TOPIC 1: PRICE DETERMINATION

IN AGRI-FOOD PRODUCT AND

FACTOR MARKETS
TOPIC 1
1. DEMAND FOR AGRI-FOOD PRODUCTS AND FACTORS
Consumption patterns: Ukraine vs Germany

Source: Greens (2018).

Household behavior.
Lecture Notes
Consumption patterns: Ukraine vs Germany

Source: Greens (2018).

Household behavior.
Lecture Notes
Recap of Demand Theory
• 𝑞1𝐷 = 𝑞1𝐷 (𝑝1 , 𝑝2 , 𝑌, 𝜆)
• 𝑞1𝐷 -demand for product 1
• 𝑝1 -price of product 1; 𝑝2 - price of product 2; 𝑌 – income of
household; 𝜆 – structure of needs and preferences of household
• In a simple form: 𝑞1𝐷 = 𝑞1𝐷 (𝑝1 ), because of ceteris paribus condition
• Rational behavior
• A consumer is like a computer
• Law of Demand: Price and Quantity vary Inversely
Law of Demand: explanation
q1
• I1 and I2 – indifference
curves (utility is the
same along the curve)
B2
• B1, B2, and B3 – budget
line
q12
A2 Substitution Effect • Income Y = p1q1+p2q2
B1
A1
Income Effect • Substitution effect is
always negative
A0 I2
q11 • Income effect
B3
• Superior good – positive
I1
• Inferior good – negative:
Giffen’s paradox.
q22 q21 q2
Law of Demand: explanation
Complementary products: only income Aggregation of individual demand
effect curves – market demand
q1 p
p p

I1 I2
B2

A2
q12 I2
B1

q q q
q11 I1 a a
A0 b b

• Change in demand – move along the demand curve

q21 q22 q2 due to price change
• Shift in demand – shift of demand curve due to
external factors
Price elasticity

Own versus cross price elasticity Graphical representation

𝑑𝑞1
𝑞1 p
• 𝜀𝑞1,𝑝1 = ൘𝑑𝑝1
𝑝1 S 𝜀 = 𝑚Τ𝑛
𝑑𝑞1
n
  1: elastic area
𝑞1
• 𝜀𝑞1,𝑝2 = ൘𝑑𝑝2 a
2 V
 1
p0 T
• Value of price elasticity depends Δp
m   1:
Inelastic
on a price, i.e. it is defined for a p1
Δq
area

point on the demand curve L

A
O q0 q1 q
Price elasticity: some properties
• Price elasticity changes as the
income changes
• Price elasticity depends on the #
of substitutes
• The lower the share of
expenditures on a product in
total expenditures the lower
elasticity
Price elasticity versus price flexibility
• King’s rule: 1% change in harvest triggers more than 1% change in
prices
𝑑𝑝 1 𝑑𝑞
• Price flexibility: dp/p:dq/q. = ∙
𝑝 𝜀 𝑞
• Example: 𝜀=-0.2; q decreased by 10%; what about dp?
𝑑𝑝 1
• Solution: = ∙0.10=-0.5; => p decreased by 50%
𝑝 −0.2
Price elasticity and total and marginal
expenditures
• Total expenditures: 𝐴 = 𝑝 ∙ q
A,p

Demand
𝑑𝐴 𝑑𝑝
• = (1 + 𝜀) A2
value = total
𝐴 𝑝 A1
A3
expeditures

• Generalize to M goods? A0
Elastic area

𝑑𝐴
• Marginal expenditures: p3

𝑑𝑞 p2

𝑑𝐴 1 Inelastic area
• = 𝑝 (1 + )
𝑑𝑞 𝜀
p1

p0

q
Income Elasticity
• Engel curve: 𝑞𝐷 = 𝑞𝐷 𝑌
• Y – income
𝑑𝑞
𝑞
• 𝜂 = ൘𝑑𝑌
𝑌
• Superior (Normal) goods 𝜂 > 0
• Inferior goods 𝜂 < 0
Expenditure Elasticity
• % response of expenditures on
individual product to a 1%
change in total expenditures
Relationships among Elasticities
• 𝑞1 = 𝑞1 (𝑌, 𝑝1 , 𝑝2 )
𝑑𝑞1 𝑑𝑌 𝑑𝑝1 𝑑𝑝2
• = 𝜂 +𝜀𝑞1,𝑝1 +𝜀𝑞1,𝑝2
𝑞1 𝑌 𝑝1 𝑝2
𝑑𝑞1 𝑑𝑌 𝑑𝑝1 𝑑𝑝2
• Under “no money illusion” condition: = 0; = =
𝑞1 𝑌 𝑝1 𝑝2
• 0= 𝜂 +𝜀𝑞1,𝑝1 +𝜀𝑞1,𝑝2 - Slutskyi-Shults relationship
Relationships among Elasticities
• Homogeneity Condition
• 𝐸𝑖1 + 𝐸𝑖2 + ⋯ + 𝐸𝑖𝑖 + ⋯ + 𝐸𝑖𝑛 + 𝐸𝑖𝑦 = 0
Example from US, retail level data
Relationships among Elasticities
• Symmetry Condition
𝑅𝑗
• 𝐸𝑖𝑗 = ( )𝐸𝑗𝑖 + 𝑅𝑗 (𝐸𝑗𝑦 − 𝐸𝑖𝑦 )
𝑅𝑖
• 𝑅𝑗 is the expenditure on j as a proportion of total expenditures;
• 𝐸𝑗𝑖 - cross price elasticities; 𝐸𝑖𝑦 - income elasticities
• It might simplifies to:
𝑅𝑗
• 𝐸𝑖𝑗 = ( )𝐸𝑗𝑖
𝑅𝑖
• Example: lamb (l) versus beef (b); 𝑅𝑙 = 0.1%; 𝑅𝑏 = 2%; 𝐸𝑙𝑏 = 0.6
0.001
• 𝐸𝑏𝑎 = 0.6 = 0.03
0.02
Relationships among Elasticities
• Engel Aggregation Condition
• 𝑅1 𝐸1𝑦 + 𝑅2 𝐸2𝑦 + ⋯ + 𝑅𝑛 𝐸𝑛𝑦 = 1
• Cournot Aggregation Condition
• 𝑅1 𝐸1𝑗 + 𝑅2 𝐸2𝑗 + ⋯ + 𝑅𝑛 𝐸𝑛𝑗 = −𝑅𝑗
Empirical Examples of Own Price and
Expenditures Elasticities, Germany 1993
Empirical Examples of Own Price Elasticities
for various HHs Groups, Germany 1993
Practical importance: Example 1
Effect of increase in incomes and
Closed Economy: production
𝑑𝑌
•𝜂 = +0.1; = 0.03
𝑌
𝑑𝑞 𝑆
• 𝜀 𝐷 = −0.1; = 0.02
𝑞𝑆
𝑑𝑞 𝑆 𝑑𝑞 𝐷
• 𝑆 = 𝐷 in a closed economy
𝑞 𝑞
𝑑𝑞 𝑆 𝑑𝑌 𝐷 𝑑𝑝
• =𝜂 +𝜀
𝑞𝑆 𝑌 𝑝
𝑑𝑝
• => =-0.17=-17%
𝑝
Practical importance: Example 1

Intervention:
• 𝑑𝑞 𝑆 =𝑑𝑞𝐷 +𝑑𝑞𝑖 , e.g. Ukraine’s
grain
𝑑𝑌 𝐷
• 𝑑𝑞 𝐷=𝜂 𝑞
𝑌
𝑑𝑌 𝐷
• 𝑑𝑞 =𝜂 𝑞 +𝑑𝑞 𝑖
𝑆
𝑌
Case Study: Food Demand in Russia
Source: Staudigel, M., & Schröck, R. (2014). Food Demand in Russia: Heterogeneous Consumer Segments over
Time. Journal of Agricultural Economics, n/a–n/a. http://doi.org/10.1111/1477-9552.12102

• There is no comparable study on food demand in Ukraine

• Time coverage: 1995-2010
• Similar to Ukraine; In Russia people spent on average 35-40% of their
incomes on food and beverages; In Ukraine - about 50%.
• Shows considerable changes in the composition of food baskets over
time, as incomes grow
• Food production at home loses in importance
Case Study: Food Demand in Russia
Source: Staudigel, M., & Schröck, R. (2014). Food Demand in Russia: Heterogeneous Consumer Segments over
Time. Journal of Agricultural Economics, n/a–n/a. http://doi.org/10.1111/1477-9552.12102
Case Study: Food Demand in Russia
Source: Staudigel, M., & Schröck, R. (2014). Food Demand in Russia: Heterogeneous Consumer Segments over
Time. Journal of Agricultural Economics, n/a–n/a. http://doi.org/10.1111/1477-9552.12102
 (Derived) Factor demand
a) Production function
q
q  f (x1 , x 2 ,..., x n )

• Start from profit function:

qmax

• 𝐺 = 𝑝𝑞 𝑥1 , 𝑥2 − 𝑟1 𝑥1 − 𝑟2 𝑥2
• Differentiate w.r.t. 𝑥1
𝜕𝐺 𝜕𝑞
x1max x1
• = 𝑝 − 𝑟1
b) Marginal product (or productivity) function 𝜕𝑥1 𝜕𝑥1
q q
 f (x1 , x 2 ,..., x n ) 𝜕𝐺
 x1 x1
• = 0 in optimum
𝜕𝑥1
𝜕𝑞
• 𝑝 = 𝑟1
𝜕𝑥1

x1
Factor demand
Aggregate (market) factor demand:
Marginal product value curve case for const. marginal productivity
A B C Market demand
q
 p, r1
x1
q q q q
 p,r  p,r  p,r  p,r
x1 x1 x1 x1
q
p A
x1 rmax
B
rmax
q
 p  r1 C
x1 rmax

x1A x1B x1C x1

x1opt x1
 Factors that affect factor demand

Agr. product prices Agr. factor prices

Marg. Product Value Curve 0
q q
 p, r1  p0 q q
x1 x1  p,r2  p, r1
x 2 x1

Marg. Product. Value Curve 1 r21

r20
q r10
 p1
x1
p1 > p0

x21 x20 x2 x11 x10 x1

x1
Factors that affect factor demand

Technical progress

a) Production function b) Marg. Productivity Curves

q
q
x1

x1 x1
Demand Policy Issues

Private and Social Demand Curves Other issues

p
Private
• Environmental goods
• Social shadow prices
demand

p0
• Transaction costs
difference

Social demand

q1 q0 q
TOPIC 1
2. SUPPLY RELATIONSHIPS IN AGRICULTURE
Factors determining supply

Supply curve Factors that determine supply

• 𝑞1𝑠 = 𝑞1𝑠 (𝑝1 , 𝑝2 , … , 𝑝𝑛 ,
𝑟1 , 𝑟2 , … , 𝑟𝑛 , 𝑇, 𝑍, 𝑉)
• 𝑞1𝑠 = 𝑞1𝑠 (𝑝1 )
• 𝐺(𝑞) = 𝐸(𝑞) − 𝐾(𝑞); profit =
revenue-costs
𝑑𝐺 𝑑𝐸 𝑑𝐾
• = − ;marginal profit =
𝑑𝑞 𝑑𝑞 𝑑𝑞
marginal revenue – marginal costs
Factors determining supply, cont’d

Price receiver assumption

𝑑𝐸 𝑑𝐾
• = 𝑝, = 𝑝;
𝑑𝑞 𝑑𝑞 Marginal costs curve

• Marginal costs = price p G

Total average costs curve

C

• => Marginal costs curve = supply

p0 H
D

curve for a firm Average variable costs curve E

Profitability threshhold

p1

Production threshold
A B F

q1S qS0 qS2 qS

Supply curves in time
p

In short run
In medium run

In long run
p1

p0

qS
qS
0
Supply elasticity analysis
Price elasticities of supply for selected
𝑑𝑞𝑆 commodities in US
𝑞𝑆
• 𝜀𝑆 = 𝑑𝑝
𝑝
Changes in supply
• Input (factor) prices
• Changes in prices of commodities competing for the same resources
or factors of production
• Prices of joint products
• Price and yield risks
• Technology
• Institutional factors
Changes in
supply
• Input (factor)
prices
• Relationship btw
hog to corn price
and the change in
number of sows
farrowing
TOPIC 1
3. PRICE DETERMINATION
Classification of Markets 1
• Perfectly competitive market:
• There are many byers and sellers
• The product is homogenous
• All resources are completely mobile
• All buyers and sellers have perfect knowledge
• Purely competitive market:
• Market participants are price takers
• Product is sufficiently homogenous
• Cost of entry/exit is low
• Market information is widely available
Classification of Markets 2
• Absolute monopoly
• Oligopoly: few large sellers
• Pure or differentiated oligopoly
• Monopolistic competition
• Large number of sellers offer similar but differentiated products (e.g. livestock
feeders)
• How to define the market structure? (e.g. market concentration
indexes)
• Usually it is sufficiently to classify markets as flex or fixed priced
Price Determination: General Plot
• General rule: MR=MC

Competitive Oligopoly Monopoly

• MR=P=MC • MR=P(1+K/e)=MC • MR=P(1+1/e)=MC

• Kє[0,1] • e.g. e=-2; => MR=0.5P
• Cournot model: or P=2MR
• K depends on the # of • e=-0.2; => MR=-4P
firms
• e.g. K=1/m for m
firms oligopoly
• Bertrand model: =
comp. equilibrium
Case Study: Analysis of Market Power –
Ukrainian Dairy Sector
• Perekhozhuk et al (2016): Approaches and methods for the
econometric analysis of market power: A survey and empirical
comparison Journal of Economic Surveys · February 2016 DOI:
10.1111/joes.12141
• Theoretical background:
• (Dairy) Industry supply: Y=f(M,N); Y – output; M – ag input (raw milk);
N – nonag. Inputs
• Farming sector: WM=g(M,S); WM-raw milk price; S – supply shifts
• Π = P*f(M,N) – WM * M - WN * N
• FOC: WM *(1+φ/ε) = P*fM; ε = (∂M/∂WM)/(WM/M)
 Price Determination: Pure
Competition
• Degree if price variability depends
on: a) demand function (elasticity),
b) magnitude of random shifts in
supply
• Carrying over inventories (storable
products) complicate price variability
Price Determination: Pure Competition
• Common practice: P=f(I/U),
where U is total use; I = ending
stocks
• I=A+I-1+M-Q-X; A-output; I-1-
beginning stocks; M-imports; Q
– consumption; X-export; U=Q+X