AGRICULTURAL PRODUCTS

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 (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.

(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 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.