Unstable Commodity Markets
A cause of market failure
Markets can fail due to unstable commodity markets. "Commodities" basically means the raw materials that we get from the Earth.
If you swap a commodity to another one of the same type, there'll be no noticeable difference between them. This is a feature of a commodity.
For example, swapping wheat produced in Country A, to wheat produced in Country B. Both countries produce wheat - to most people it wouldn't matter where wheat would come from.
Other commodities?
Oil, tea, gold etc.
What is the cause of the market failure? What is the problem in this market?
They are highly likely to fail, especially in the agricultural industry, because the goods that are produced in these industries are highly dependent on external factors that are out of our control.
For example, if you're growing wheat, your production yield isn't just down to you. It's down to the quality of the land, the weather, natural disaster, pests etc. This can severely affect the supply in this market.
The thing is with crops, is that the goods cannot be produced in a machine like (let's say for example) a USB disk drive. A USB disk drive can be produced at any time of the year, millions at a time. The business owner/manager is totally in control of how many to produce and when to produce them.
A farmer, on the other hand, does not have this luxury. A farmer has to put the hard work in, but this could all go pear-shaped if the weather turns against him. If everything does go wrong, then the farmer has to wait another year to produce more crops in his field.
The supply is totally dependent on the weather and the goods take a long time to be produced. That's why in this market, we tend to also see inelastic supply curves - because output cannot suddenly be increased by the farmer, even if there is a dramatic increase in price/demand.
So why is it a market failure? How is social welfare not being optimised?
It's a market failure because of the following reasons.
Income instability: A farmer cannot make a stable income in this sort of market, so many farmers may go out of business causing unemployment. Because farmers can't accurately predict their income from year to year, it will also cause them to think twice before making any investment. If farmers had a little more security over their income, then they'd be more likely to invest in new machinery, for example.
Price instability: Prices in the market will tend to be extremely volatile. This is because supply is always changing and is never totally consistent. Some years there'll be a bad harvest, and prices will rise as a result. With population growth it means there'll be a greater strain on poverty. This causes inequality of income/wealth to worsen. It will cause a bigger gap between rich and poor in society.
What can we do to help solve this issue with government policy?
One way is by implementing a buffer stock scheme.
Read this revision page on this government policy.
In summary, we have learned:
What commodities are
Why commodity markets are unstable by nature
Why it's a market failure
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