Outline and compare the effects of price support mechanisms and income support mechanisms giving details of the effects on welfare of consumers, producers and taxpayers in both cases
Government intervention is notably present in the agricultural markets and there is much debate about how efficient the different mechanisms used by the government actually are, and whether using a price support mechanism or an income support mechanism is more effective when providing for consumers, producers and taxpayers alike.
One of the main reasons that intervention is necessary is due to the considerable price fluctuations that agricultural prices are subject to, resulting in adverse effects for both consumers (high prices) and producers (low income) alike. Fluctuating prices makes rational economic decisions difficult and discourages farmers from making long-term investment plans, which over the years reduces the growth of efficiency within the agricultural industry, resulting in the need for government intervention. Unpredictable harvest output as a result of pests and bad weather can explain the existence of these considerable price fluctuations. However in contrast to the unpredictable supply of agricultural products, the demand remains relatively constant, since the price elasticity for food is very low. As a result of this unpredictable supply and relatively constant demand, large differences can occur between supply and demand resulting in the need for changing prices in order to form a new equilibrium. For example, following the outbreak of foot and mouth disease in Europe producers received record prices for EU pork due to the supply shortages, with prices for pigs rising by a record 21%.
Furthermore, government intervention is necessary due to the increasing levels of competition from abroad that farmers must endure, with cheap foreign imports threatening many farmers. Towards the end of the 1990’s thousands of pig farmers from across the UK protested that cheap foreign imports were forcing them out of business, with the NFU arguing that on average farmers were losing around ï¿½92 pounds per animal since supermarket prices failed to meet rearing costs.
The above reasons clearly illustrate the need for government intervention, however it is important to establish the most effective form of government intervention as well as analysing how the different mechanisms used effect the welfare of different groups of people.
One of the most effective income support mechanisms occurs where the government gives the producers a subsidy. A subsidy is generally a monetary grant given to producers, and is used in markets where the market price is considered too low for farmers by the government. By paying producers a subsidy per unit produced in addition to the market price farmers are encouraged to produce more, and as a result the market price is forced down.
In the absence of a subsidy, market price is Pe, the equilibrium point where supply equals demand. With the introduction of a subsidy farmers now receive the price Pg and as a result output extends to Q1, which in turn results in price being paid by the consumers falling to Pm due to this additional supply. The difference between the price received by producers and the price paid by consumers represents the subsidy paid by the government per unit, which in this case is Pg – Pm. Therefore the amount covered by the taxpayers is this value times the total output.
The introduction of the subsidies was brought about in order to assure farmers a fair income, which encourages them to continue producing the product and hence keeps the agricultural sector in a healthy state. However it is argued that these subsidies provide farmers with an unfair advantage on the world market since producers receive higher than market prices, and can remain in business despite being inefficient. Furthermore unpredictable harvest output may result in taxpayers paying extortionate levels of ring subsidies during years of good harvest. These problems have prompted many people to support another method of intervention known as the price support mechanism.
Within the European Union this price support mechanism is operated under the Common Agricultural Policy, which ensures producers receive high prices as well as ensuring that consumers have to pay these high prices. High fixed prices can be achieved on products produced within the EU by setting an intervention price at a level higher than that of the would be market price, which can be achieved by governments buying surplus products in order to restrict supply and keep prices high.
At Pw, the world price, Qd1 and Qs1 are quantity demand and supplied respectively with the surplus being exported on the world market. However with the introduction of an intervention price at Pi the Intervention Board will now have to purchase d-a in order to restrict supply and maintain the fixed high price of Pi. Although this method of intervention is favourable to producers, consumers will find that products will become highly expensive whilst taxpayers will find themselves covering the costs of buying the surplus as well as paying for the storage, which over time may be costly. In the summer of 2005 the EU struggled to fund the purchasing of 13.55 tonnes of grain.
Where products are imported from outside the EU, high fixed prices can be maintained by imposing a tax known as the import levy, which varies depending on the threshold price set (the minimum price at which import products may be sold)6.
However like the income support mechanism, this mechanism also has its problems. These large volumes of surplus products are considered by many to be wastage at the expense of third world countries, where millions face starvation. Furthermore this artificial method of raising prices thru taxes, disrupts free market trade resulting in resources being allocated inefficiently.
Both income and price support mechanisms provide assistance to producers from dangers posed to them by the agricultural market, however both also present problems and it is my belief that a fine balance between the two systems would provide the best form of government intervention in order protect those within agricultural markets.
John Sloman, Economics (2nd Edition), Financial Times, Prentice Hall, 2002
Joseph Stiglitz and John Driffill, Economics, W. W. Norton & Company Inc, USA, 2000
N. Gregory Mankiw, Macroeconomics, Worth Publishers, USA, 2003
Pig Farmers protest over cheap imports, http://news.bbc.co.uk/1/low/uk/149539.stm
EU struggles to control grain surplus, http://www.foodnavigator.com/news/news-ng.asp?id=59002
Common Organisation of Agriculture Products, http://europa.eu.int/scadplus/leg/en/lv-b/l11047.htm
1 Christopher Barclay, Farming after Foot and Mouth, http://www.parliament.uk/commons/lib/research/rp2001/rp01-067.pdf#search=’foot%20and%20mouth%20prices%20rose’
2 Pig Farmers protest over cheap imports, http://news.bbc.co.uk/1/low/uk/149539.stm
3 John Sloman, Economics, Pg 91
4 John Sloman, Economics, Pg 93
5 EU struggles to control grain surplus, http://www.foodnavigator.com/news/news-ng.asp?id=59002
6 Common Organisation of Agriculture Products, http://europa.eu.int/scadplus/leg/en/lvb/l11047.htm