MODULE 6: AGRICULTURAL ECONOMICS
PRINCIPLES OF AGRICULTURAL ECONOMICS
Agricultural economics is defined as an applied science which aims at maximizing
agricultural output while minimizing cost, making use of economic principles and other
relevant disciplines. That is, how mankind chooses to use technical knowledge and scarce
production resources (land, labour, capital and management) to produce goods and
services and to distribute them for consumption to various members of the
community/society.
It can also be defined as the study of how limited resources are allocated to produce
goods and services and how to distribute them for consumption.
ECONOMIC SYSTEMS
These are ways of providing answers to the basic economic problems; what to produce, how
much to produce, how to produce and for whom to produce.
The economic questions are used by countries to manage their resources efficiently. The
economic systems are:
Planned economy (command)
Under this system the government or the state plans and controls the use of resources.
Resource allocation decided by the government
Prices are controlled by the government
Planning is very difficult as people have different taste
Advantages
There is equitable distribution of wealth and income
Inflation is effectively controlled
Competition is avoided - no competition in production
Consumer basic needs are easily met
Disadvantages
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Less incentives or motivation to workers as the government fixes wages and private
property is not allowed.
Involves very high administrative costs
Producers not motivated to produce more
Products are rationed to the consumers
Over production of certain goods due to misjudgment on the preference of consumers.
No consumer choice
Free market economy (capitalism)
In this economy, there is no government intervention except for the provision of public
services
Resource allocation is made by companies or private individuals.
Price is the key variable in resource allocation – only those resources backed by money
are supplied.
Market forces will determine the price
A firm can produce any commodity it wishes / market the commodity anyhow/where
Advantages
Consumers are free to buy and sell what they want.
Producers are highly motivated by profit hence they have incentive to respond quickly to
changes in consumer preference.
Producers also are motivated by high demand in certain goods and services, as a result
the higher the consumer’s income will influence what is produced.
Disadvantages
Monopolies are likely to happen and this may force small companies to close down.
Public goods are under provided and can only be provided by the government.
Mixed economy (socialism)
This system combines characteristics of the planned and free-market economies. Both planning
and market price are used when allocating resources. In a mixed economy, there are two sectors,
market and non-market sectors.
Market sector: goods and services are sold to consumers by producers who must cover their
cost of production and make profits from their sales.
Non-market sector: goods and services which are shared by the public their cost is covered by
the government and they are usually subsidized such as hospitals, roads, education, street lights
etc.
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FACTORS OF PRODUCTION / RESOURCES
These include land, labour, capital and management.
LAND: refers to all natural resources of climate, soli, minerals, vegetation and water. These are
found either on the earth’s surface or underneath. Land is fixed in a location and each piece of
land has its unique set of natural characteristics. Land is also geographically immobile.
LABOUR: includes all human resources i.e. time and effort used in the production of goods and
services. Labour may be skilled or unskilled and it includes both physical and mental efforts.
CAPITAL: refers to manmade items used to produce goods and services e.g. buildings,
machinery and money. It excludes land. Capital may be divided into:
Fixed/Durable Capital; it provides services throughout its life time e.g. buildings and
machinery.
Working/ Circulating Capital; it circulates through the production process of goods and
services e.g. money, feeds and fertilizers
MANAGEMENT/ ENTREPRENEURSHIP:
An entrepreneur is a person who perceives a business opportunity and pursues it, utilizes
the chance or takes advantage of the opportunity to make profit.
The main function of an entrepreneur is to assess the risk of undertaking a business and
decide on whether to start or not to start that particular business.
The other function is to organize/direct/control production processes where decisions are
made on how other resources should be allocated to come up with goods and services.
Management makes decisions on e.g. what to produce, what method to use and where to
sell the product.
DEMAND
It is the amount of goods and services consumers are willing and able to buy at any given price at
any given time.
Law of demand
It states that the higher the price of the commodity, the lower the quantity demanded and the
lower the price of a commodity the higher the quantity demanded.
Demand schedule
A demand schedule shows the different quantities of product that consumers are willing and able
to buy at each given price and time e.g.
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Price(Pula) Quantity demanded per month
50 50
40 80
30 130
20 190
10 300
The demand schedule above shows that as the price of a commodity increases. The quantity
demanded decreases. From the demand schedule above, a demand curve can be plotted.
THE DEMAND CURVE
Price (Pula) Demand curve
Quantity demanded
DETERMINANTS OF DEMAND
Price of the commodity: if the price of the product sold is high, the quantity demanded will be
low because most consumers will be willing but unable to buy, but the lower the price the higher
the quantity demanded since now consumers will be willing and able to buy the commodity
being sold.
Consumer’s income: if consumers earn more, the quantity demanded for a commodity will be
high since they will now be having the buying power, but the lower the consumer’s income the
lower the quantity demanded.
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Consumer’s taste and preference/fashion: if the consumers like the product most, they will
buy more of it hence the higher the consumers taste and preference for a particular good the
higher the demand and vice versa.
Price of other products: if the price of substitute goods is lower, consumers will demand or buy
more of the substitute e.g. if the price of maize meal is high and that of sorghum meal is low,
consumers will demand more of sorghum meal than maize meal
Advertising: the more and well advertised a product is the higher the product will be demanded
than the product that is not well known.
Population size: the higher the population the higher the demand of a particular commodity.
ELASTICITY OF DEMAND(Ed)
It is the percentage change in the quantity demanded of a product or service to a given
percentage change in price of that product or service, other things being equal.
Ed = % change in quantity demanded
% change in price
Q 2−Q1 P2 − p1
Ed= ÷
[ ( Q1 +Q2 )÷2 ] [ ( P1 + P2 ) ÷2 ]
There are three types of elasticity of demand;
1. Elastic demand
It occurs when Ed is greater than one. i.e. it occurs when % change in quantity demanded is
greater than % change in price e.g. luxurious items a small fall in price will lead to a greater
increase in quantity demanded.
2. Inelastic demand
It occurs when Ed is less than one i.e. it occurs when % change in quantity demanded is less
than % change in price.
3. Unitary elastic demand
It occurs when Ed is equal to one i.e. % change in quantity demanded is equal to % change in
price.
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SUPPLY
It is the amount of goods and services offered for sale over a given time and at a given price.
Law of supply
It states that the higher the price of the commodity, the higher the quantity supplied.
Supply schedule
The supply schedule below shows that when the price of commodity supplied increases the
quantity offered for sale also increases.
Price(Pula) Quantity supplied per month
50 300
40 190
30 130
20 80
10 50
From the supply schedule above, a supply curve can be plotted.
THE SUPPLY CURVE
Price (Pula)
Quantity supplied
DETERMINANTS OF SUPPLY
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Price of the commodity: if the price of the product sold is high, the quantity supplied will be
high, but the lower the price the lower the quantity supplied.
Price of other products: if the price of substitute goods is lower, producers will supply less of
the substitute e.g. if the price of maize is high and that of sorghum is low, producers will supply
less of sorghum mea than maize.
Cost of production: the higher the lower the supply.
Technology: improved technology enables farmers to supply more for sale because more is
produced.
Number of sellers: the higher the number of producers for as particular commodity the higher
the supply.
ELASTICITY OF SUPPLY (Es)
It is the percentage change in the quantity supplied of a product or service to a given percentage
change in price of that product or service, other things being equal.
Es = % change in quantity supplied
% change in price
Q2 −Q1 P2 − p1
Es= ÷
[ ( Q1 +Q2 ) ÷2 ] [ ( P1 + P2 )÷2]
There are three types of elasticity of supply:
1. Elastic supply
It occurs when Es is greater than one i.e. it occurs when % change in quantity supplied is greater
than % change in price e.g. luxurious items a small fall in price will lead to a greater decrease in
quantity supplied.
2. Inelastic supply
It occurs when Es is less than one i.e. it occurs when % change in quantity supplied is
less than % change in price.
3. Unitary elastic supply
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It occurs when Es is equal to one i.e. % change in quantity supplied is equal to % change
in price
THE LAW OF DIMINISHING RETURNS
The law states that ‘if a variable input is increased while other inputs are held constant, a
point is eventually reached where the additional output for each additional input declines’.
Example: The relationship between fertilizer and crop yield
No OF FERTILIZER BAGS AREA OF LAND (ha) OUTPUT (tons)
1 50 2
2 50 4
3 50 6
4 50 8
5 50 8
6 50 7
7 50 6
In the table above, fertilizer is a variable input and land is a fixed input. As units of fertilizer are
increased, the output increases until at the 5 th unit where output remains constant and at 6 th unit,
the output declines to 7 tons.
A graph showing law of diminishing returns
Output (tons) C D
Fertilizer
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A-B= Increasing returns B-C= Diminishing/decreasing returns
C-D= Zero returns D-E= Negative returns
Equilibrium price
This is the price at which the quantity of a product demanded is equal to the quantity of a
product supplied i.e. the price at which consumers are willing and able to buy all that
producers offer for sale. At this price, there are no unsatisfied buyers and sellers. This is
called the market clearing price i.e. no excess demand or excess supply.
At a lower price, quantity demanded is more than quantity supplied, therefore a product
will be sold quick hence there will be shortage or scarcity. As a result, producers may
raise prices knowing that consumers will buy. This will force price back to equilibrium.
At a higher price, quantity demanded is lower than the quantity supplied, therefore less
consumers will buy the product hence there will be excess (surplus). As a result,
producers may be forced to lower the price so that all is sold. This will force price back to
the equilibrium.
Graph showing Equilibrium Price
Price D S
Pe
Qe
Quantity
Pe = Equilibrium price or Market clearing price
Qe= Equilibrium quantity
E = Equilibrium point (where supply and demand curve meet) i.e. a point where consumers
maximize satisfaction and producers maximize profit.
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RISK AND UNCERTAINTY
These refer to those unforeseeable and unavoidable factors facing man during production. As a
result, farmers are never sure of what is going to happen in the future.
RISK
It is the difference between expected results and the actual outcomes. When farmers produce a
product at times they do not get what they expected due to natural factors or conditions.
UNCERTAINTY
It is the state of imperfect knowledge about future outcomes. This is normally applied in
situations where outcomes cannot be predicted.
Risk Uncertainty
Can be estimated Cannot be estimated
Can be insured against Cannot be insured against
e.g. weather changes, fire, theft, pests e.g. price fluctuations, change in demand,
and diseases, accidents to workers change in technology, change in
government policy
How to adjust to risk and uncertainty:
Input rationing
Farmers should avoid using a lot of input in one enterprise e.g. applying less fertilizer so that if
the enterprise fails, not much of the fertilizer will be lost.
Insurance
This involves farmers paying small amounts of money (premiums) to an insurance company so
that in case of loss or damage, the farmer can be paid for what is insured.
Diversification
It means running different enterprises at a time so that if one fails, the other may be successful.
TYPES OF GOODS
Complementary goods
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Two goods are complementary if:
An increase in one product causes an increase in the other.
An increase in demand of one causes an increase in demand of the other e.g. bread &
butter.
An increase in the price of one leads to decrease in the demand of the other e.g. leather &
shoes.
Production of one product helps in production of another e.g. beef & leather.
One product produces an input used by the other. e.g. cowpeas& maize
An increase in the price of one leads to an increase in the price of the other e.g. milk &
cheese.
Supplementary goods
Two goods are supplementary if:
An increase in one product does not cause an increase or decrease in the production of the
other.
An increase in demand of one product does not affect the demand of the other product.
An increase in the price of one product does not lead to a decrease in the demand of the
other e.g. maize and vegetables.
Production of one product has no impact in the production of the other product e.g. maize
and sunflower.
An increase in the price of one product does lead to an increase or decrease to the price of
the other product e.g. sorghum and beans.
OPPRTUNITY COST
If a farmer has a choice before him as to which crop to grow, he needs to consider which
one will give him the best return for his inputs;
For example, if he decides that maize will give him a better return than sorghum, it is
possible to assess the relative value of the two crops. Assuming that he chooses to grow
maize, the opportunity cost in this case is the price which he would have gained if he
grew sorghum;
Therefore the opportunity cost is defined as the value of the forgone alternative when
a choice is made.
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