Chapter 4: Demand and supply in Agricultural marketing

4.1. The Basic Idea of Supply & Demand

Supply-and-demand is a model/typical for understanding the

determination of the price of quantity of a good sold on the
market
 The Concept of Demand
• Demand is used in the language to mean almost any kind of
wish or desire or need.

• But to an economist, demand refers to both willingness and

ability to pay.
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 Needs : are the basic human requirements. People need food,
air, water, clothing, and shelter to survive.
• People also have strong needs for recreation, education and
entertainment.
 Wants - are desires for specific satisfiers of the needs. A want
for one person may not be a want for another person
 Demands-are thus wants for specific product that are
backed/financed by an ability and willingness to buy the
product.
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 Quantity demanded (Qd) is the total amount of a good that buyers would choose
to purchase under given conditions/at different price.

 The given conditions include:

• price of the good
• income and wealth
• prices of substitutes and complements
• Population
• preferences (tastes)
• expectations of future prices
 The Law of Demand states that when the price of a good rises, and everything else
remains the same, the quantity of the good demanded will fall/decrease or an
inverse relationship between the price and the quantity demanded.

 In short,↑ P → ↓Qd
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A Demand Curve is a graphical representation of the relationship
between price and quantity demanded (ceteris paribus).
 It is a curve or line, each point of which is a price - Qd pair
 That point shows the amount of the good buyers would choose to buy at
that price.
 Change in price→result change in quantity demanded→ movement
along demand curve
 Change in non price determinant → change in demand →shift in
demand curve
 In other words, shifts occur “when the ceteris are not paribus.”
 Cont……

Examples:

 The price of a substitute good drops → implies a leftward shift.

 The price of a complement good drops → implies a rightward

shift.

 Incomes increase → implies a rightward shift (for most goods).

 Preferences change → could cause a shift in either direction,

depending on how preferences change
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 Demand versus Quantity Demanded. Remember that quantity
demanded is a specific amount associated with a specific price.

 Demand, on the other hand, is a relationship between price and

quantity demanded, involving quantities demanded for a range of
prices.

 “Change in quantity demanded” means a movement along the

demand curve.

 “Change in demand” refers to a shift of the demand curve, caused

by something other than a change in price
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 Consider first a rightward shift in Demand

 This could be caused by many things:

an increase in income, higher price of substitute, lower price of

complements, etc. Such a shift will tend to have two effects: raising
equilibrium price, and raising equilibrium quantity. [↑P*, ↑Q*].

 Price changes cause movements along a demand curve.

  Elasticity of demand

 Elasticity is the percentage change in one variable given a

percentage change in another variable.
 The important elasticities of demand are price elasticity of
demand, income elasticity of demand and cross elasticity of
demand.

 Price elasticity of demand

 Tells us the percentage change in quantity demanded resulting
from a percentage change in price.
 Price elasticity of demand is negative but usually expressed in
positive or absolute values.
Cont…
 Cont…

 When the price elasticity of demand = 0 then demand is said to be

perfectly inelastic. This means that demand does not change at all when
the price changes
 When the price elasticity of demand is between 0 and 1 (i.e. the
percentage change in demand from A to B is smaller than the
percentage change in price), then demand is price inelastic
 When the price elasticity of demand = 1 (i.e. the percentage change in
demand is exactly the same as the percentage change in price), then
demand is said to be unit elastic
 When the price elasticity of demand > 1, then demand responds more
than proportionately to a change in price. Demand is said to be price
elastic
 Cont…

 Cross price elasticity of demand (EXY)

 Is the proportionate change in the quantity demanded of a
commodity (X) resulting fro a proportionate change in the price of
another commodity (Y).

 Commodities X and Y are substitutes if EXY is positive,

complementary if EXY is negative, and independent if EXY is close
to zero.

 Firms use the concept of EXY to measure the effect of a change in

the price of related commodities on the demand for the commodity
that the firm sells.
Cont…
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 Income elasticity of demand (EI)

 Is the proportionate change in the quantity demanded of a
commodity resulting from a proportionate change in the income of
the consumer.

 Goods for which EI is positive are called normal goods, while

goods with negative EI are called inferior goods.

 Consumers purchase less of inferior goods when their income

rises because they can afford more expensive products.

 Normal goods are classified as necessities if EI is between 0 and 1

and as luxuries if EI exceeds 1.
 Cont…

 Examples of necessities are food, clothing, and housing.

 Examples of luxuries are vacations, jewel, and luxury cars.

 Example, If the demand for commodity X is 400 units with I =

Birr 10,000 and 600 units with I = Birr 11,000, then EI is:

Thus, commodity X is a normal good and a necessity.

 Cont…
 Determinants of price elasticity of demand
 Availability and closeness of substitutes

 The more substitutes available for a product, the more elastic is its
demand.

 Nature of the product

 As the price of a luxury increases, the reduction in quantity

purchased is relatively large.

 In contrast, a good considered a necessity will tend to have a more

inelastic demand.

 People are not so responsive to a change in the price of a

necessity.
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 The proportion of income spent on the particular commodity

 The greater the portion of the consumer's budget to a product, the

more elastic is the demand for that product.

 The speed with which the law of diminishing utility operates

 This speed may vary from person to person.

 The faster the law operates, the more inelastic the demand for the
product will be.
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 The Concept of Supply
 The behaviour of the supplier is definitely different from the behaviour of
demanders
• Again, economists think of it differently. Supply is not just the amount of
something there, but the willingness and ability of potential sellers to produce and
sell it.
• Supply is the quantities that people are or would be willing sell at different
prices during a given time period, assuming that other things affecting these
quantities remain unchanged
 Quantity supplied (Qs) is the total amount of a good that sellers would choose
to produce and sell under given conditions. The given conditions include:
• price of the good
• prices of factors of production (labor, capital)
• prices of alternative products the firm could produce
• technology
• productive capacity
• expectations of future prices
 Cont…
 When we talk about Supply, we’re talking about the relationship
between quantity supplied and the price of the good, while holding
everything else constant.
 The market supply of a given product is the sum of the individual
supplies of that product.
Price Individual. Individu Individu Individu Individu Individu Market
A al. B al. C al. D al. E al. F supply

2.5 1 6 5 4 7 2 25
3 2 7 6 5 8 3 31
3.5 3 8 7 6 9 4 37
4 4 9 8 7 10 5 43
4.5 5 10 9 8 11 6 49
  The Law of Supply
• The Law of Supply states that “when the price of a good rises, and everything
else remains the same, the quantity of the good supplied will also rise.”
• In short, ↑P → ↑Qs
• prices and quantities supplied of a commodity are directly related, all other
things remaining unchanged.
• A Supply Curve is a graphical representation of the relationship between price
and quantity supplied (ceteris paribus).
• The supply curve shows the amount of good or service suppliers will be willing
and able to sell at a particular time at a particular price, ceteris paribus.
• The supply curve is upward sloping because, all else being equal, as the price
of a good rises, people are willing to sell a greater quantity of the good.
• Changes in supply or shifts in supply occur when one of the determinants of
supply other than price changes.
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 Change in price→result change in quantity supplied → movement
along supply curve
 Change in non price determinant of supply → change in supply
→shift in supply curve
 Non price determinants of supply
 Costs and technologies
 Prices of other goods or services offered by sellers
 Future expectations
 Number of sellers
 Weather condition
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 Supply versus Quantity Supplied. Analogous to the demand
versus quantity demanded distinction.
 “Change in quantity supplied” means a movement along the
supply curve.
 “Change in supply” refers to a shift of the supply curve,
caused by something other than a change in price.
 Now consider a rightward shift of supply (caused by lower
factor price, better technology, or whatever).
 This will tend to have two effects: raising equilibrium quantity,
and lowering equilibrium price. [↓P*, ↑Q*.]
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 Elasticity of Supply

 Is defined as the responsiveness of quantity supplied of a

good to a change in its price.
 Elasticity of supply is measured by the percentage change in
quantity supplied of a good by a percentage change in its
price.
 Cont..
 Notice that, unlike the price elasticity of demand, the figure is
positive.

 This is because price and quantity supplied change in the same

direction.

• Example, suppose the price of beef increase from Birr 20 per unit
to Birr 21 per unit and consequently the quantity supplied rises
from 25 units to 30 units.

• Calculate the elasticity of supply.

 4.2. Demand forecasting
 Demand forecasting is involved with the estimation of the future demand of a
given product on the basis of the past and present demand data.
 This forecasting is helpful in that it helps the producer to decide how much to
produce and hence how much input to use so as to get maximum profit without
wasting the inputs and the outputs.
 Forecasting can be done in different ways. But the most commonly used
techniques are the following.
 Least square method: - In forecasting demand using this technique, the trend of
demand in the last few years (mostly not less than 5 years) is determined by a
linear trend equation derived from the previous demand situation.
 It is given by the linear relationship as Y= a + bT where Y is the dependent
(influenced variable) and T is the independent variable (influencing variable).
 From this equation the coefficient a and b can be determined to know the trend
of the demand.
T Y
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TY T2
0 10 0 0
1 13 13 1
2 14 28 4
3 17 51 9
4 18 72 16
5 18 90 25
6 19 114 36
7 20 140 49
8 22 176 64
9 23 207 81
10 22 220 100
11 24 264 121
12 24 288 144
13 25 325 169

Where T=time N= number of observations, Y= demand

 T  91 Y  269 T=6.5 Y= 19.21

The coefficient “b” can be calculated by using the following formula

 TY  nT Y  1998  14(6.5 X 19.21)  1.097 a= Y  bT  19.21  1.097 x6.5  12.08
T  nT 2 819  (14)(6.5)2
2

So, the trend equation now becomes Y= 12.08 + 1.097 T

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 This means for each additional units of time, the demand will change
by 1.097 and hence the demand for the coming year can be
determined by substituting the appropriate value of T in the equation.

 This trend analysis approach can also be used to forecast both output
and input prices and hence input costs can also be forecasted by
using the same approach.

 Note; - In order to use this forecasting technique, we should have at

least a minimum of a five years’ time series data on the issue under
consideration.
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 Chain ratio method: - The potential sale of a product may be estimated by
applying a serious of factors to a measure of aggregate demand.
 For example, a given dairy producing and processing enterprise can
estimate the demand for dairy products (potential sale of dairy products) for
the coming few years in the following way.
 Example if:
[Link] no of population in the region ………………. 1, 000,000
[Link] of consumers of product X ……………….. 0.5
[Link] no of consumers of product X …………………..500,000
[Link] annual amount of consumption …………. 20 Kg / consumer
[Link] amount of consumption of product X in a year......10, 000,000
 Once the total amount of consumption of product X in a year is obtained, then
it can be multiplied by the annual growth rate of population to estimate the
potential demand in each year.

 So, if 10,000,000 is the total annual consumption of the product by all the
consumers and if 2% is population growth rate, then the potential sale for each
year can be:

Year 0 …………………….10, 000,000

Year 1 …………………….10, 000,000 + 2/100X 10,000,000 = 10,200,000

Year 2……………………..10, 200, 0000 +2/100X 10,200,000 = 10,404,000

 4.5 Market equilibrium

 Market Equilibrium (Price) is the price level where quantity

demanded is equal to quantity supplied

 It is also called market clearing level because all the

commodities provided for market are sold in the market since
the demand is there

 The price level at this intersection point is called equilibrium

price and the quantity at this level is called equilibrium
quantity.
Cont...
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 At the equilibrium price of Birr 3, the Qd of 19 exactly equals the
Qs of 19.
 Qd and Qs are equal only at equilibrium point.
 At any price above Pe, there would be a surplus.
 More is supplied than consumers are willing and able to purchase at
that price.
 Thus, any price above Pe fails to clear the market.
 Price will fall to the equilibrium price of Pe.
 At any price below Pe, there would be a shortage.
 Price will rise to Pe.
 When supply matches demand the market is said to clear.
 There is no shortage and no surplus.
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 Government intervention to stabilize price

 Setting of price ceiling and price floor is important tools that

government uses to stabilize price

 Government use floor price when it is thought that producers

are in danger

 Floor Price plays a significant role when it is set above

equilibrium price.
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 Government intervention through price ceiling is done when it is
thought that consumers are hurt

 Price ceiling work better when it is set below equilibrium price

 The intervention of government to correct market imperfection

by using ceiling and floor prices can be illustrated by using the
following graph

 Price Ceilings and Floors

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 when there is market disequilibrium in the form of excess

supply, floor price (minimum legal price) above the
equilibrium price will be charged to safeguard/protect the
suppliers
 and this makes the original supply curve to shift upward and
meet the demand curve at the level of the floor price
 so as to create a new equilibrium level of supply which is of
course less than that of the original
  Consumer and producer surplus

 Through market interaction of suppliers and demanders, a single

price is determined in a market which we call equilibrium price

 generating benefit for:

 Consumers who are willing to buy at higher price than the

equilibrium price and

 Producers who are willing to sell at lower price than the

equilibrium price.

 These gains are associated with the concept of consumer and

producer surplus, which is depicted below:
Consumer and producer surplus…
 Consumer and producer surplus…
 Area ABD and BDC show consumer and producer surplus, respectively.

 Market equilibrium price is Birr 3 per unit at which producers are

willing to sell 19 units of produce and similarly consumers are willing
to buy the amount.

 Consumers are willing to pay the area ABEO, however, the actual
payment is only DBEO leaving a benefit for the consumers the size of
area ABD.

 Similarly, producers are willing to accept CBEO but they actually

receive a size of an area DBEO, leaving a benefit of area size of DBC
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 In any developing economy the producer’s surplus of farm products

plays a significant role

 This is the quantity which is actually made available to

the non-producing population of the country
 From the marketing point of view this surplus is more
important than the total production of commodities
 The arrangements for marketing in the expansion markets have
to be made only for the surplus quantity available with the
farmer and not for the total production
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 The rate at which agricultural production expands determines the

pace of agricultural development while the growth in the
marketable surplus determines the pace of economic
development

 Here the knowledge of marketed and marketable surplus helps

the policy makers, as well as the traders in the following areas

 The producer’s surplus is of two types: marketable surplus and

marketed surplus
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 Marketable surplus: the quantity of the produce which can (or

should) be made available to the market
 It is the residual left with the farmers-producer from the total
production, after accounting for the on farm requirement of the
product in terms of family consumption, seed, feed, payment
(kind) to labor, payment to artisans, etc.
 It is a theoretical, ex-ante concept of producer’s surplus
 It shows quantity actually sold after accounting for losses and
retention by farmers, if any and adding previous stock left out
for sales
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 Marketed surplus: It is that quantity of the produce which the

producer-farmer actually sells in the market, irrespective of his
requirements for on-farm consumption

 It is an ex-post concept, may be greater, less or equal to the

marketable surplus.

 It is that quantity of the produce which the producer-farmer

actually sells in the market, irrespective of his requirements for

on-farm consumption.
End of Chapter 4