Chapter one

1. Introduction to Economics of Agriculture

1.1 Definition and scope of Economics of Agriculture

 Dear students! Well come to the course of economics of agriculture. In order to get
better understanding on the course economics of agriculture, prior knowledge on
microeconomics part I and II are mandatory. What Economics of Agriculture is about?

To make it simple, before we attempt to define the term economics of agriculture, let us
begin with splitting the two words “Agriculture” and “Economics” and then attach
specific definition for each.

What is agriculture? I hope that every one of you is well familiar with the word
agriculture. Agriculture is the purposeful tending of crops and livestock. It includes group
of interrelated activities that encompasses the planting, raising, subsequent care and final
disposition of a wide range of crops and livestock. Alternatively, we can define agriculture
as the production, processing, marketing, and distribution of crops and livestock.
Agriculture is also the study of farming.

What is economics? The modern definition of economics, like other science, is brought
evolutionary from the earlier definition of Adam Smith “economics as the study of
wealth” to the modern Keynesian definition “as the study of administration of scarce
resources and of the determinants of income and employment”. There is no single
definition for the word economics. But for our purpose let us define economics as a
science of analyzing the use of limited resources to achieve the desired wants.

Now let us bring these two terms to define Economics of Agriculture. Here what we
should understand is like any field of study Economics of Agriculture was defined by
different scholars and economists at different time and place.

Then let us see some of the definition of Economics of Agriculture which are defined by
different scholars and economists at different time and place;
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  Economics of Agriculture is a branch of economics that specially dealt with land
usage.
 Economics of Agriculture is a part of economics that survey agriculture in its many
facets/forms.
 Economics of Agriculture is the branch of economics originally applied the principle
of economics of the production of crops and livestock.
 Economics of Agriculture is a science that deals with the allocation of scarce
resources among those competing alternative uses found in the production, distribution
and consumption of food and fiber.
Then we can define Economics of Agriculture as a discipline that adopts the principle of
economics to the problems of agricultural production and people engaged in agriculture
and allied activities. Thus, Economics of Agriculture is an applied science dealing with
how humans choose to use scarce productive resources and technical knowledge to
produce agricultural output and to distribute these for consumption to various members of
society over time.

Because agriculture is special (almost unique) in a number of ways, a specialized branch

of economics called Economics of Agriculture has developed to address the problems
associated with it.

Agriculture is faced with economic and sociological forces which are characterized by
relationships arising amongst men on account of agriculture being followed as a vocation and a
way of life. These relationships that agricultural economics deal with comprise of:

 Relationship of contact (supplementary, complementary or competitive) between the

different branches of the enterprise such as the simultaneous raising of cereals and animals on
the same farm;
 Relationships of activity between the different means employed in the process of production,
as in the simultaneous employment of machinery and human labor;
 Relations of value between the means employed in production and the product itself; and
 Commercial relations with the people to whom farmers sell their products or from whom
they buy their requirements.

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Then agricultural economics covers the examination of each element of agricultural production
whether in connection with any one of the above-mentioned relationships in particular or with
several of them together for the purpose of obtaining the greatest net profit.

We can also describe the scope of agricultural economics from the words of Taylor who According
to him, it (Economics of Agriculture) specifically treats the selection of land, labor and equipment
for a firm, the choice of crops to be grown, the selection of livestock enterprises to be carried on;
and the whole question of the proportions in which all these agencies should be combined.

The central theme in studying agricultural economics is that resources- land, labor, capital etc are
limited or too few to satisfy all human wants and that as a consequence of this scarcity choice must
be made. The problems with which we will study are ones of “constrained choice” (socio-
economic influences-land tenure, farm size, market system, infrastructure, government actions, and
cultural influence); that is how limited quantities of inputs are allocated between alternative
production uses of agricultural as well as non- agricultural activities, and of how limited income
are allocated between the many products consumers may buy.

Agricultural economics does not study only the behavior of a farmer at a farm level which is the
micro analysis. But agricultural problems have also a macro aspect. Instability of agriculture and
agricultural unemployment are the problems which have to be dealt with, mainly at the macro
level. And then, there are the general problems of agricultural growth and the problems like those
concerning tenure systems and tenurial arrangements, research and extension services which are
again predominantly macro in character. Such problems-their origin, their impact and their
solutions- all are the subject matter of agricultural economics.

In agricultural economics, we also study; for example, how the development of agriculture helps
the development of the other sectors of the economy: how can labor and capital flow in to the non-
agricultural sector, how agricultural development initiates and sustains the development of other
sectors of the economy. What this implies is that agricultural economics not only develops
principles concerning the use of scarce resources in agriculture but also examines the principles:
regarding the outflow of scarce resources to other sectors of the economy and about the flow of
these resources from other sectors in to the agricultural sector itself.

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From the above, we may conclude that the scope of agricultural economics is very vast with in its
scope must be included every phase of a nation's activities that in any way affect the farmer in his
efforts to make a living. At the farm level, agricultural economics is concerned with developing
ways and means by which each productive unit may be so organized and operated its products so
disposed of and the resources so allocated to various uses that the farm may yield maximum net
returns. On the sectoral level it deals with those problems that emerge when farmers attempt to
affect changes in farming that cannot be accomplished by individual action. Finally agricultural
economics must be concerned with solutions of those problems that require the active participation
of the government, i.e., problems connected with price control, supply of credit, international
trade, etc.

1.2 Nature and Historical Development of Agriculture

Is Agricultural economics a science or an art?

Agricultural Economics is both a social science (art) and a natural science. As a social
science, it does not differ significantly in its scope from general economics. A farmer's
activities, decisions and functioning are greatly affected by society which in turn is equally
affected by the farmer's decisions. To the extent, farmer's decisions are affected by his
own psychology, social institutions and religious and other taboos, his activities cannot be
measured in as precise manner as would be possible in a laboratory experiment. In this
respect, agricultural economics is subject to all such influences as exist within the domain
of social sciences.

On the other hand, agricultural economics as a natural science dealing with a thorough
examination and evaluation of scientific innovations suggested by soil scientists. And in
fact, some agricultural economists have called agricultural economics as an applied
science.

Foster and Leoger also say," Agricultural Economics is an applied science and as such is
concerned with the identification, description and classification of economic problems of
agriculture to the end that these problems may be solved." Also, according to Gray, “Agricultural

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Economics may be defined as the science in which the principles and methods of economics are
applied to the special conditions of agricultural industry."

In general, Agricultural Economics is both a science as well as an art. As such a science, it

explains the cause-and-effect relationships between various economic variables operating in
agriculture. And relationship as found to exist can be used for solving various problems affecting
agriculture. As such Agricultural Economics is an art.

Is agriculture being unique from other sectors?

The nature of Agricultural Economics is unique because of the important role nature plays
in its working. In no other economic phenomenon as in agriculture is the nature so
directly and strongly involved. Varying agro-climatic conditions, economic systems, soil
fertility and soil capacities lead to inter- regional and intra- regional heterogeneity in the
agricultural production conditions. This creates the problem of differential achievements
under different geo-economic conditions. The problems of agricultural production are,
therefore, multi- dimensional and the subject of agricultural economics has to develop in
the light of these problems that it seeks to investigate and work with. In general,
agricultural production has several general characteristics that distinguish it from other
forms of production. These are:

 The existence of many small production units (despite differences among countries,
agriculture employs by far the largest share of the world population)

 The plurality of products from one producing unit (individual producing unit or farm
typically engage in production of several different types of commodities)

 The biological nature of the production process (production processes are engaged to
the life cycle of the particular plant or animal that is involved requiring considerable
quantities of heat, moisture, and soil nutrients)

 The nature of location decision

 The existence of considerable degree of production for self-sufficiency. i.e., majority

of farmers in the world plans their activities in terms of production for home
consumption rather than for the market. In other words, it does not enter commercial
channels.

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 Its sensitivity to natural forces such as rainfall intensity, climate, temperature and the
like.

The application of economic theory to agriculture problems has gone through a process of
slow acceptance. The origin of the field, now known as Economics of Agriculture reaches
back in many directions and over a long period of time. The field came from two separate
sources: -from the physical sciences, and latter from economic theorists.

Since agriculture its production systems are influenced by physical (topography, climate),
social (tradition, culture) and economic (market infrastructure) factors, a comprehensive
body of science, which includes physical science, social science, and economic theory, is
fundamental.

The severity and length of the agricultural depression beginning in the 1880s caused
increasing attention to be devoted to its causes and possible solutions. Primarily
agronomists and horticulturalists made the most notable early efforts. They recognized
that the ability to grow plants and animals was not sufficient to make farmers succeed.
Agricultural economics is an important subject area because it is concerned with society’s
basic needs. Getting food and other agricultural products to all people in the world in the
right form at the right time is an extremely complex process.

1.3 The Role of Agriculture in Economic Development

In developing economies, agriculture is still considered to be the mainstay of the

economy. The contribution of agriculture to economic development lies in the following:

 Providing food to the rapidly expanding population

 Increasing the demand for industrial products and thus necessitating the expansion of
the secondary and tertiary sectors, i.e., Market Contribution

 Providing additional foreign exchange earnings for the import of capital goods for
development through increased agricultural exports, i.e., Product Contribution

 Increasing rural incomes to be mobilized by the state

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 Transfer of labour and capital

 Providing productive employment, i.e., Factor Contribution

 Improving the welfare of the rural people

I. Food production

Food production efficiency is central to the process of economic growth because of the
following reasons:

Food production efficiency creates demand linkage i.e. with increased per capita
food production; farmers’ demand for labor-intensive goods increased then
investment increased then employment in non-farm sectors will expand.
It is possible to achieve food self-sufficiency and make progress towards improved
food security.
It is also possible to prevent inflationary pressure through improved efficiency in
food production.

In redeveloping countries, demand for food increases at t fast rate because of three basic
reasons:

Fast growth of population.

Growth of per capital income.
High income elasticity of demand for food.

There are also three major reasons why a growing agricultural surplus is important:

To increase food supplies (and agricultural raw materials) at non-inflationary prices

To widen the domestic market for industrial goods through increased purchasing
power with in the rural sector (it mean rising effective demand)
To facilitate inter- sectoral transfers of capital needed for industrial development.

II. The Market contribution

A rise in rural purchasing power, as a result of the increased agricultural surplus there is a
great stimulus to increased development. The market for manufactured goods is very small

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in developing countries where peasants, farm laborers and their families are too poor to
buy factory goods. Increased rural purchasing power caused by expansion of agricultural
output and productivity will tend to raise the demand for manufactured goods and extend
the size of the market. This will lead to the expansion of the industrial sector.

Moreover, the demand for such inputs as fertilizer, better tools, implements, tractors,
irrigated facilities in the agricultural sectors will lead to the expansion of the industrial
sector. Besides, transport and communications will expand. The long-run effects of these
expansions will be higher profits, which tend to increase the rate of capital formation
through their investment.

III. The product contribution

Developing countries mostly specialize in the production of a few agricultural goods for
exports. As output and productivity of exportable goods expand, their exports increased
and result in large export earnings. Thus agricultural surplus leads to capital formation
when capital goods are imported with foreign exchange. This is providing additional
foreign exchange earnings for the import of capital goods for development through
increased agricultural export i.e. purchasing some production items that are means of
production from other sectors at home or abroad; and selling some of its product, to other
sector i.e. the disposal of agricultural product in any way other than consumption within
the sector.

IV. The factor contribution

A developing country needs large amount of capital to finance the creation and expansion
of the infrastructure and for the rural development of basic and heavy industries. In the
early stages of development, increasing the marketable surplus from the rural sector
without reducing the consumption levels of farm population can provide capital. Labor as
the principal input can be a source of capital formation when it is reduced on the farm and
employed in other productive works. One major possibility of increasing farm receipts and
thus capital formation is by mobilizing increased farm incomes through agricultural
taxation, land taxes, agricultural income tax, land registration charges, school fees, fee for

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providing agricultural technical service and other types that cover the cost of services
provided to the farm population.

V. Transfer of labor

According to the standard definition, Agricultural Transformation is the process by

which a predominantly agrarian economy evolves into a diversified, industrial economy.
This implies a substantial decline in the share of agriculture in the total labor force. A
historical experience of today’s developed countries indicate massive shift of labor from
agriculture (where the amount of capital per worker and average productivity were
relatively low) to industry and services, where they were relatively high. This structural
transformation of labor can be explained in terms of two factors. These are;

A. Higher income elasticity of demand for industrial products and low elasticity for food.
B. Growth in agricultural output with a constant or even declining labor force .This has
resulted from substantial increases in total factor productivity in agriculture.
Structural transformation accompanying rising per capital income can be considered along
two dimensions:

 Changing output shares

 Reallocation of the labor force
In both cases structural transformation is characterized by relative decline in the
importance of agricultural sector in the economy like DC’s.
In general, the time it takes to transfer the bulk of the labor force from agriculture to
higher productivity sector depends up on three determinants:
The initial weigh (Ln/Lt), meaning the ratio of the non- agricultural labor force (Ln)
in the total labor force (Lt).
The rate of growth of total labor force (L’t ), (which is , roughly equivalent to
population growth rate) and ;
The rate of growth non- farm employment (L’n).
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Thus the rate of structural transformation of agriculture (RST) can be expressed as follows

RST=Ln (L’n-L’t)/Lt

Where, the expression in the bracket, i.e. (L’n-L’t), indicates the rate of at which the non-
agricultural labor force increases .this equation shows that:
The higher the proportion of the agricultural labor force at the start of the projection (the
initial period) the longer the time needed to reach the turning point and the lower the
growth rate of the total labor force and the higher the growth rate of the non-agricultural
labor force ,the shorter the time needed to reach the turning point

VI. Transfer of capital

The mechanism for the transfer of capital assumes two channels. These are through;

I. Governments
II. Free market transfer

I. Transfer through governments include;

A. The direct transfer method

This consists: direct taxes, example Japan (land tax) and compulsory deliveries of
agricultural commodities, example Russia (compulsory deliveries of agricultural output).

B. The indirect transfer method

This consists of: price control, foreign exchange manipulation, turning terms of trade
against agriculture, etc.

Note that transfer through government should be accompanied by to technological

progress in agriculture. Direct transfer without sufficient surplus may lead to disincentive
structure, political problems, etc.

II. Free market (voluntary) transfer

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For the free market transfer, three conditions should be satisfied:

There should be sufficient marketable surplus.

Farmers must be net-savers, they must consume less than what they produce.
Farmer’s savings must exceed their investment in agriculture.

Generally, balance of payment will be surplus if all the above conditions will be satisfied.

VII. Improving the welfare of the rural people

Rise in per capital income leads to substantial rise in demand for food. Here income
elasticity for food is very high. The increase in the growth rate of population due to
decline in mortality rates and slow reduction in fertility rates tends to raise further demand
for food. The demand for food increases with expansion of population in towns and
industrial areas. Where increased population of agricultural commodities lags behind the
growth in demand for them, there will be a substantial rise in food prices.

To offset domestic shortages and prevent rise in prices, food may be imported from abroad
but this can be at the cost of capital goods needed for development. The state may
introduce price controls and rationing. A rise in rural purchasing power as a result of
increased agricultural surplus is a great stimulus to industrial development.

The market for manufactured good is small since peasants, farm laborers, and their
families are poor to buy. There is a lack of real purchasing power reflecting the low
productivity in agriculture especially in the least developing countries. The demand for
such inputs as fertilizer, better seeds, implements, tractors, and irrigational facilities in the
agricultural sector will lead to great expansion of the industrial sector. Means of transport
and communication will expand when agriculture surplus is to be transport to urban areas
and manufactured goods to the rural areas. If there increased output, some will exported
and result in larger foreign exchange earnings. Agriculture expands and diversifies
employment opportunities in the rural areas. Increased income as a result of the
agricultural surplus tends to improve the rural people welfare. Thus increased agricultural
surplus has the effect of raising the standard living of the rural poor.

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 1.4 Interdependence of Agriculture and Industry

We can easily understand the interdependence of agriculture not only with industry but
also with other sectors like service and foreign trade. There are two linkages that tied
agriculture with the rest of other sectors, forward and backward linkage. Concerning with
forward linkage agriculture will provide inputs i.e. primary agricultural commodities,
consumer goods and services in turn agriculture will receive payment for those provision.
When we see the backward linkage industry will provide important input in turn that
accelerate the development of agriculture sector. You can easily understand from the
following diagram;

Farm inputs, consumer goods &service

Non- Agriculture
Product contribution
agricultural

Sector & Factor contribution

the over all
Market contribution

Export Foreign exchange Agricultural export

Imports earning
Foreign
trade
Cash income from export

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These contributions play a crucial role during the initial stage of economic development,
when agriculture is the dominant sector of the economy. However, the importance of
agriculture in the economy progressively declines as growth takes place in other sectors .
however, the decline in relative importance of agriculture is accompanied by substantial
increases in productivity and structural transformation of sector.

In other words, the relative importance of agriculture declines as a process of structural

transformation takes place. ”structural transformation” is defined as a process by which a
predominantly agrarian economy evolves in to a diversified industrial economy; structural
transformation constitutes advance in agricultural science and technology. Substantial
increases in total factor productivity, high degree of specialization, radical changes in the
structure of demand for food, and increased inter sectoral interdependence in the economy.
These features imply a rapid growth of agriculture, which is associated with the decline in
the relative importance of the sector.

Why a rapid growth of agriculture is accompanied by a decline in the relative importance

of the sector seems a paradoxical phenomenon. However, these seemingly contradictory
processes can be explained in terms of the following developments:

A. Because of agricultural technological progress, the unit cost of production declines

relative to other sectors, thus leading to the movement of domestic terms of trade
against agriculture;

B. Consistent with Engel’s law, the share of food in the total household expenditure
declines as per capital income rises, i.e. low income elasticity of demand for food
(this leads to relatively slow growth of markets for food); and

As new economic sectors emerge and grow (e.g. the service sectors) the relative importance of
agriculture declines

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