Ag Marketing Unit 2

Elasticity of Demand
-a measure of the responsiveness of changes in quantity demanded to changes in prices and income
-when price of good changes by 1% by what percent does quantity demanded for that good change
Inelastic
-the percent change in quantity demanded is less than the percent change in price
Elastic
-the percent change in quantity demanded is more than the percent change in price
Own Price Elasticity of Demand
= Change in Q/Change in P x P/Q

-Inelastic: -1

As price decreases…
-revenue rises when demand is elastic
-revenue falls when demand is inelastic
-revenue reaches its peak when elasticity of demand equals 1
Factors Affecting Price Elasticity of Demand
-degree of substitutability (lots of substitutes=more elastic)
-proportion of income spent on the good (higher proportion of income=more elastic)
-luxuries (more elastic) vs. necessities (more inelastic)
Making Decisions with Demand Elasticities
-since elasticities are unit free they can be used to measure price sensitivity in markets of different sizes when different currencies or commodities are involved
Cross Price Elasticity of Demand
-measures how much demand for one good shifts when the price of some other good changes by 1%

=Change in Qi/Change in Pj x Pj/Qi

-substitutes: nij>0
-complements: nij<0 -independent: nij=0

Income Elasticity of Demand
-measures degree to which buyers respond to a change in their income by buying more or less of a good

=Change in Q/Change in I x I/Q

-normal good: nI>0
-inferior good: nI<0

Price Flexibility
-with respect to ag commodities, changes in price are more related to changes in supply–demand is relatively stable and price insensitive at the farm gate
=the % change in price associated with a 1% change in quantity
Elasticity of Supply
-a measure of the responsiveness of producers to a change in price of a commodity
-when price changes by 1% by what percent does quantity supplied change
Own Price Elasticity of Supply
=Change in Q/Change in P x P/Q

-inelastic: 01
-unit elastic: n=1

*Always positive!

Input Price Supply Elasticity
=Change in Qi/Change in Pj x Pj/Qi
Factors Affecting Price Elasticity of Supply
-Degree of substitutability (ability to transfer into/out of an activity or the availability of alternative activities)
-Government involvement
-Time (long run vs. short run and length of production process)
Applications of Supply and Demand Analysis
-farm prices are more variable than nonfood prices because of inelastic supply and demand curves and the unpredictable changes in food supply
-because of inelastic curves, shifts in demand or supply result in larger price changes
-who benefits from cost-reducing technology? (suppliers and consumers in form of lower prices)
Price Determination
-the use of economic concepts of demand and supply to indicate how the terms of trade or price associated with transactions involving an exchange of ownership become established
-how the relative strength of seller/buyer interests affect prices
-well represented by supply/demand analysis
Central Markets
-physical or virtual locations in which buyers and sellers meet, where supply and demand meet
-concentration of buyers and sellers increases transparency and lowers transaction costs
-one of principal roles of central markets is price determination
Price Discovery
-denotes mechanisms or arrangements by which buyers and sellers arrive at specific prices and other terms of trade
-focus on characteristics of actual processes used by participants for arranging terms of trade
-products change ownership numerous times along marketing chain (there is a costly price discovery process for each transaction)
-price discovery varies by product, culture, time, and technology
Price Discovery Activities
1) Individual
2) Group Action
Individual Agreements
1) Timing of transfer of ownership:
-immediate (i.e. grocery store)
-forward contracts (price and time of delivery pre-established–Production and Marketing contracts)
-repeated contracting, establishing long term relationships and trust
-futures contracts

2) Pricing Schemes:
-explicit prices (seller posts prices)
-negotiation
-formula prices (buyer and seller agree on how to automatically adjust prices in future in case of price fluctuations)

Group Action
-Auctions (bidding process organized in some way)
-Group Bargaining (cooperatives of producers, creates more balance in power between buyer and seller but can lead to free rider problem)
Government Intervention
-government can influence price discovery process by facilitating interaction between buyer and seller or by controlling prices
Demand
=consumer demand, primary demand or demand at the retail level
-where demand originates from the consumer
-always above derived demand since retail prices are higher than what producers receive
Derived Demand
-farm level demand
-derived from retail demand
Marketing Margin
-difference between prices at different levels of marketing system
-aka. farm-retail price spread
-measures the value added by the marketing chain
-under perfect competition value added=marketing costs
Derived Demand Shifters
-any primary demand shifter will shift the derived demand curve
-value-adding changes in product features also shifts derived demand
Supply
=producer supply, primary supply, or supply at the farm level
-where supply originates from the producer
-always below derived supply
Derived Supply
-consumer or retail level supply
-derived from farm level supply
Derived Supply Shifters
-any primary supply shifter will shift derived supply
-change in marketing costs (labor, transportation, storage, utilities, etc.)
Effects of Price Elasticities on Price Changes
-slope of demand and supply curves
-if slope of farm level demand is more inelastic than slope of retail level demand the magnitude of price change is greater at farm than at retail level and vice versa
-if slope of farm level supply is more inelastic than slope of retail level supply the magnitude of price change is greater at farm than at retail level and vice versa
Marketing margins are not a measure of…
-the efficiency of the marketing sector
-profits of the marketing sector
-a large marketing margin does not necessarily cause low farmer shares and does not imply that there are too many middlemen
Farmer’s Share
=the difference between the retail price of food and the marketing margin (P farm/P retail)
=the percentage of the consumers food dollar that goes to the farmer
-measured by USDA in 2 ways: Market bill and Market basket
Marketing Bill
-provides estimates of the difference between total yearly consumer expenditures for domestically produced food and price received by farmers
-annual cost for the food sector’s marketing services, including transporting, processing, and distributing domestic farm foods
-includes at home and away from home
-components: labor, packaging materials, transportation, energy, taxes, interest, profits, and advertising
Marketing Basket
-tracks changes in the value or costs of marketing a group or basket of food products relative to farm value
-calculated as an index
-purpose: measure variations in prices over time, track changes in retail food prices, farm prices, and the price of providing services associated with marketing a fixed quantity of US farm originated foods
Basket vs. Bill
Basket:
-only home
-fixed set of quantities, changes in value of basket are result of changes in prices of US farm commodities purchased by US consumers

Bill:
-home and away from home
-reflects changes in price, quantity, production mix, and marketing services

Why consumer food expenditures have increased over time
1) Population increase
2) Inflation
3) Demand for convenience
Rationalizing increasing marketing bill
1) Increase in income induces greater demand for marketing services
-more income: income elasticity of demand is much higher for marketing services than for raw food products

2) Increase in energy and wages affect marketing costs more than agricultural costs
-marketing sector is more labor and energy intensive

Why farmer shares change across products
-farmers shares reflect variation in time, form and place utilities added by farmers and marketing firms
Final Product Value is influenced by…
-degree of processing
-perishability of product
-product seasonality
-transportation costs
-bulkiness in relation to product value
Farmer share will be…
-larger for products that are minimally processed
-smaller for products that are highly processed or whose production is highly concentrated in limited geographical areas
Farm to Retail Price Spread
=difference between retail price per unit and farm value of an equivalent amount of food sold by farmers
Index
-numerical scale used to compare variables with one another or some reference number
-condenses information from multiple factors into a single, easily understood number
-compares prices and quantities in a meaningful way
-mostly used for comparisons across time
Key Factors in Calculating an Index
1) What items to include in an index
2) What sort of weights to attach
3) What base year to use
Average of Price Relative
-type of price index
-a relative price indicates the percent change in price for a commodity
-assumes price change for each commodity is equally weighted/important

Pr= (P1/P0) x 100
-Pr=relative price of a commodity
-P1=price for one particular year
-P0=price in an initial or base year

Real Prices
-nominal price adjusted for inflation or deflation

=Nominal Price/Price Index x 100

Consumer Price Index
1) Measures inflation or changes in the general price level in the US
2) Cost-of-Living adjustments
3) Used as a deflator