AGRICULTURAL PRICES AND MARKETS
Sponsored by a Grant TÁMOP-4.1.2-08/2/A/KMR-2009-0041 Course Material Developed by Department of Economics,
Faculty of Social Sciences, Eötvös Loránd University Budapest (ELTE) Department of Economics, Eötvös Loránd University Budapest
Institute of Economics, Hungarian Academy of Sciences Balassi Kiadó, Budapest
2
Author: Imre Fertő Supervised by Imre Fertő
June 2011
Week 2
Demand for agricultural products Literature
• Tomek, W. G.–Robinson, K. (2003): Agricultural Product Prices. Cornell University Press, Chapter 2–3
• Hudson (2007): Agricultural Markets and Prices. Blackwell, Chapter 1
• Chai, A.–Moneta, A. (2010): Engel Curves. Journal of Economic Perspectives, 24 (1) 225–240
• Bouamra-Mechemache, Z.–Réquillart, V.– Soregaroli, C.– Trévisiol, A. (2008):
Demand for dairy products in the EU. Food Policy 33, 644–656
• KSH (2010): Development of food consumption, 2008 (Statisztikai tükör) http://portal.ksh.hu/pls/ksh/docs/hun/xftp/stattukor/elelmfogy/elelmfogy08.pdf
• Regmi, A.–Takeshima, H.–Unnevehr, L. (2008): Convergence in Global Food Demand and Delivery. USDA, ERS, Washington, ERR No. 56
3
Demand for agricultural products
• Different approaches of consumer behaviour
• The basics of demand theory
• Determining factors of demand
• Price elasticity of demand
• Income elasticity of demand
• Relationships between demand elasticities
• The pattern of food consumption
• The methodologies of demand analysis
• An empirical example: the Hungarian beer consumption
Different approaches of consumer behaviour
• Rational choice
• Bounded rationality
– Searching information – Processing information
• Impulsive behaviour
– Theory of rational addiction (Becker–Murphy)
• Behaviour based on habit
• Behaviour based on social status – Veblen effect
– Snob effect – Group effect
4
Demand theory
• Utility
– The unit of the theory is individual consumer or household – Utility maximalisation with budget constraints
– We do not measure the utility – Two axioms
• Consumer prefer more to less
• Consumer will buy only at lower price – Utility function
– Utility: the level of well-being or satisfaction that an individual experiences
• Indifference curves
– Set of goods, which has the same utility for the consumers
– Growing income implies higher indifference curve – The rate of substitution – Substitution effect (HH)
• Substitutes: –HH
• Complements: +HH – Income effect
5
Price and income effects if price of good 2 increase
Substitution effects Income effect ÖH
Good 1. superior Q1↑ Q1 Q1↑
Good 1. inferior Q1↑ Q1↑ Q1↑↑
Good 2. superior Q2↓ Q2↓ Q2↓↓
Good 2. inferior Q2↓ Q2↑ Q2↑↓
6
Demand theory
Determinants of demand
• Demand function
• Qd=f(Pi, Ps, Pc, Y, N, T, G), where – Qd: quantity demand – Pi: price of product – Ps: price of substitutes – Pc: price of complements – Y: average income – N: number of population
– T: Taste and preferences of population – G: Income distribution of population
• Max(F,H) assuming
• Pf*F+PhH=Y – U: utility – F: food – H: house – Y= income – Pf: price of food – Ph: rent of houses
U=F*H+λ(Y-Pf*F+PhH)
• Take partial differential
• Partial differentials equal to zero
• Solve for F and H
• E.g.: U=f(F,H)
• 20F–H=1000 U=F*H+λ(1000–20F–H) dU/dF=H–20λ=0
dU/dH=F–λ=0
dU/dλ=1000–20F–H=0 F=25, H=500
7
How can various factors affect on demand quantity
– Pi: increase or decrease – Ps: increase or decrease – Pc: increase or decrease – Y: increase
– N: increase – T: change – G: change
Demand elasticity
• Own price elasticity
– If Ep<–1 elastic
– If Ep=–1 unitary elastic – If Ep>–1 inelastic
– If Ep=0 perfectly inelastic – If Ep=∞ perfectly elastic
• But!
– Demand elasticity may change along demand curve
) / /(
) /
(
p
dQ dP P Q
E =
) /(
) (
) /(
)
(
0 1 0 1 0 1 0 1p
Q Q Q Q P P P P
E = − + × + −
8 – E.g. linear demand curve
– Q=10–P
– If P=5, then Ep=–1 – If P=8, then Ep=–4 – If P=4, then Ep=–0,25
9
Relationship between price elasticity and total revenue
• TR=P*Q
– dTR=Q*dP+PdQ (/TR)
– dTR/TR=Q/TR*dP+P/TR*dQ – dTR/PQ=Q/PQ*dP+P/PQ*dQ – dTR/PQ=dP/P+dQ/Q
– dTR/PQ=dP/P*(1+Ep)
• If
– Ep<–1, then total revenue grows – Ep=–1 then total revenue is constant – Ep>-1, then total revenue declines
Relationship between price elasticity and marginal revenue
• TR=P*Q
– dTR=Q*dP+PdQ (/dQ)
– dTR/dQ=Q*(dP/dQ)+P – dTR/dQ=P*(1+Q/P*dP/dQ) – dTR/dQ=P*(1+1/Ep)
• Amoroso-Robinson relation
• If
– Ep<-1, then marginal revenue decreases – Ep=-1 then marginal revenue is constant – Ep>-1, then marginal revenue increases
10
Cross price elasticity
• If Eij>0, then i and j are substitutes
• If Eij<0, then i and j are complements
• If Eij=0, then i and j are independent
Income elasticity of demand
• If EY<0, inferior good
• If 0<EY<1, normal good
• Ha EY>1, luxus good
• Engel curve: for food products EY<1
) / /(
) /
(
i j j iij
dQ dP P Q
E =
• But!• Income effect may cause complication
• Assume: share of i
product is much higher in total expenditures than substitutes
• If price of product i is going up, then demand of product j may decline, thus two products are complements
) / /(
) /
( dQ dY Y Q
E
Y=
11
Engel law
• “The poorer the family, the greater the proportion of its total expenditure that must be devoted to the provision of food…
• The proportion of the expenditures used for food, other things being equal, is the best measure of the material standard of living…“
Ernst Engel (1861)
12
Income elasticity of demand
• Income elasticity of demand is calculated in empirical works usually on the basis of expenditures data instead of quantity demand
• This is the expenditure elasticity
• If products are well-defined than income and expenditures elasticity is coincided
• Expenditures elasticity > income elasticity
• The difference between them implies that consumers choose the better quality products
• Quality-income elasticity: expenditures elasticity/income elasticity
Relationships between demand elasticities
• Slutsky–Schultz equation:
– Eii+Ei1+Ei2+…+Eiy=0
• Symmetry condition
– Eij=(Rj/Ri)Eji+Rj(Ejy–Eiy)
• Ri share of i product in total expenditures
• Rj share of j product in total expenditures
• Engel equation
– (R1E1y+R2E2y+ …+RnEny)=1
13
Three types of goods
Impact of income changes
Impact of own price
Superior EY>0
Inferior EY<0 Normal
Ep<0
Normal superior good: e.g.
milk, butter
Normal inferior good e.g. milk powder
Giffen Ep>0
- Giffen good
Staple foods for poor people
14
Approaches of demand analysis
• Data:
– Time series
• Aggregate macro data – Cross-sectional data
• households survey – Panel data
• Combination of time series and cross-sectional data
• Approaches
– Single equation models
– Total demand system estimations
• Linear expenditure system (LES, Stone, 1954)
15
• Almost Ideal Demand System (AIDS, Deaton–Muellbauer, 1980)
• Generalized Ideal Demand System (GAIDS, Bollino, 1990)
• Rotterdam model, (Theil, 1976)
• Translog model (Cristensen-Jorgenson-Lau, 1975)
Single equation models
Model Function Elasticity
Linear Y=α+βX β(X/Y)
Log-log logY=α+βlogX β
Log-lin logY=α+βX βX
Lin-log Y=α+βlogX β(1/Y)
Reciprocal Y=α+β(1/X) –β(1/XY)
An example: Hungarian beer consumption
Period: 1980–2004
Number of observations: 25 Variables:
Per capita consumption in l (beer, wine, spirits) Price in Hungarian Forints (beer, wine, spirits) Income: per capita GDP
16 Deflation: price and income data are deflated by CPI
Qbeer=α0+ α1Pbeer+α2Pwine+α3Pspirit+α4Income+ε We estimate in Log-log function form
Per capita income consumption in l 1980–2004
0 20 40 60 80 100 120 140 160
1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004
beer consumption wine consumption spirit consumption
17
Results
Conclusions
• Demand for agricultural products are usually – Price inelastic
– Income inelastic
– But, there is a significant differences across product in terms of price and income elasticity
– Derived demand
