It is often argued that fanners face extraordinary instability and risk and that this causes eccoaaic inefficiency in agriculture. One implication is that in principle, farm programs can counteract instability and risk, thus inpxwing economic efficiency. But despite all of the attention given to stabilization and risk reduction policies for agriculture, there remains a great deal of confusion over the mechanisms through which instability and risk can lead to economic inefficiency.
The objective of this paper is to outline systematically the ways in which instability and risk can lead to inefficient resource use in agriculture, and hence hew stabilization and risk reduction policies may improve economic efficiency. We recognize explicitly that for instability and risk to be sources of economic inefficiency in agriculture, they must lead to sane farm of market failure. In the paper, we examine three sources of market failure: disequilibrium, incomplete forward markets, and incomplete contingency markets. We claim that these are the only sources of market failure directly associated with instability and risk.
The conclusion is that government Intervention In agriculture can, In principle, correct for these market failures but that In practice the potential efficiency gains may be small and are very difficult to realize.