get P₁ for the crop in year 1 they will therefore plant Q₂ of the crop for year 2 (this will get them P₁ on their supply curve).  However in year 2 there is a surplus and they realise that to sell all of Q₂ they will have to drop the price to P₂.  Based on this they will plant Q₃ of the crop for year 3.  However in year 3 there is now a shortage putting up prices to P₃.  This time they will pant Q₄ of the crop.  However this time there is a surplus pushing down prices to P₄.  This situation will continue until eventually the farmers get it right and reach the long run equilibrium of P_e.