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
Many are considered basic necessities;
There are no close substitutes;
They account for a relatively small proportion of people’s
The effects of this are shown on the following
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
(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 (Sgood) the
government buys the surplus (Qg – Q3) and stores it
to use if there is a bad harvest (Sbad) releasing Q3
– Qb. Such
solutions are only useful for non-perishable s like grain, wine, milk powder
or food which can be frozen.
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.
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.
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
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 Pe
and Qe. 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 Pe.