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Agricultural policy objectives
The farm problem
Economics of Food Markets
Lecture 3
Alan Matthews
Lecture objectives
• To examine stated objectives of
government intervention in agricultural
markets
• To review explanations why farm incomes
may have a tendency to lag behind nonfarm incomes
• To discuss alternative patterns of
agricultural adjustment
Extensive government
intervention in agri-food markets
• Most countries adopt an active agricultural
policy. Evidence that policy addresses
significant and widespread socio-economic
issues.
• High share of EU spending on agriculture
• High levels of border protection
• High transfers from consumers and taxpayers to
agriculture (OECD PSE estimates)
Rationale for agricultural policy
•
•
•
•
food security
instability of agricultural markets
lagging farm incomes
maintenance of the rural
population/rural development
• environmental and landscape benefits the multifunctionality of agriculture
Food security
• Market-determined size of agricultural sector
may mean relying on food imports
• Food security often equated with food selfsufficiency
• What is risk to food supply in developed
countries?
– Sources of risk (war, disease, climate)
– Input markets may be more vulnerable than product
markets
– Risk a function of diversification of import sources
– Huge overproduction in relation to subsistence needs
– Self-sufficiency not necessarily the most efficient
response (stocks, supply contracts)
Objectives of the Common
Agricultural Policy
• Article 39 objectives
– to increase agricultural productivity
– to ensure a fair standard of living for the agricultural
community
– to stabilise markets
– to ensure the availability of supplies
– to ensure that supplies reach consumers at
reasonable prices
• Generally, income objectives dominate farm
policy objectives in developed countries,
although rarely defined very explicitly
Sources of price instability
P
P
Q
Q
The cobweb model of price instability
- where supply is a function of lagged price
Price
Price
SS
SS
S'S'
P2
P0
P2
Pe
P3
P1
S'S'
P0
Pe
P1
DD
Q0 Q
2
Qe Q3 Q1
Quantity
DD
Q2
Q0 Qe Q1
Q3
Quantity
..but some problems
• Even cycles require equal supply and
demand elasticities
• Naïve expectations mechanism
• Observed cycles tend to be twice as long
as those predicted by model
• Note that price and output instability offset
each other from the point of view of
revenue or income instability
• … but basic insight remains valid
Declining terms of trade
• Demand grows slowly
because of slow
population growth and
Engel’s Law
• Supply grows more
rapidly due to
technological change
• Treadmill effect
• Rising living standards in
nonfarm sectors
Why does farm labour market not
return to equilibrium?
• With downward pressure on farm incomes, we
expect outmigration from farming to restore
relative incomes; why does this not happen?
• ‘love of farming’ – nonpecuniary considerations
• Market imperfections – barriers to movement
• Human capital explanation – markets do work
• Fixed asset theory – resources trapped in
agriculture
Illustration fixed asset theory
Supply of
labour
P
Acquisition cost
Demand for labour
(MVP)2
Demand for labour
(MVP)1
Salvage value
Labour supply should fall from Q1 to Q2 as
a result of the fall in the demand for
labour, but decision to exit is made
with respect to the salvage price, so
labour Q1Q2 is trapped in the sector
Q2
Q1
Q3
Q
Agricultural adjustment and the
farm problem
• price instability in a supply-demand framework caused by low
price elasticities of supply and demand
• agricultural adjustment in a supply-demand framework: the
‘treadmill’ of technical change together with Engel’s Law drives
food prices down and leaves farms unviable
• technological change and input substitution also encourage farm
amalgamation and lower the demand for labour in agriculture
• low farm incomes result from ‘sticky’ labour supply response
– barriers to exit
– neoclassical human capital explanation
– fixed asset theory
The pattern of agricultural
adjustment
• Changes in resource use – reduction in labour input
accompanied by intensification through greater use of
variable and capital inputs
• Changes in output mix – farm diversification into niche,
exotic or higher value added activities
• Increased size of farm business and increased
specialisation
• Reduction in farming activity – either through part-time
farming and pluriactivity or through retirement and exit
• growing concentration of production and output on larger
farms accompanied by the growing marginalisation of smallscale farming, leading to increased differentiation in farming
• Differences in survival strategies depends on the resource
base of the family farm and family circumstances.
Recommended readings
• Gardner – Farm Problem
• See also Matthews 2003 in Lecture1