AGRICULTURAL PRICES AND MARKETS

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 5

Marketing margin

Imre Fertő

Literature

• Tomek, W. G.–Robinson, K. (2003): Agricultural

Product Prices. Cornell University Press, Chapter 6

• Hudson (2007): Agricultural Markets and Prices.

Blacwell, Chapter 4

• Ferris. J. N. (1997): Agricultural Prices and

Commodity Market Analysis. McGraw–Hill, Chapter 5

• Schrimper, R. A. (1995): Subtleties Associated With Derived Demand Relationships. Agricultural and

Resource Economic Review, October, 241–246

• Canning, P. (2011): A Revised and Expanded Food Dollar Series. A Better Understanding of Our Food Costs. USDA ERS, ERR. No. 114

Theory of marketing margin

• Approaches of marketing margin

• Empirical measurements of marketing margin

• Types and changes of marketing margin

• Price elasticities and marketing margin

• Market structures and marketing margin

Approaches of marketing margin

• Producers and consumers do not meet with each other directly, marketing system is between them

• Marketing margin (MM)

– Difference between the price paid by consumers and that obtained by the producers

– The price of all marketing services that occurs between the farm gate and the consumers

(transport costs, packages costs, wages, profit etc.)

• MM can be described – in per cent

– in absolute value

• MM

– Refers only to the price difference

– But makes no statement about quantities

Marketing margin

P

Q S_d

S_p

D_d D_p

Retail sector

producers MM

Marketing margin

D_r AVC ATC S_m

Q₀ P

Q_ms ATC

P_r-P_f

Empirical measures of marketing margin

• Marketing bill:

– This is an estimate of total marketing costs of all domestically produced farm food purchased by civilians in the domestic country

– Several ways of investigating the marketing bill

• Costs components: labour, transport, rents, profits, etc.

• Institutional costs: wholesaler, retailer, processor, etc.

• Individual commodity costs: meat, fruit, vegetables, etc.

• Farm-food market basket:

– This is a measure of average costs of fixed quantity of farm products

– There are four components to the Market Basket series

• Retail price

• Farm value

• Farm-retail price spread

• Farmers share of the consumer or retail dollar

Empirical measures of marketing margin

• Farm-retail price spread

– Farmers share of the consumer or retail dollar – It should measured by equivalent value

– Example

• For steers, 2,5 kg of live weight yield 1 kg of retail beef cuts

• 2000 retail beef price = €8,40/kg average all cuts

• 2000 steer price = €1,20/kg live weight

• 2000 farm-retail price spread = €5,40/kg retail cut (= 8,40 – 2,5*1,20)

• Stylized fact:

– The share of producers in consumer dollar decreasing over time

Interpretation of changing farmers share

• Is a large farm-retail price spread necessarily bad?

– Shift in consumption patterns towards food with higher value added and more food eaten-away- from-home (marketing bill)

– Factor productivity increases more rapidly in agriculture than in manufacturing, let alone services

– Could be due to growing market power

– Latter suspicion fuelled when reductions in farm prices are not passed through in lower retail

prices

Source: Agri-Aware website

Real food prices are declining….

Changes in MM

• Change in MM caused by changes in derived S

and D, NOT by changes in primary S and D

• Why?

• Consider primary D and S shifters?

• How does change in marketing costs affect

primary D and primary S?

• Primary D – Income

– Population

– Price other goods – Tastes

• Primary S

– Price/profit competing products

– Technology – Input costs – Weather

Changes in MM

• Derived D and S shifters include factors associated marketing services

– Transport costs – Processing costs

– Processing technology – Assembly costs

• Thus change in MM reflected as derived D and S shifters

• By how much?

– ΔMM=P

-P

E.g. The growth of transport costs

P

Q S_d

S_p

D_d D_p

MM

D’_d S’_d

Q Q*

Growing transport costs → Increasing MM

•Q↓

•P_f↓

•P_r↑

Effect of changing MM

• Incidence of transportation costs: farmers and consumers

• Depends on

– Relative own-price elasticity of S and D

• What happens if D is more elastic than S

• What happens if S is more elastic

than D

Perfectly inelastic D

P

Q S_d

S_p

D_d=D_p MM

S’_d

Q

Perfectly inelastic S

P

Q S_d=S_p

D_d D_p

Árrés

D’_d Q

Types of MM

• Constant MM

– MM=c, where c≥0 and constant

– Paralel D curves – E_d=E_r(P_d/P_r) where,

• E_d: derived demand (farm) elasticity

• E_r: retail demand elasticity P_d:

derived demand (farm) price

• P_r: retail price

• Proof:

– For any ΔQ,

• ΔP_r=ΔP_f and Q_r=Q_f

• E_d/E_r=dQ/dP_r*P_r/Q*d P_f/dQ*Q/P_f=P_d/P_r

• Properties

– Ha P_d/P_r<, |E_d|>E_r

– D_d is more inelastic than D_p

– Larger margins

between d and r mean larger differences in prices elasticities between d and r

Types of MM

• Fixed percentage MM

– MM=aP

, where 0≤a ≤1 – E

=E

– Unlikely entire margin would be like this

• Proof:

– If P

=kP

, where k is a constant and Q

=Q

– E

=dQ/dkP

*kP

/Q=dQ/dP

*P

/Q=E

Percentage MM

D_f

D_r

S_f

S_r

MM

MC₁

ATC₁

AVC₁

MC₂

ATC₂

AVC₂ Marketing firm high fix costs

+ economies of scale

Types of MM

• Combination of absolute and percent MM:

– MM linear combination of constant

absolute amount (c) and constant per cent of retail price (a)

– MM=c+aP

, where c>0 and 0≤a ≤1 – Unit margin decreases with lower

prices as quantity marketed increases

– E

=E

(1-(c/(1-a)*P

)

Combined MM

D_f

D_r

S_f S_r

M M

MC

AVC Prices are more

volatile at the farm level than at the consumer level Marketing firm with

high fix costs + high VC

Price elasticities and incidence of MM

• R_f=1/(1+(P_r*E_s)/P_f*|E_d|)), where

– R_f= total price changes at the farm level

• Proof:

– If ΔMM= ΔP_r– ΔP_f, then % changes at the farm level – But |E_d|=dQ/dP_r*P_r/Q and E_s=dQ/dP_f*P_f/Q

– Thus dP_r=dQ/E_d*P_r/Q and dP_f=dQ/E_s*P_f/Q

– Thus R_f=dQ/E_s*P_f/Q/((dQ/E_d*P_r/Q)+dQ/E_s*P_f/Q)) – dQ/Q simplify and * E_s/P_f

– R_f=1/(1+(P_r*E_s)/P_f*|E_d|))

Price elasticities and incidence of MM

• R

=1/(1+(P

*E

)/P

*|E

|)), if

– E

=0, then R

=1, producers pay entirely the changes of MM

– E

=0, then R

→0, consumers pay

entirely the changes of MM E

= |E

|, R

= P

/(P

+P

)

– E

>|E

|, R

<P

/(P

+P

)

– E

<|E

|, R

>P

/(P

+P

)

Joint products

• X: basic commodity

• X

and X

: joint products

• W

and w

: fixed yields per unit X

• X

=w

X, X

=w

X

• P

and P

unit prices of joint products

• E

=(P

w

+P

w

)/(1/E

(P

w

)+(1/E

(P

w

)

– If P

w

or P

w

=0, then E

=E

or E

MM with variable ratio

MM and imperfect competition

P

Q S_f

S_m

D_f

D_r MM

MR_c

S_r

Q Q*

S_r: retail S_f: producer S_m: MM

S_r–S_f=S_m MR=MC

Conclusions

• Marketing margin can be defined by the price

differences between two market levels (producer and consumer)

• Theoretical models suggest that marketing margin depends on:

• Changes in factor prices

• Efficiency in marketing sector

• Changes in supply of agricultural products

• Changes in derived demand

• The impacts of market power in processing and retail sector on marketing margin are not

unambiguous