AGRICULTURAL ECONOMIC

PROBLEMS
 Market Failure
1. Volatile Prices / volatile supply
2. Low and volatile income for farmers
3. Environmental costs of intensive farming
(negative externalities)
4. Agriculture key component of rural life
(positive externalities)
5. Monopsony power of food purchasers.
 1. Volatile Prices in Agriculture

• Prices in agricultural markets are often much

more volatile than other industries. This is
because:
– Supply is price inelastic in the 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.
 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 there 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 an incentive for greater supply.
Therefore, next year supply increases and prices plummet again!
• In some years, consumers can be faced with a 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.
 Continued
• 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)
 5. Monopsony
• 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.
 Definition of Buffer Stock Scheme
• Buffer stock scheme is a government plan to stabilise prices in
volatile markets. This requires intervention in buying and selling.
• Prices for agricultural products are often volatile because:
– Supply can vary due to the weather.
– Demand is inelastic
– Supply is fixed in the short term
• Buffer stock schemes aim to:
– Stabilise prices
– Ensure the supply of food
– Prevent farmers/producers going out of business because of a drop in
prices.
 Advantages of buffer stocks
1. Stable prices help maintain farmers incomes. A rapid drop in prices can
make farmers go out of business, which leads to structural
unemployment.
2. Price stability encourages more investment in agriculture.
3. Farming can have positive externalities e.g. helps rural communities. A
drop in price could cause a negative multiplier effect within rural areas.
4. Target prices help prevent excess prices for consumers and help reduce
food inflation. This might be important for households living in poverty,
who may struggle to pay high prices during years of shortage.
5. It helps to maintain food supplies and avoid shortages.
6. It is possible the government could make a profit from a buffer stock
scheme. If it buys during a glut and sells during a shortage, it can make a
profit.
 Problems of buffer stocks
• Cost of buying excess supply could become quite high for the
government and may require higher taxes.
• Minimum prices and buffer stocks could encourage oversupply as
farmers know any surplus will be bought. It could even encourage
excess use of chemicals to maximise yields because farmers know any
excess supply can be sold – even if the market doesn’t want it.
• Government subsidy to farmers may encourage inefficiency amongst
farmers. There may be less incentive to cut costs and respond to
market pressures.
• Some goods cannot be stored in buffer stocks, e.g. fresh milk, meat
e.t.c.
• Government agencies may have poor information e.g. what price to
set, how much to buy? is there really a surplus? In practice, it can be
difficult to know whether there is a surplus until later in the year.
 Continued
• Administration costs of the scheme.
• Minimum prices for foodstuffs may require tariffs on
imports.
• Globalised markets. Agriculture is a globalised market. If
some countries form a buffer stock scheme and buy excess
supply, they may find that other countries ‘free-ride’ on
their efforts to keep prices high and undercut them.
• Are buffer stocks designed to help producers or consumers?
Often agricultural buffer stocks are aimed at providing
minimum prices and minimum incomes for farmers
 Problems of government intervention in
agriculture
• Cost of subsidising agriculture in the 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)
• 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.
Disadvantages of the CAP Price Suport scheme

• The Common Agricultural Policy (CAP) is a European

policy which involved:
– Setting minimum prices for many agricultural products
– Setting import tariffs to protect from cheap imports
– EU purchases of surplus food to maintain minimum
prices
– Since 2005, farmers have been subsidised through Single
Farm payments (SFP) and rural development funds
– The impact of minimum prices in agriculture was to
encourage significant over-supply
The main problems of the CAP are:
1. Cost
2. High Prices
3. Farmers in other countries face lower
incomes
4. Trade Negotiations
5. Environmental Problems
6. Inefficiency
 1. Cost
• Higher prices encouraged extra supply, this resulted in a surplus of
food. The EU had to buy this surplus. This is very inefficient and
expensive. Although minimum prices have been mostly removed, the
EU still give subsidies to farmers.
• In 1970, the CAP accounted for 87% of the EU.
• In 1995 Agriculture cost 40 billion Euros or 58% of the budget.
• In 2013 the budget for direct farm payments (subsidies) and rural
development – the twin “pillars” of the CAP – is 57.5bn euros (£49bn),
out of a total EU budget of 132.8bn euros (that is 43% of the total). (
BBC)
• The CAP budget for the period 2014-2020 will be €278bn (£200.2bn),
with the UK receiving €27.7bn (£20bn) over the course of the seven-
year period.
 2. High Prices
• To increase incomes of farmers, consumers
have to pay higher prices for food. This is 
allocatively inefficient and also increase
inequality because low-income groups pay a
higher % of their income on food
 3. Farmers in other countries face lower
incomes
• Firstly the excess food supplies are dumped onto
world markets. This caused prices to fall and lower
revenues. Farmers in developing economies cannot
compete with the subsidised European farmer.
• Secondly, the EU bought fewer imports because of
the variable import levy’s Therefore demand from
Europe fell
The combined effect was to reduce farmers welfare
in both the US and the developing world.
 4. Trade Negotiations
• The CAP has been a major stumbling block
during trade negotiations between the EU and
the rest of the world. The US has retaliated
against EU exports in response to the high
degree of protection given to agriculture.
 5. Environmental Problems
• The incentives of the CAP encouraged farmers
to increase output with the use of artificial
fertilizers and pesticides causing problems for
the environment. To some extent reforms of
CAP are trying to deal with this, giving
subsidies for greener use of farmland. But, big
agri-business still get large lump sums.
 6. Inefficiency
• Subsidizing farmers through higher product prices is
an inefficient method because it penalises the
consumer with higher prices. Also, it means large
farmers will benefit the most. They have received
more than they need but small farmers are still
struggling e.g. hill farmers with a low number of sheep
• Minimum prices remove the disciplines of the market
and encourage inefficiency
• Despite these problems, it has proved difficult to
reform CAP because of political pressures.