In this article we will discuss about the pricing of agricultural products in India:- 1. Price Determination in Abnormal Market Conditions-Monopolistic and Oligopolistic Markets 2. Pricing of Agricultural Goods under Conditions of Duopoly 3. Pricing of Agricultural Products under Imperfect Competition 4. Pricing or Agricultural Products under Conditions of Perfect Competition. Learn about:- 1. Pricing Of Agricultural Products 2. Definition of Pricing in Agriculture 3. Price Determination of Agricultural Products 4. Factors Affecting Prices of Agricultural Commodities 5. Importance of Pricing in Agriculture 6. Pricing Strategy for Agricultural Products.
Price Determination of Agricultural Products
Price theory for agricultural products is not a separate theory. It is the special application of the same theory of price as is studied in general economics. It is seldom if ever that the market for agricultural products can be found to be monopolistic. In certain special cases, it can be converted into cartel type market.
Tea or coffee planters or rubber growers can form an association for marketing purposes. However, even such cases are rare and sooner or later they get converted into competitive situations. As anywhere else, in agriculture also the production conditions (along with the demand conditions) determine prices and prices determine the production and demand conditions. However, there are certain rigidities and inelasticities which have been studied.
In a strict sense, transportation, storage, and processing are a continuation of the production process begun on the farms and can be treated as a part of the economics of production. Market efficiency is an important part of agricultural economics.
It refers to two aspects:
(i) Producers try to obtain maximum output (revenue terms) with minimum of inputs (costs in terms of money), and
(ii) Consumers try to obtain maximum returns (utils) with minimum of sacrifices (prices paid).
Prices are “invisible hands’ on which the capitalist or free enterprise system relies upon heavily. They are considered to be allocative levers. High prices are signals that more investment (and hence more output) is needed somewhere. Low prices are indicative of over-investment or what comes to the same thing as under-consumption / low demand.
A producer allocates his resources amongst various uses while a consumer allocates his budgetary provision amongst various commodities. This work is done in such a manner that the producer obtains equal marginal productivity from all possible investments while the consumer obtains equal marginal utility from all expenditures. The wider ramifications percolate to the fields of distribution of income, asset holding and even government revenue collection.
1. Price Determination in Abnormal Market Conditions-Monopolistic and Oligopolistic Markets:
In case of agricultural products, there can be a local monopoly. In a village, there must be just one seller of milk—the rest may be having milk for self-consumption. There may be just one orchard wherefrom certain types of fruits can be had in local market. Very rarely a country may have a natural monopoly for growing in typical crop. However, very soon such crops can be grown in other countries.
Besides, that country which has such a type of monopoly, there must be several growers who must be having keen competition amongst them. Thus, in the internal market, there can be a competitive set-up and in international market there can be a monopoly.
For this there has got to be an additional condition. The domestic producers should market their produce through an organisation of the cartel type or the government should purchase the output from the domestic producers and sell it in international market through state trading organisation.
A country can be a monopolistic seller of an agricultural product, if it is the only country which has marketable surplus. There can be several growers but only one country which can sell abroad. This too will be an ephemeral position. Nothing should prevent another country from producing more and generating marketable surpluses. Thus, by and large, it can be said that a monopoly for an agricultural product can be- (i) very localised, and (ii) enjoy that position for a very short period.
A monopoly can emerge in another way. A firm may be the only one which supplies fruit juice, or dehydrated vegetables, or tinned milk or animal product, or such things as bread, potato crisps, or bottled milk. It can be argued that if this type of processing is done it should not be considered a monopoly pertaining to agriculture but to manufacture.
The fundamental interest of a monopolist is not to charge a very high price or to sell fully what has been produced. His interest is to earn maximum profit.
Maximum profits can be earned in two ways:
(i) He can charge a high price but he will have to remain content with selling less, or
(ii) He can sell a large output but for that he will have to charge a low price.
A monopolist has no close substitute (we presume that intervention is also not there), yet a monopolist has to ‘compete’ for the limited money in the pockets of the people. He cannot charge a very high price yet sell a very large output. He cannot have best of the both possibilities.
Whether the monopolist will adopt the first policy or the second will depend upon two things:
(i) Elasticity of demand for the product, and
(ii) Law of return applicable to the output.
Other things remaining the same, he will charge a high price if the demand is inelastic and will charge a low price if the demand is elastic. Since the demand for agricultural products is inelastic or has low elasticity a monopolist will be tempted to charge a high price.
The monopolist has to lower the price in order to sell more. In case of a perfectly competitive market, infinite amount of output can be sold at the same price. Thus, the average price (average revenue) and the marginal price (marginal revenue) curves converge or are the same.
However, in case of a monopoly they differ and slope downwards to the right. The AR and MR curves slope downwards and can be steep (inelastic demand) or flatter (elastic demand). Thus, T set of curves shows that equal reduction in price secures greater increase in demand in case of elastic demand (flatter curve) and lesser increase in demand in case of inelastic demand (steeper curve).
M set of curves shows that to secure the same increase in demand, greater reduction of price will be necessary in case of inelastic demand (steeper curve) than in case of elastic demand (flatter curve).
The costs curves are the usual ‘U’ shaped curves.
Drawn separately for:
I. Constant costs,
II. Decreasing costs, they will be as shown below in c set, i set and d set.
III. Increasing costs, and
Various combinations of the costs and revenue curves can furnish us with the following six situations:
I. Constant Costs:
a. A monopolist produces up to a point where his marginal costs equal the marginal revenue. Q’ becomes the equilibrium output corresponding to E’ equilibrium point.
b. Since the total revenue is always the sum of- (i) average price multiplied by the (ii) output, the Q’M’ line is to be extended to AR curve, to find out the average price that will be charged. It is M’R or OP.
c. The M’C is the average cost per unit. OC is also the same. Per unit profit becomes CP or ER.
Total revenue OQ’R’P
Total costs OQ’E’C
Total profits CE’RP
d. In case of inelastic demand, the output is lower and the price higher. In case of elastic demand, the output is larger and price relatively lower. The profit margin per unit is also higher in the first case than in the second case.
II. Decreasing Costs – Increasing Returns:
In case of decreasing costs or increasing returns the MC and AC curves also slope downward to the right just like AR and MR curves.
a. E is the point of equilibrium where MC and MR are equal.
b. QE line is extended AR curve to find out the price per unit; it is the same as OP or QR.
c. QR line cuts the AC line at point C and thus OC or QC becomes the cost per unit.
d. CP or CR becomes the profit per unit.
e. Total revenue is OQRP; total costs are OQEC, and total profits CCRP.
f. It can be seen that the price is higher in case of inelastic demand and output is lower. In case of elastic demand, the price is lower and output is larger. In both the cases abnormal profits are earned. [Normal profits are where average costs and average revenue (price) are equal. It is to be remembered that in economics, average costs include normal profits].
III. Increasing Costs – Decreasing Returns:
In case of the increasing costs or decreasing returns, the MC and AC curves rise-MC raises more than AC. In fact it is the rise in MC that makes the AC curve goes up.
a. Here also E is the point of equilibrium where the marginal costs and marginal revenue are equal. OQ becomes the equilibrium output.
b. When QE line is extended to AR line it gives the price per unit QP or OP. This QP line cuts the AC curve at point C. QC or OC becomes the cost per unit. CP becomes the profit per unit.
c. Total revenue is output x P=OQPP, total costs are output x AC=OQCC, and total profits are profit per unit x total output=CCW.
d. Here also it can be seen that price is higher in case of inelastic demand and output is lower. In case of elastic demand, the price is relatively lower and output relatively larger. In both the cases there are super marginal profits.
The most realistic situation about agricultural goods pricing is that long run situation where:
(i) Decreasing returns or increasing costs are obtained, and
(ii) Demand is inelastic. The rest are just probable situations.
2. Pricing of Agricultural Goods under Conditions of Duopoly:
This is also quite an unrealistic situation. However, we can imagine that there are two exporters of wheat from USA or two exporters of cocoa from Ghana.
When the products are the same, i.e., when there is no product differentiation, the duopolists have to share the market and charge a high price. They can become monopolists in their own areas. If, however, they compete, they can indulge in cut-throat competition and we will have perfectly competitive type model.
This will bring price- war and they may be ruined. Or if they come to senses, they will share the market after the competition. Sooner or later this situation will become a perfectly competitive model when more firms enter. Only in rare case, both can merge and form a monopoly.
When the products are differentiated, e.g., there are two types of oranges or two types of apples or grapes (or any product) that is sold; they can afford to charge different prices. However, since both products are very close substitutes, the margin of price difference will not be much.
3. Pricing of Agricultural Products under Imperfect Competition:
A few sellers selling differentiated products make up ‘imperfect competition’, also known as ‘monopolistic competition’ (but the number of firms will be lower) or ‘oligopolistic competition’. These producers have greater chances or thriving if they can produce and sell differentiated products.
Various grades of the same fruits have different tastes and aroma and their producers can have a distinct clientele. Higher priced goods will naturally be purchased by high income group persons. Giffin type of goods can be designated in the same group of products. Grapes grown in Maharashtra region are in no way comparable with the grapes of Chaman (Afghanistan).
[Here semi-processed goods and agricultural products which assume the form of ‘manufactured’ goods, e.g., canned peas are not excluded, nor is the sugar market included in the market of agricultural goods.
In the short period the price determination under imperfect competition can be shown the same way as that of the monopolist. Two points will be kept in mind-First, the AR and MR curves will not be shown to be very steep but quite flat since the demand will be pretty elastic due to presence of a close substitute. Hence, secondly, very high price will not be shown.
In the long run, an oligopolistic producer/seller will earn normal profits and the position can be shown as under:
4. Pricing or Agricultural Products under Conditions of Perfect Competition:
This is the condition that usually obtains for agricultural products. The essential characteristics of perfect competition are as follow-
First, the product produced or sold is homogenous. There may be differences of grades (various categories or grades of tea or wheat or sugarcane). Within these grades the competition is perfect.
Secondly, the number of buyers and sellers is large. There will be perfect competition in the condition of bilateral monopoly—when monopoly meets a monopsony. This condition is different where each buyer or seller buys/sells only a small part of the total output. Each one of them is of atomistic size.
Thirdly, the demand for the product is price elastic but less elastic to income. No single buyer can force the seller to reduce the price as no single seller can charge a higher price from a consumer. If a seller wants to charge higher than the equilibrium market price, he will lose all customers. If the buyer wants to pay a lower than equilibrium, price no seller will sell to him.It is an impersonal market.
Fourthly, the individual buyer or seller is price taker and not a price-maker. A seller or product adjusts his supply to be prevailing price and not the opposite of it. Buyers and sellers do not act in unison. If they act to affect the price, then it does not remain a perfectly competitive model.
Fifthly, it is also presumed that the farmers as also the buyers of agricultural products have perfect knowledge of the market, i.e., the supply and price conditions of inputs and outputs.
Sixthly, it is also presumed that the farmers also enjoy conditions of perfect mobility or use-Though their land is immobile, it has mobility/elasticity. If a particular crop becomes unremunerative another one can be grown albeit in the next lifecycle. It is also presumed that the farmers can employ their labour and capital in alternative uses—though in less developed countries such resilience is not present because of structural rigidities.
It may be conceded that perfect competition is quite a myth and pure and perfect competition hardly exists anywhere, not even in USA. However, we can have conditions that approach pure competition.
In a country like USA which swears by free enterprise, there are large firms which export farm products abroad. (There big firms supplied India wheat much less than the quantities for which the prices were charged because in India we did not have facilities for weighing the entire shiploads).
Individually the marginal cost curve of farm-family becomes its supply curve. The demand curve for the individual farm will be a horizontal line which will be both average revenue curve and the marginal revenue curve.
Price Determination for the Entire Farm Output:
Using the Marshillian technique of simultaneous and instantaneous equilibrium with the help of a supply and a demand curve, we can get this diagram for the determination of price.
DD is the total demand curve and SS is the total supply curve. E becomes the equilibrium point. OM becomes the equilibrium output that is coveted and produced/supplied.
There can be eight types of changes in the equilibrium so arrived:
1. If the demand curve is the same, and the supply P falls curve shifts to the right (supply function improves)
2. If the demand curve is the same, and the supply P rises curve shifts to left (supply function deteriorates)
3. If the supply curve is the same, and the demand P rises curve shifts to the right, i.e., demand function improves
4. If the supply curve is the same, and the demand P falls curve shifts to the left, i.e., demand function deteriorates/falls.
5. If supply curve shifts to the right and the P fall in a demand curve shifts to the left, i.e., the former steep way improves and the latter declines.
6. If the supply curve shifts to the left (supply P rises function declines) and the demand curve shifts sharply to the right (demand rises)
7A. If the supply changes more than proportionately P falls to the demanded but in the same direction, then in case of rightward shift.
7B. If the supply changes more than proportionately P rise than demand but in the case of leftward shift
8. Both rise or fall in the same proportion No change
We can give diagrammatic representation:
The first four changes listed above are depicted in the above two diagrams. The first change is depicted in the first diagram but to understand the second effect, we have to look to the notations in the parentheses. The same is true for third and fourth effects which are shown in the second diagram above.
In the third diagram of this series, it has been shown that both demand and supply increase but since the demand has increased more than proportionately as compared with the supply, the net effect is rise in price to OP’. It we look at the notations in the parentheses, it can be seen that demand has fallen more than proportionately to the fall in the supply and hence there is fall in the price.
Without corresponding movement in the supply, the changes in demand would have brought sharp rise or fall (with increase and decrease) in the price. Movement of supply in the same direction had been responsible for offsetting some influence.
In the fourth diagram of this series, it has been shown that the demand and supply rise/fall in such a manner that the price remains the same. If there is no mismatch between demand and supply, even at higher and lower level of output, the price remains the same.
In the last diagram of this series it has been shown that the movement in the supply curve is greater than the shift in the demand curve. Hence the influence of supply is greater. When the supply curve shifts to the right more than proportionately to the demand, the price falls and vice versa. Of course, without sympathetic shift in the demand curve, the change in the price would have been as sharp as shift in the supply function.
Price Setting for the Agricultural Output as a Whole under Various Laws of Returns:
Agriculture is ultimately subject to law of decreasing returns to scale. The fertility of the soil is villain of the piece. As at present, economists still consider nature to be niggardly and hence primary activities are considered to be subject to diminishing returns much earlier than other economic activities However, we can have constant costs (under constant returns), decreasing costs (under increasing returns—usually in the ‘short’ period), and increasing costs (under decreasing returns).
The following generalisations can be made:
1. If production is under constant costs, an increase or decrease in the demand will not alter the cost per unit and hence while the price shall remain unchanged, the output shall vary with the demand in the same direction and in the same proportion —technical conditions permitting.
2. If production is subject to increasing returns or decreasing costs, an increase in demand will enable the producer to overcome indivisibilities or reap greater economies of production (economies shall be greater than diseconomies) and hence per unit cost and price shall go down. Higher demand yet lower price looks more like an exception than a rule, but if decreasing costs are obtained it will be so.
3. If production is subject to increasing costs or decreasing returns, then an increase in the demand will increase the cost per unit and hence the price also.
Diagrammatically these situations can be as under:
In the ‘A’, ‘B’ and ‘C’ diagrams cost have been shown in money terms , an increase in demand in the first case leaves the price unchanged; in the second case it brings down the price and in the third case it increase the price; all via costs effect.
If the costs are expressed in terms of the output foregone (rather than in money terms), then the costs curves will be as under.
Normal versus Market Price:
Normal price is national or just the weighted average of various market prices. Market price is the actual equilibrium price for the moment. It is temporary and changes as often as conditions warrant. If it is more than the average cost, there is abnormal profit and if it is less than the average cost, there is loss. Normal price gives normal profit and round it the market price oscillates.
Equilibrium of a Farm:
Just as a firm in manufacturing sector is a price-taker in the perfectly competitive market, a farm is in a similar position. A farm-family cannot set a price but has to adjust production—rather than marketed surplus, to be precise—accordingly. In this case, the adjustment to production can be made in the next sowing season but adjustment between’ stock’ and ‘supply’ can be made in the current year.
If in the short period, the farm-family cannot even recover variable cost, it will not sell. It should keep the stock of marketable surplus as stock of un-marketed surplus, i.e., it should not sell. (It is presumed that the family is not threatened with zero cash position.) The price at which the farm-family would like to add to the costs, rather than take whatever revenue it can is known as ‘reservation price’.
The farm- family would like to store the marketable surplus as un-marketed surplus and incur the cost of interest, rent and whatever else there is. In case of perishable goods, the reservation price becomes meaningless, unless cold-storage facilities exist.
A farm-family takes the price as given. (Here we are discussing the Marshallian quasi-equilibrium positions.) At various prices, the farmhouse will take certain decisions. We can illustrate with the help of a diagram.
In the diagram that follows there are four prices P, P2, -P3 and P4. They are determined by the interaction of the total supply curve for a farm product.
1. At price P, which is the lowest, not even the fixed costs are covered. As such the farm-family should be produce. However, this can be the case only if the farm-family knows that this will be the price after harvesting, and secondly, this price should know to the farm-family at the time of sowing.
In case the output has already been produced, then at this price nothing should be sold. The farm-family should wait for the terms of trade to improve. E point is production starting point if we are moving from lower to higher price and “shut down” point if we are moving from higher price to lower price—in the theory of the firm.
2. If the price rises to P2 the price curve becomes tangent to the average variable costs, though it is still below the average costs. The farm-family suffers losses though average variable costs are recovered. The farm-family can produce, and market the products for cash requirements.
(This theory will not apply for that production which is made for self-consumption. The factual position that usually obtains is that the farm-family produces for self-consumption irrespective of the price that might be prevailing. Only in those cases where the farm-family can get cheaper food from elsewhere as also can secure alternative employment for all farmhands, it may take a decision of not producing anything. The farm-family should know that if all farm-families think like this, they cannot get any agricultural products from others. Hence, it is presumed that price positions do not affect the production decisions in so far as the production is for self- consumption.)
3. At price P3, the price line is tangent to average costs. This is the equilibrium position for the farm-family. Here the farm- family earns normal profit. This is the unique position about which the economists are quite enamoured.
4. If the price were to rise further to P4 the farm-family will earn extra point. It is scarcely likely that it will sell that part of the produce that it had kept for self-consumption and seeds for the next year. However, all marketable surpluses may be disposed of at this price, unless expectations are that the prices shall rise further. PT is short period super profit.
In the long run there are neither extra profits nor losses. Inefficient firms will get out or non-profit making farmers will no longer be in the market of disposable surpluses. In the long run the marginal cost and marginal revenue as also the average cost and average revenue will be tangent at one point, where output will be determined.
The joint supply case is easy to understand. In case of carcass meat the meat, bones, skin, guts, blood, etc. become joint products. Hay and grains are joint products. Jointly supplied products are of particular importance in agricultural processing industries. A change in the demand for one jointly supplied agricultural product can have far- reaching effects on the market prices for the jointly-supplied products and the quantities of these products available in the market place.
Changes in the conditions of demand facing one of the finished products will have an impact on the availability of the other products derived from this same raw material. All types of the demand for the cattle carcass products and all types of the supply of the same determine the total demand and supply and hence the price conditions. If just one part of the body of animals is required in larger quantities, the whole of the animal is to be slaughtered.
The supply of other things will increase, probably more than the demand. Their prices will go down but the part most demanded will have to be priced so high that the total price recovered in no case is less than what it used to be. If possible, the total recovery is less than what used to be earlier, the persons who demand the special part cannot get it in the required quantities.
The problem with joint supply is that one cannot know how much each products costs individually. A method can be devised to find it out, if the two products are in fixed proportions, say wheat and folder.
If we can have a technique which all increases the output of wheat without increasing the output of hay, we can know the marginal cost of producing wheat. Mexican variety of wheat was introduction of a revolutionary technique. Earlier if the wheat plan used to have more grains, the plant used to get flattered. A sturdy plant could enable growing of more wheat without increasing the quantum of hay. The marginal cost of wheat can be found out. However, such cases are rare, and joint products do pose problem of disaggregating the costs.
In case two joint/alternative products are competitive (sugar and jaggery) a rise in the price of the sugar will force the customers to use the jaggery; a rise in the price of jaggery without there being rise in the price of sugar will force the people to use more of sugar.
However, a fall in the price of sugar or even of jaggery will induce people to use more sugar. Such is the relationship between the alternative products. Cheapening of sugar will shift some poor consumers from jaggery to sugar, i.e., they can increase quantities of consumption. Then jaggery being a giffin good, the savings in the purchase of jaggery will enable the consumers to use more of sugar.
If the joint products have inelastic demand even for one, then both will be used in the same quantity despite increase in price.
If the demand for one is elastic, then in the event of rise in price of one, the consumption of both will go down because the supply cannot to sustain.
Total costs are to be recovered. If the AC is less than the AR in one case (loss), then the AR should be higher than AC in the second case so much that total costs are recovered. The price of the joint products must together be enough to cover their joint or combined expenses of production, but the apportionment of the total price between the two joint products will depend upon the relative demand for them and not so much upon their cost of production.
When the same commodity is demanded for two or more purposes, its demand will composite demand, e.g., sugarcane is demanded for juice extraction, jaggery and sugar. Such commodities will be so used in different uses that the marginal utility derived from different uses is the same. The principle of price determination is that the marginal cost in each use will be equal to its marginal utility.
Different substitutes of a commodity make composite supply, Tea, coffee, cocoa or herbal tea are competing goods and hence constitute composite supply. All these commodities cannot be sold at the same price. Much will depend upon the type and number of users of these commodities. In other words, the elasticity of demand for these products will determine their respective prices. A commodity which is coveted more or of which demand is intense (inelastic demand) will command a higher price.