Problems of Agriculture (Market Failure)

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 issues relating to agriculture.

Types of Market Failure in Agriculture

  1. Volatile Prices
  2. Low Income for Farmers
  3. Environmental costs of Intensive Farming
  4. Agriculture key component of rural life
  5. Global inequality from tariffs on Agriculture

Volatile Prices in Agriculture.

Prices in agricultural markets are often much more volatile. This is because

  1. Supply is price inelastic in short term
  2. Demand is price inelastic
  3. Supply can vary due to climatic conditions.

prices

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:

  1. 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.
  2. 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!.
  3. 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

3. Environmental Costs of Intensive Farming

Modern technology has enabled increase 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.

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. Global Inequality.

This isn’t market failure, but a problem arising from developed governments attempting to overcome market failure. To protect farmers, countries like the EU, US and Japan, place external tariffs on food imports to increase food prices. However, this leads to lower income for developing countries who export food. Another problem is that developed countries have often ‘dumped’ excess food production on world markets leading to lower prices. Therefore farmers in developing countries suffer from falling prices and lower demand.

Agriculture is one of the main stumbling blocks to free trade.

Cost of Agriculture

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)

Related

Photo: A field in the Cotswolds by Tejvan

2 Responses to Problems of Agriculture (Market Failure)

  1. Curt Doolittle February 11, 2012 at 3:55 pm #

    Fascinating. Fascinating that you would consider any of these properties a market failure.

    1) Farming has declined as an employer of people since 1900 to the point where it is now little more than a subsidized hobby industry that we support for purely aesthetic reasons. For that reason alone, it cannot experience ‘market failure’. It’s a commoditized industry. Farming is an industrial occupation for conglomerates. Everyone else in the business is in it out of love or habit not profit.

    2) The US western expansion was created in an era of farming, and the land settled by farmers (and ranchers). The era of industrial expansion was created to support the expansion of farming. Now that farming has become mechanized and industrialized, people are leaving the breadbasket for the commercial and technological centers – that’s why those parts of the country are being depopulated.

    3) It is impossible for farming to experience ‘market failure’. It is only possible for people to cling to an unproductive means of production, and to fail to develop alternative careers.

    The problem is political failure. Not market failure. Markets can’t fail. They can be insufficient to solve certain problems of capital concentration that only governments can accomplish. The political failure of attempting to persist farming is a failure because the market is telling us that farming is no longer valuable as an occupation. The political system is failing because it cannot develop alternatives to farming fast enough.

    It’s a problem of political failure not market failure. And it’s human failure. The romantic and luddite desire for antiquated means of production.

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