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 2

Demand for agricultural products

Imre Fertő

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/elel mfogy08.pdf

• Regmi, A.–Takeshima, H.–Unnevehr, L. (2008): Convergence in Global Food Demand and Delivery. USDA, ERS, Washington, ERR No. 56

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

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

Demand theory

• 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

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↑↓

Demand theory

• Max(F,H) assuming

• P_f*F+P_hH=Y – U: utility – F: food – H: house – Y= income

– P_f: price of food – P_h: rent of houses

U=F*H+λ(Y-P_f*F+P_hH)

• 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

Determinants of demand

• Demand function

• Q_d=f(P_i, P_s, P_c, Y, N, T, G), where – Q_d: quantity demand

– P_i: price of product

– P_s: price of substitutes – P_c: price of complements – Y: average income

– N: number of population

– T: Taste and preferences of population – G: Income distribution of population

How can various factors affect on demand quantity

– P_i: increase or decrease – P_s: increase or decrease – P_c: increase or decrease – Y: increase

– N: increase – T: change – G: change

Demand elasticity

• Own price elasticity

– If E_p<–1 elastic

– If E_p=–1 unitary elastic – If E_p>–1 inelastic

– If E_p=0 perfectly inelastic – If E_p=∞ perfectly elastic

) /

/(

) /

(

p

dQ dP P Q

E 

) /(

) (

) /(

)

(

p

Q Q Q Q P P P P

E      

Demand elasticity

• But!

– Demand elasticity may change along demand curve

– E.g. linear demand curve – Q=10–P

– If P=5, then E

=–1 – If P=8, then E

=–4

– If P=4, then E

=–0,25

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+E_p)

• If

– E_p<–1, then total revenue grows

– E_p=–1 then total revenue is constant – E_p>-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/E_p)

• Amoroso-Robinson relation

• If

– E_p<-1, then marginal revenue decreases – E_p=-1 then marginal revenue is constant – E_p>-1, then marginal revenue increases

Cross price elasticity

• If E_ij>0, then i and j are substitutes

• If E_ij<0, then i and j are complements

• If E_ij=0, then i and j are independent

• 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

) /

/(

) /

( ^{i j j i}

ij dQ dP P Q

E 

Income elasticity of demand

• If E

<0, inferior good

• If 0<E

<1, normal good

• Ha E

>1, luxus good

• Engel curve: for food products E

<1

) /

/(

) /

( dQ dY Y Q

E



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)

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:

– E_ii+E_i1+E_i2+…+E_iy=0

• Symmetry condition

– E_ij=(R_j/R_i)E_ji+R_j(E_jy–E_iy)

• R_i share of i product in total expenditures

• R_j share of j product in total expenditures

• Engel equation

– (R₁E_1y+R₂E_2y+ …+R_nE_ny)=1

Three types of goods

Impact of income changes

Impact of own price

Superior E_Y>0

Inferior E_Y<0 Normal

E_p<0

Normal superior good: e.g. milk, butter

Normal inferior good e.g. milk powder

Giffen E_p>0

- Giffen good

Staple foods for poor people

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)

• 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

Deflation: price and income data are deflated by CPI

Q_beer=α₀+ α₁P_beer+α₂P_wine+α₃P_spirit+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

_cons 2.320492 .6965751 3.33 0.003 .8674615 3.773522 ljov .1707309 .0831078 2.05 0.053 -.0026289 .3440908 ltomenyar -.491161 .0993606 -4.94 0.000 -.6984236 -.2838985 lborar .1189198 .0648215 1.83 0.081 -.0162954 .254135 lsorar -.213585 .1892578 -1.13 0.272 -.6083699 .1811999 lsorfogyabs Coef. Std. Err. t P>|t| [95% Conf. Interval]

Total .094967425 24 .003956976 Root MSE = .03609 Adj R-squared = 0.6709 Residual .026046712 20 .001302336 R-squared = 0.7257 Model .068920713 4 .017230178 Prob > F = 0.0000 F( 4, 20) = 13.23 Source SS df MS Number of obs = 25 . reg lsorfogyabs lsorar lborar ltomenyar ljov

Results

Prob > chi2 = 0.7000 chi2(1) = 0.15

Variables: fitted values of lsorfogyabs Ho: Constant variance

Breusch-Pagan / Cook-Weisberg test for heteroskedasticity Prob > F = 0.0107

F(3, 17) = 5.10 Ho: model has no omitted variables

Ramsey RESET test using powers of the fitted values of lsorfogyabs

Durbin-Watson d-statistic( 5, 25) = 1.705783

Slutsky-Schultz

condition is not valid ΣE_ij=-0,415

Mean VIF 4.63

ljov 2.72 0.367513 ltomenyar 4.46 0.224437 lsorar 4.52 0.221305 lborar 6.82 0.146635 Variable VIF 1/VIF

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