The supply of agricultural products is very inelastic compared to manufactured goods. This is because crops take a lot of time to grow and a slight change in price or demand cannot be reflected in a quick change of supply due to the difficulty in planting new crops and waiting for them to flourish. The supply of agricultural products tends to shift dramatically from year to year because of good or bad harvests. Some years there are abnormal weather changes that can do harm to the amount of crops that can be provided to meet the demand. While some years everything goes right and there is maybe even more supply than demand. Since the demand for agricultural products is inelastic, a small shift in supply can lead to a large change in price for the consumers.
This is why prices fluctuate considerably from year to year due to these changes in supply. Because of these changes in supply, and therefore changes in price, the farmers’ revenue also fluctuates accordingly depending if they are in a good or bad year.
Agricultural markets in less economically developed countries run on primary product reliance. Where the whole country depends on only one or two primary products for export revenue. For example, the supply of coffee in Columbia. This reliance creates problems for the country economically. If the world supply increases there will be a decrease in world price and world demand for a product. These decreases will inflict either less money coming in for products or too much supply for demand. Both of these situations will decrease a country’s export revenue and if this revenue is the country’s main source of money, and decrease can significantly hurt that country’s economy. These countries should be in balance of payments deficits or else another problem of international debt will occur.
b.) What policies can be used to intervene in agricultural markets? (10)
Agricultural markets are markets with a large amount of government intervention to keep the markets stabilized. Because of the dramatic drops of supply and changes in prices the government sets up policies to protect both consumers and producers. In the European Union the Common Agricultural Policy (CAP) was set up in 1969 to control the agricultural markets. The CAP was put in place to increase agricultural productivity as well as stabilizing markets. By doing so they would control the fluctuations of the prices and try to increase the income of the farmers to ensure a fair standard of living for them. The CAP also helped to provide certainty of supplies and ensure these products to consumers for reasonable prices. And in doing all of this, participating in the overall economic growth.
The main policies of the CAP are buffer stocks and subsidies for guaranteed prices. Buffer stocks are put in place to try and save excess supply from minimum and maximum prices and use in time of a bad harvest. The CAP puts in a minimum price policy to protect producers, so that their prices can never drop below the floor price and their revenue will stay at a reasonable amount. A maximum price is also put in place to protect consumers. Since the agricultural market is inelastic, in theory the farmers could raise their prices and the consumers would still have to pay. The ceiling price makes sure that the consumers aren’t put into this situation where they are obliged to buy overpriced products to eat. Because of these price policies prices aren’t set up according to supply and demand and therefore a surplus or shortages may occur.
Say for example, the agricultural market had a good year in 2000 where their harvest was at maximum and the supply curve shifted to the right. Because of the minimum price there was excess supply. The EU commission then buys up that extra supply and creates a buffer stock in order not to waste it for later years when the supply curve might decrease. Then in 2001 there was a severely cold winter that brought on a bad harvest and because of the maximum, the supply couldn’t meet demand and there was a shortage. The buffer stock from 2000 is then released to satisfy the excess demand at the maximum price.
Another policy is guaranteeing prices using subsidies. The CAP does this so the farmer is guaranteed a price. This way, the consumer is paying a low price to keep up the demand for the agricultural goods, while the farmer isn’t losing revenue by actually lowering his prices. The government pays the farmers in subsidies by paying the difference between the price guaranteed to the farmers and the price paid by the consumers. For example, the price paid for corn by the consumers is 1 euro while the farmers are guaranteed 3 euros for the corn they produce. The government pays the 2 euros difference to satisfy both the consumer and producer to stabilize supply and demand.
Although the CAP helps the consumers and producers greatly, there are also a few problems that this policy creates. First of all this policy takes up a large percentage (80%) of the EU’s money. So a lot of the money that could be used to improve Europe is used up for paying farmers. Also by setting up these minimum and maximum prices, overproduction occurs and a solution needs to be found for the excess supply. Either put in buffer stocks, if possible, if not, dumping occurs where the supply is sold cheaply abroad because it is perishable. This buffer stock policy encourages the inefficiency of farmers knowing that if they cant meet demand one year, the EU will take care of the excess demand through stock. Also knowing that they don’t have work to meet demand because of the money they are guaranteed already through subsidies from the government. New Zealand’s milk market has been extremely successful without subsidization because farmers have many incentives to work hard because they aren’t guaranteed money, and this is why it is a very strong market.
