AGRICULTURAL PRICES
AND MARKETS
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
AGRICULTURAL PRICES AND MARKETS
Author: Imre Fertő
Supervised by Imre Fertő June 2011
ELTE Faculty of Social Sciences, Department of Economics
AGRICULTURAL PRICES AND MARKETS
Week 8
Price differences and quality
Imre Fertő
Literature
• Theory:
– Tomek, W. G.–Robinson, K. (2003): Agricultural
Product Prices. Cornell University Press, Chapter 7.
Hudson (2007): Agricultural Markets and Prices.
Blackwell, Chapter 8
• Application:
– Parcell, J. L.–Schroeder, T. C. (2007): Hedonic retail beef and pork product prices. Journal of Agricultural and Applied Economics 39 (1) 29–46
Outline
• Issue of quality in the economics
• Quality grading in the food chain
• Operational and price efficiency
• The impact of quality grading on D and S
• Relationships between quality grades
• Quality grades and marketing margin
• Classification issues
Issue of quality in the economics: an example
• Impact of non-observable quality (Akerlof 1976)
• Assume. Farmers produce wheat:
– Production costs:
• Good quality: 1,5 Ft/kg
• Bad quality: 1,4 Ft/kg – Processor pays
• Good quality : 2 Ft/kg
• Bad quality : 1 Ft/kg – Perfect information
• Farmers produce good quality
• Farmers’ profit= 2 Ft/kg–1,5 Ft/kg=0,5 Ft/kg
Continuation of example
• Imperfect information (processor can not observe the quality of wheat)
– Processor assumes that farmers
produce good quality, thus he offers P = 2 Ft/kg
– But, some farmers produce bad quality wheat, thus they are able to increase their profits
• Consequence: there is no equilibrium if all
farmers produce bad quality wheat
Continuation of example
• Imperfect information
• Assume
– Processor pays 1,5 Ft/kg for bad quality, – Processor is risk neutral
– Maximum ability to pay depends on the average quality:
• P=ρ(2Ft)+(1– ρ)1,5Ft, where
• ρ the share of farmers producing good quality
• In this case ρ=0, thus p=1,5 Ft/kg
Continuation of example
• Consequences:
– Farmers earn 10 fillér per kilogramm – Profit of processor is zero
– Equilibrium exists, but it is not optimal
– Farmers produce low quality wheat in the equilibrium, although high quality wheat would be better for players and society – Market failure (adverse selection) due to
unobservable quality
Standards and grades in food chain
• Solutions for imperfect information – Grades and standards
– Contracts
– Vertical integration
• Grading systems
– Quality: subjective thing
– Food quality standards: well-defined aspects of the quality of products
– grades: classification of products regarding to quality standards
• Two aspects:
– Delivery function of the marketing system – Transparency of comparison
Price efficiency
• A well-defined system of grades can improve the efficiency of marketing system
• Price efficiency: (allocation aspects)
– Increases the meaningfulness of price quotations
– Increases the precisions of price formation through increased knowledge
– May increase the level of competition in a market – Permits more systematic allocation of available
supplies to different demands
– Facilitates the collection of reliable information
on demand, supply and prices
Other consequences of standards
• Grading systems are not costless, and in some
instances, the cost of grading system may exceed the benefits of it
• May enhance potential price discrimination in certain markets
• May reduce the supply and flow of lower grade
produce, thus leading to price increase and reduced consumer choice
• Grades based on the quality at the production level may be meaningless to consumers
• Likewise, grades based on consumer preferences may not be meaningful for producers
Operational efficiency
• Operational efficiency (costs aspects)
– Limits time and expense of bargaining about quality
– Increases the ability to buy and sell based on description (e-business!)
– Encourages specialisation of marketing functions – May lead to larger geographical areas for
marketing
– May reduce the amount of unnecessary
information required for promotion and advertising – May discourage product differentiation based on
perceived quality differences
Measuring efficiency
Technical efficiency=OQ/OP Price efficiency=OR/OQ
Economic efficiency=OR/OP
Measuring efficiency
• Technical efficiency (TE):OQ/OP
– If TE=1, then we are at the isoquant
– If distance between Q and P, TE approaches to zero, i.e. 0<TE≤1
– Q is not most profitable technology, although it is efficient technically
• Price/allocative efficiency (AE): OR/OQ
– Best technological ratio regarding to P /best
technology regarding to best technological ratio
• Economic Efficiency (EE): OR/OP
• We can calculate efficiency for firm or industry
• Structural efficiency (SE), weighting by size of firms
• Example: three firms
– EE(1; 0,5;03) weights (4/7; 2/7; 1/7) – SE=1*(4/7)+0,5*(2/7)+0,3*(1/7)=0,757
Impact of quality grades on demand
A
B J
K
L G2
G1 Different preferences, same purchasing power
A and B consumers with different preferences, relating equilibrium points are K and L J a fixed ratio between quality grades (unclassified goods)
K and L are at higher level of indifference curve then J
Impact of quality grades on demand
A
B N G
H G2
G1
A and B consumers with different purchasing power, relating equilibrium points are G and H
T a fixed ration between quality grades N is less preferable than H
M
T
Same preferences, different purchasing power
Impact of quality grades on supply
P
Q Dg
Du
Qi Pu
Pg
Consumers are willing to pay more for graded products, thus aggregate demand shifts to right
Dg is higher than Du thus with the same quantity, and higher price, producers’ income increases
The net benefit for certain farmers depends on the premium based on grading systems
Benefits of grading
• Buying can be more convenient and cheaper
• Grades are an important prerequisite for future markets
• Ensure to identify the loss happening during transportation
• Farmers better off with producing higher quality goods
• Ensure the market intelligence
• Measure for farmers’ education in order to
improve the quality of their products
Price relationships among grades
Distribution of quality
No changes changes
Demand homogeneous
heterogeneous
Homogeneuos demand, same quality
quality quantity
poor high
C B A
If quality grades are good substitutes, then the market is cleared
Homogeneous demand, changing quality
quality quantity
poor high
C B A
D1: if quality is controlled then large premiums are for medium (B) and high quality (A) goods D2: there is only one grade
D3: if consumers are willing to pay large premium for high quality (A)
D1
D2
D3
Price, ordinal quality, costs of provision of grading should be positively correlated to each other
