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 8
Price differences and quality 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
3
• 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
4
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 able to increase their profits
• Consequence: there is no equilibrium if all farmers produce bad quality wheat
• 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
• 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
5
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
6
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
7
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
8
• 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 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
9
Impact of quality grades on supply
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
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
10
• Farmers better off with producing higher quality goods
• Ensure the market intelligency
• Measure for farmers’ education in order to improve the quality of their products
Price relationships among grades
Homogeneuos demand, same quality
Distribution of quality
No changes changes
homogeneous Demand
heterogeneous
11
Heterogeneous demand, same quality
• No figure, because consumers are not agreed in the quality
• Quality grade may exist, but prices depend rather on the relative demand and supply
• E.g. USA wheat grades
Heterogeneous demand, changing supply
• If market is segmented we can use quality grades
• But market competition is not so strong as in case 2, because, demand is heterogenous, thus quality grades are imperfect substitutes
• Quality grade may help to meet demand and supply
• E.g. vegetable, fruit, tobacco
12
Criteria of grading
• Relevant quality characteristics
• Correct and unified measurements
• Understandable terminology
• It should include the average of production
• Costs of grading should be acceptable
Problems of using grades
• Identification of the quality
• Number of classes and grades
• Quality deterioration
• Grading along food chain
• The relationship between grades and brands
Conclusions
• Agricultural markets are being increasingly characterised by product heterogeneity
• Consumers have a greater demand on markets to produce products with specific qualities
• Grading and classification systems have increasing importance because they may improve the operational and price efficiency of marketing system
