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
- Volatile Prices
- Low Income for Farmers
- Environmental costs of Intensive Farming
- Agriculture key component of rural life
- Global inequality from tariffs on Agriculture
Volatile Prices in Agriculture.
Prices in agricultural markets are often much more volatile. This is because
- Supply is price inelastic in short term
- Demand is price inelastic
- 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!.
- 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)
Photo: A field in the Cotswolds by Tejvan