ESTIMATION OF AGRICULTURAL SUPPLY RESPONSE BY

COINTEGRATION APPROACH

A Report Submitted under Visiting Research Scholar Programme 2008

Amarnath Tripathi

Indira Gandhi Institute of Development Research

Gen. A. K. Vaidya Marg, Film City Road
Goregaon (E), Mumbai- 400065
CERTIFICATE

2
ACKNOWLEDGMENT

I would like to thank Indira Gandhi Institute of Development Research, Mumbai for
providing me visiting scholarship and all the facilities required for the implementation of
my study. I am extremely grateful to Dr. G. Mythili, Associate professor, Indira Gandhi
Institute of Development Research, Mumbai for her kind guidance and sincere support
during my stay at IGIDR. I extend my warm thanks to Professors J. Sarkar, S. Thamos, and
C. Verramanai for giving me valuable suggestions during the course of my study.

I would like to express my deepest sense of gratitude to Dr. A. R. Prasad, Professor,

Banaras Hindu University, Varanasi my PhD supervisor at Banaras Hindu University
without whose help and encouragement this report would not have been completed.

3
CONTENTS

1. List of Tables ...(05)

2. Abstract ..(06)

3. Introduction ...(07)

4. A Brief Literature Review on Supply Response .(09)

5. Basic Framework and Approaches in Estimation ..(19)

a. Indirect Approach .. .(19)

b. Direct Approach ..(20)

c. Nerlove and ECM Model (21)

6. Empirical Framework .(23)

a. Model ..(23)

b. Estimation Procedure .(25)

c. Selection of States ..(26)

d. Period of Study (26)

e. Data Sources (27)

7. Results and Discussion (28)

8. Conclusion and Policy Implication (41)

9. References (43)

4
List of Tables

Table 1: Earlier Studies in Indian Context……………………………………………………................(13)

Table 2: Share of Agricultural Income in total income for all major states………………………..(26)

Table 3: The Mean Values of Selected Variables………………………………………………............(27)

Table 4: Descriptive Statistics………………………………………………........................................(28)

Table 5: Correlation Matrix………………………………………………………………………………….(28)

Table 6: Results of ADF Test……………………………………………………………………………….(30)

Table 7: Results of ADF Test……………………………………………………………………………….(31)

Table 8: Bivariate Analysis for All India……………………………………….....................................(32)

Table 9: Bivariate Analysis for High Agricultural Based States……………………………………..(32)

Table 10: Bivariate Analysis for Medium Agricultural Based States………………………………..(33)

Table 11: Bivariate Analysis for Low Agricultural Based States…………….................................(33)

Table 12: Multivariate Analysis for All India……………………………………………………………..(34)

Table 13: Multivariate Analysis for High Agricultural Based States………………………………...(34)

Table 14: Multivariate Analysis for Medium Agricultural Based States……………………………(34)

Table 15: Multivariate Analysis for Low Agricultural Based States…...........................................(35)

Table 16: Results of ECM for All India……………………………………………………………………(36)

Table 17: Results of ECM for High Agricultural Based States……………………………………….(37)

Table 18: Results of ECM for Medium Agricultural Based States……..........................................(37)

Table 19: Results of ECM for Low Agricultural Based States………………………………………..(37)

Table 20: Aggregate Agricultural Elasticities w.r.t. Agricultural TOT………………………………(38)

5
ABSTRACT

The issue of agricultural supply response is a very important one as it has an impact on
growth, poverty, and environment. The size of agricultural supply response is expected to
improve after removing some of the constraints that farmers were facing before. Though
many constraints have been removed from agrarian system and many incentives have been
provided to farmers, still the supply response for Indian agriculture is price inelastic. Hence
the question “why supply response is price inelastic” becomes relevant. The present study is
an attempt to find supply response through cointegration approach and to see if the response
has been better at the all India level in comparison to previous studies. Further, it also focuses
on the question whether there is difference in the supply response among highly agricultural
based, medium agricultural based, and low agricultural based states. The study indicates that
aggregate agricultural output elasticity with respect to agricultural TOT is very low and not
statistically different from zero.

Key Words: Agricultural Supply Response, Cointegration Analysis, and Error Correction
Model

JEL Classification: C22, Q11

6
INTRODUCTION

One of the most important issues in agricultural development economics is supply response
since the responsiveness of farmers to economic incentives* largely determines agriculture’s
contribution to the economy. Further, the response elasticities are also important for policy
decision regarding agricultural growth. That is why it has been a debatable issue among
economist and policy makers in both India and abroad for the last five decades. Agricultural
Supply Response represents change in agricultural output due to a change in agricultural
output price. The concept of supply response is dynamic and different from supply function
which is the static concept. The supply function describes a price quantity relation, where all
other factors are held constant. The response relation is more general concept; it shows the
change in quantity with changes in prices as well as supply shifters† and, therefore,
approximates to the long run, dynamic concept of supply theory.

In India, agriculture has made remarkable growth after initiation of new agricultural strategy
in mid-sixties. Indian agriculture has progressed not only in output and yield terms but the
structural changes have also contributed. Government provided more incentive such as
remunerative prices to protect farmers’ interest, availability of credit facilities, improving
irrigation facilities, improving markets of both output and input, more investment in
agricultural research and extension services, etc. to farmers to produce more. After these
developments, it is expected that farmers would become more price responsive. The previous
studies as well as recent studies (Krishna, 1980 Palanivel, 1995, Rao, 2003, etc) have shown
that Indian agriculture is low price responsive. Then, the question arises “why is the supply
response low for Indian agriculture?” The present study is an attempt to reexamine supply
response through better approach as compared to the previous studies. Further, it also
focuses on the question whether there is difference in the supply response among highly
agricultural based, medium agricultural based, and low agricultural based states.

*
Economic incentives are offered to encourage people to make certain choices or behave in a certain way.
†
Except product own price there are several factors that influance supply; as for example, ralative prices of the
substitute products, climatic conditions, technological, progress (improvement in the art of production), changes
in the institutional and policy variables and even attitude of the producers. In economic terminology these
factors are called supply shifters.

7
The previous studies on agricultural supply response in India used time series‡ and panel
data§. Most of the studies applied Nerlovian Framework** (1958). However, most economic
time series data are trended overtime and regression between trended series may produce
significant results with high R2’s, but may be spurious (Granger and New Bold, 1974). So,
we use cointegration analysis†† and error correction model (ECM)‡‡ to overcome the problem
of spurious regression§§.

The ECM takes into account the partial adjustment in production and the mechanism used by
farmers in forming expectations. These are the fundamentals of agricultural supply response
model. So, ECM can be used in this context. We found one study related to India and many
studies for other countries based on application of ECM in estimating agricultural supply
response.

The present study is organized as follows: Section (II) presents review of literature related to
India agriculture. Section (III) discusses fundamentals and approaches of estimation of
agricultural supply response. This section also shows the relevance of ECM in estimating
agricultural supply response. Section (IV) discusses methodology and estimation procedure
used in the study. Section (V) gives the results and findings. Section (VI) makes some
observations on the causes of low supply response. Section (VII) concludes the whole study,
gives limitation of the study and suggests policy implication.

‡
A time series is a set of observations on the values that a variable takes at different times.
§
Panel data is a special type of pooled data in which the same cross-section unit is surveyed over time.
**
Nerlove proposed a dynamic distributed lag model in which he introduced a dynamic element into the
response equation by creating expectation.
††
Cointegration is an economectric property of time series variables. If two or more series are themselves non-
stationary, but a linear combination of them is stationary then the series are said to be cointegrated.
‡‡
Error correction model is useful for representing the short run relationships between variables.
§§
Sometimes we expect no relationship between variables, yet a regression of one on the other variable often
shows a significant relationship. This satiation is called spurious regression.

8
A BRIEF REVIEW OF LITERATURE ON SUPPLY RESPONSE

There are two types of studies found in the existing literature; one is at individual crop level
and the other is at the aggregate output level. First type of studies shows change in the
composition of agricultural output to a change in the relative price of individual agricultural
commodities. On other hand, second type of studies shows change in total agricultural output
due to change in the relative price of agricultural commodities compared with industrial
goods, referred to terms of trade in the literature. A review of relevant literatures follows.

Raj Krishana’s (1963) study is the first study among those studies that used Nerlove
framework in Indian Context. He used pre-Independence data for Punjab (Undivided) and
concluded that the Punjab farmers have responded to economic stimuli.

Jai Krishna and Rao (1965, 1967) tried quite a few price formulations to specify the price
variables and those on which farmers base their expectations. They found that traditional
regression models give satisfactory results if not superior results compared with those
obtained by using adjustment lag model as far as proportion of explained variation in wheat
acreage is concerned.

Parikh’s (1967) work of supply response through the distributed lag models comes very close
to the Nerlovian framework. He has used both adjustment lag and price expectation models
along with the distributive lags. After analyzing different formulations with the data given in
the appendices of Dharam Narain’s study (1965), Parikh arrived at the result that non-price
factors are quite important as compared to the price factors. It is worth noting here that the
data set covered the period prior to 1939.

Herdt, (1970) has evaluated supply response at aggregate output level for period 1907 to
1964 for Punjab agriculture. He divided the reference period into two sub-periods: 1907 to
1946 and 1947 to 1964. He concluded that the 1907-1946 period tends to support the
hypothesis of a positive, although small, aggregate supply response of agriculture. The
results for 1951-1964 suggest the opposite, or at least do not support the hypothesis. He used
disaggregated approach given by Tweeten and Quance (1963) to measure supply elasticites.

9
Madhavan (1972) utilized a production function framework to arrive at the desired demand
for land. A production function under the assumption of constant ratios of elasticity is
maximized to obtain the factor demand equation. The estimated equation indicated that
actual planted area of a crop in the given period is a function of the log of relative price of the
crop, the expected yield of the crop under consideration as well as that of the competing crop
and the weather index.

Cummimgs (1975) examined supply responsiveness of the Indian farmers for post-
Independent period by using Nerlove model. This work was followed by another study which
is the joint work of Askari and Cummings (1976). They used a slightly modified version of
the Nerlove model with maximum-likelihood estimation procedure to overcome the problem
of serial correlation and non-consistency of the estimates.

Narayana et al. (1981) estimated supply response crop-wise for Indian agriculture. They
formulated expectation function for each crop by isolating stationary and random
components in past prices and attach suitable weights for both in prediction. The method is
based on ARIMA technique combined with BOX-Jenkins procedure.

Bapna et al. (1984) derived a system of output supply and factor demand equation from the
profit function. They began with monotonically increasing profit function and derived output
supply and factor demand curves. Two systems are derived from the maximization of the
profit function, namely, Generalized Leonteif and Normalized Quadratic Systems. The
authors pooled the time series and cross section data by following error component model. It
is confirmed by the authors that a Maximum-Likelihood Estimation procedure would be
better than the three-stage least-squares procedure. The results were obtained for 96 districts
spread over semi-arid tropical regions of the country. The authors indicated that 25 out of the
32 own elasticities had the anticipated sign and also demonstrated remarkable extent of price
responsiveness of the semi-arid tropical farmers. Very high supply elasticity was noted for
sorghum despite the small proportion of its marketed surplus.

Hazell, et al (1995) used national and state level data for estimating the aggregate supply
elasticities for Indian agriculture. The results from the national and state level analyses are
very similar, and show that aggregate supply is inelastic. Both levels of analyses showed that

10
growth in agricultural output in India in recent decades is largely attributable to increased
irrigation.

Palanivel, (1995) estimated the aggregate agricultural supply response by using more
appropriately constructed variables for the period 1951-52 through 1987-88. The model was
developed within the basic Nerlovian partial adjustment framework. He constructed his own
agricultural terms of trade (TOT)***. He used farm harvest prices and retail prices in
estimating the index for prices received and the index for prices paid by farmers,
respectively. He argued that since farmers sell bulk of their products immediately after the
harvest, farm harvest prices seemed to be a better approximation for the prices received.
Similarly, he also pointed that as farmers purchase their requirements (particularly family
consumption items) from retail markets, rural retail prices seemed to be a better
approximation for the prices paid. His results indicated that the elasticity of aggregate
agricultural output with respect to TOT is positive and statistically significant but non-price
factors are equally, if not more, important.

Mishra, (1998) attempted to assess the impact of economic reforms initiated in 1991 along
with price and non-price factors on aggregate supply in the post-green revolution period. His
results assured that the aggregate supply measured either through aggregate output or
marketable surplus does respond significantly positively to terms of trade.

Surajit Deb, (2003) explored the presence of long-run relationship between TOT and
agricultural output by using cointegration analysis and error correction model. The bivariate
results between TOT and output level in agriculture reflect no statistically significant
cointegration. The non-cointegratedness indicates that no direct long-run relationship exists
between TOT and output level in Indian agriculture. This, in turn, would suggest that a
favourable TOT structure alone may not be effective in sustaining higher agricultural growth.
Further, he included irrigation ratio as a technology between TOT and output. Then he found
that variables are cointegrated. Finally he concludes that growth in agricultural output may
respond better if specific structural variables are suitably combined with the price variables.

Chandrasekhara Rao, (2004) examined agricultural supply response at aggregate level for
Andhra Pradesh by using Nerlove Partial Adjustment Model. He found the short-run

***
The agricultural terms of trade is defined as the ratio of prices received and prices paid by farmers.

11
elasticites of output with respect to TOT for aggregate agriculture vary from 0.20 to 0.29 and
the long-run elasticities vary from 0.21 to 0.31. The results also indicated that non-price
factors are more important determinants in aggregate agricultural supply than price related
factors in the state of Andhra Pradesh.

Mythili, (2008) estimated supply response for major crops during pre-and post-reform
periods using Nerlovian adjustment-cum-adaptive expectation model. Estimation is based on
dynamic panel data approach with pooled cross section - time series data across states for
India. The study found no significant difference in supply elasticities between pre-and post-
reform periods for majority of crops. This study also indicated that farmers increasingly
respond better through non-acreage inputs than shifting the acreage. This includes better
technology, use of better quality of inputs and intensive cultivation.

Many more studies (Thamarajaki, 1977; Krishna, 1982; Mungekar, 1997; Desai and
Namboodiri, 1997) are also available in the context of Indian agriculture. Thamarajakshi,
(1977) reported a statistically significant and effective relation between aggregate farm
output and non-price factors (irrigation) but the author could not detect any statistically
significant impact of TOT on agricultural output. Krishna, (1982) also drew same conclusion
but difference between both the studies was that Krishna observed a marginal impact of TOT
on agricultural output. Mungekar, (1997) and Desai & Namboodiri, (1997) reported negative
impact of TOT on agricultural output. Both studies also observed significant impact of non-
price factors such as irrigation, rainfall, area under high yielding verity seeds, fertilizer use,
rural roads and other infrastructure facilities.

After reviewing these studies, some common inferences can be drawn. The supply response
of individual crop is well documented but study related to aggregate output remains to be a
less researched area. Most of the studies have followed same methodology given by Nerlove
in original form or with some modification. Most of the studies have reported low supply
response. They also indicated that non-price factors are relatively more important than price
factors. However, there has been controversy as to whether aggregate agricultural supply is
really not responsive. Schiff and Montenegro (1997), argued that aggregate agricultural
supply response is, in fact, high but that there are other constraints such as financing that
hinder this response such that a low elasticity is found. A lot of methodological questions

12
have been raised on the previously used model (Nerlove Model) and the estimation
techniques applied. For instance, the Nerlove Model is unlikely to capture the full dynamics
of agricultural supply (Thiele, 2000), this model has inability to give adequate distinction
between short-and long-run elasticities (McKay et.al., 1998), it uses integrated series, which
poses the danger of spurious regression (Granger & Newbold, 1974), etc. Therefore, an
alternative of Nerlove model is required. For this particular case, the suitable techniques are
the general co-integration methodology and the ECM (detailed in the next section). Indeed,
one work (Surjit Dev, 2003) has been done based on cointegration approach but his special
emphasis was on long-run relationship between agricultural output and price. The present
study is an attempt to fill this gap. This study has done the analysis at the aggregate all India
as well as at the diaggregated state level. Supply response at the disaggregated level can
throw more light since aggregation at the all India level might have hidden the variation that
could explain the response better. This study has classified states into low, medium and high
agricultural based states and to see if the response varies significantly between them.

13

S.No. Author Title of the Paper
1. Raj Krishana Farm Supply Response in
(1963) India-Pakistan: A Case
Study of the Punjab Region
2. Dharam Narain The Impact of Price
Movements on Areas under
Selected Crops in India
3. Rao & Krishana Price Expectation and
(1965, and 1967) Acreage Response for
Wheat in Uttar Pradesh
4. Krishana and Rao Dynamics of Acreage
(1967) Allocation for wheat in Uttar
Pradesh: A Study in Supply
Response
5. Parikh (1967) Market Responsiveness of
Peasant Cultivaters: Some
Evidence from Pre-War India
6. Subbarao (1969) Farm Supply Response: A
Case Study of Sugarcane in
Andhra Pradesh
Table 1: Earlier Studies in Indian Context
Objective/ Data Base/ Period of Study Estimated Model Results Remarks
Objectives of the & Methodology
Study
To estimate supply i. Time series Nerlovian adjustment Positive but low supply It is the first study
elasticities ii. 1914/15 – 1945/46 model elasticities w.r.t. price among those
iii. OLS Estimation Procedure studies that
examined
agricultural supply
response in Indian
Context
To evaluate impact of i. Time Series Tabular analysis Found positive relationship This study was
price changes on ii. 1900-1939 between changes in price discussed only
decision of acreage iii. Simple ratio and acreage of crops coovement of
allocation changes in price
and acreage.
To formulate i. Time series Traditional regression Acreage response Especially focused
alternative price ii. 1951/51 – 1962/63 model changed drastically with on price
expectation model iii. OLS estimation procedure change in expected price expectation
and to study their used. behaviour of
impact on acreage farmers
response coefficients
i. Time series i. Nerlovian This study was an
ii. 1951/51 – 1962/63 adjustment model extension and
iii. OLS estimation procedure ii. Traditional modification of
regression model study reported
earlier.
i. Time series Distributed lag model Non-price factor is quite The used data set
ii. 1900-1939 important in comparison to covered period
iii. OLS estimation procedure price factor. prior to 1939
To examine the i. Time series Traditional Regression Changes in relative The study
acreage and output ii. 1952/53 – 1964/65 Model acreage under sugarcane introduced relative
response of iii. OLS estimation procedure are positively associated profitability as the
sugarcane in Andhra with changes in its relative most appropriate
Pradesh to changes in price. factor in allocation
its relative prices of acreage. The
relative profitability
was measured by
relative prices and
relative gross
income per hectare.
S.No. Author Title of the Paper
7. Herdt (1970) A Disaggregated Approach
to Aggregate Supply
8. Maji et.al (1971) Dynamic Supply and
Demand Models for Better
Estimation and Projections:
An Econometric Study for
Major Foodgrains in the
Punjab Regions
9. Kaul and Sadhu Acreage Response to Prices
(1972) for Major Crops in Punjab:
An Econometric Study
10. Madhavan (1972) Acreage Response of Indian
Farmers: A Case Study of
Tamil Nadu
Objective/ Data Base/ Period of Study Estimated Model Results Remarks
Objectives of the & Methodology
Study
To evaluate supply i. Time series Multiple Regression The study found positive It is the first study
response of aggregate ii. 1907-1964 Model using supply response for period among those
agricultural output iii. OLS estimation procedure disaggregated 1907-1946 and studies that
approach given by insignificant supply examined
Tweeten and Quance response for period 1951- agricultural supply
64. response at
aggregate output
level in Indian
Context
To estimate supply i. Time series Nerlovian adjustment Price coefficient was found First time
and demand ii. 1948/49 – 1965/67 model. significant only introduced risk
elasticities iii. OLS estimation procedure variable in Indian
context
To estimate acreage i. Time series Nerlovian adjustment Found inelastic supply This study was the
response with respect ii. 1960/61 – 1969/70 model response for each modification over
to change in relative iii. OLS estimation procedure selected crops Maji et.al.’s study.
prices and risk In this study
variable. cofficent of variation
was used to
measure risk
variable instead of
standard deviation.
To examine whether i. Time series Multiple regression Tamil Nadu farmers This study yield
and to what extent ii. 1947/48 – 1964/65 model respond with change in better results in
Indian farmers iii. Production function relative prices but the comparison to
influenced in their approach degree of response differs earlier studies
production decisions iv. OLS estimation from crop to crop based on Nerlove
by economic stimuli procedure framework both in
terms of statistical
significance of the
coefficients and the
explanatory power
of the equation
15
S.No. Author Title of the Paper
11. Cummings (1975) The Supply Responsiveness
of Indian Farmers in the
Post-Independence Period
12. Narayana et.al. Estimation of Farm Supply
(1981) Response and Acreage
Allocation
13. Bapna et.al.(1984) Systems of Output Supply
and Factor Demand
Equations for Semi-Arid
Tropical India
14. Hazell et.al. (1995) Role of Terms of Trade in
Indian Agricultural Growth: A
national and State level
Analysis
Objective/ Data Base/ Period of Study Estimated Model Results Remarks
Objectives of the & Methodology
Study
To examine supply i. Cross-section Nerlovian adjustment The study showed high Discussed the
responsiveness of ii. Maximum likelihood model degree of supply causes of variation
Indian farmers estimation procedure response. in supply elasticites
The study also confirmed across regions.
that there is large variation
in supply response
elasticities across regions.
To investigate how do i. Time series Autoregressive The study gives more The study modified
farmers form their ii. 1950 -1974 integrated moving satisfactory results in the
expectations and how iii. Box-Jenkins estimation average model comparison to Nerlove conventional
do their expectations procedure model. econometric
affect their crucial techniques to
decisions about land overcome a
allocation? limitation of the
traditional
Nerlovian model.
But the study
losses long-run
information
because of using
Box-Jenkins
method.
To estimate supply i. Panel Data Output supply and Demonstrated remarkable This study applied
elasticities ii. Error component model input demand equation extent of price system approach.
iii.Maximum likelihood derived from profit responsiveness of the
estimation procedure function semi-arid tropical farmers.
To analyze relative i. Time series (for national Multiple regression The result from the The study used
contributions of terms level analysis) and panel model national and state level gross terms of trade
of trade and non-price data (for state level analyses was very similar as a indicator of
variables in explaining analysis) and shown that aggregate terms of trade.
agricultural growth ii. 1952 – 1988 (for national supply response is
level) 1971-1988 (for inelastic.
state level
iii.OLS and 2SLS
estimation procedure
16
S.No Author Title of the Paper Objective/ Data Base/ Period of Study Estimated Model Results Remarks
Objectives of the & Methodology
Study
15. Palanivel (1995) The Aggregate Supply To estimate supply i. Time Series Nerlovian expectation Inelastic supply response This study followed
Response in Indian response of aggregate ii. 1951/52 – 1987/88 cum adjustment model for each case; aggregate both linear and non-
Agriculture agricultural output in iii. OLS estimation procedure agricultural output, linear least square
India iv. NLS estimation procedure aggregate crop output estimation
procedure and
found similarity in
results
16. Mishra (1998) Economic Reforms, Terms To assess the impact i. Time Series Multiple regression The aggregate supply Focus on the
of Trade, Aggregate Supply of economic reforms ii. 1966/67- 1995/96 model measured either through interaction between
and Private Investment initiated in 1991 along iii. OLS estimation procedure aggregate output or terms of trade and
with price and non- marketed surplus does technology
price factors on respond significantly
aggregate supply in positively to the terms of
the post-green trade (i e, relative prices).
revolution period
17. Rao (2004) Aggregate Agricultural To estimate supply i. Time Series Nerlovian adjustment The supply elasticities with In this study,
Supply Response in Andhra response of aggregate ii. 1980/81 – 1999/2000 model respect to terms of trade agricultural terms of
Pradesh agricultural output in iii. OLS estimation procedure for aggregate agricultural trade was
Andhra Pradesh output, crop output, calculated for the
foodgrain crop, and non- state level.
foodgrain crops were
found positive but
statistically non-significant
18. Sunil Kanwar (2004) Price Incentives, Nonprice To estimate acreage I. Panel Data Nerlovian adjustment Non-price factors; Unlike earlier
Factors, and Crop Supply and yield II. 1967/68-1999/2000 model irrigation, consumption of studies instead of
Response: The Indian Cash responsiveness of III. Random Effect fertilizer, high yield variety using aggregated
Crops individual crop with Model seeds, and infrastructure time series data,
respect to price and IV. GLS estimation are highly significant in this study used
non-price factors procedure higher agricultural growth panel data.
19. Mythili (2006) Supply Response of Indian To examine whether i. Panel Data Nerlovian adjustment The study found no There was a dearth
Farmers: Pre and Post there is deference in ii. 1970/71 – 2004/05 cum adaptive significant difference in of studies on supply
Reforms supply response of iii. Random effect model expectation model supply elasticities between response in post
major crops between iv. Generalised method of pre and post reform reform era. This
pre- and post-reform moments periods for majority of study fills this gap.
period crops.

17
S.No Author Title of the Paper
20. Mythili (2008) Acreage and Yield
Response for Major Crops in
the Pre- and Post-Reform
Periods in India:
A Dynamic Panel Data
Approach
Objective/ Data Base/ Period of Study Estimated Model Results Remarks
Objectives of the & Methodology
Study
To examine whether i. Panel Data Nerlovian adjustment With proper specification Mythili presented
there is deference in ii. 1970/71 – 2004/05 cum adaptive of the price variable, the an improvement
supply response of iii. Random effect model expectation model acreage over her earlier
major crops between iv. Generalised method of elasticity significantly studies with proper
pre- and post-reform moments increased by about 20 to specification of
period 40% post reforms as price variables.
compared to pre
reforms for all crops,
except cotton and
groundnut.
18
BASIC FRAMEWORK AND APPRAOCHES USED IN ESTIMATION

In agriculture the observed prices are known after the production has occurred, while
planting decisions are based on the prices expected to prevail later at the harvest time.
Because of this time lag, producer price expectations play a key role in the analysis. Three
alternative agricultural producer price expectations hypotheses commonly found in the
literature are naïve expectation, adaptive expectation, and rational expectation. Naïve
expectation means expected price is the actual price in the previous period. Adaptive
expectations means that people form their expectations about what will happen in the future
based on what has happened in the past. According to rational expectation an economic agent
forecast his future event on the basis of all available information. Farmers, especially in the
developing countries, are mostly low literate and hence it is hard to obtain all the relevant
information. Therefore, rational expectation behavior is not relevant. The present study
assumed that farmers learn from their past mistakes, and so in this situation, adaptive
expectation becomes more relevant. Further, it is also important in the analysis of supply
response that observed quantities may differ from desired ones because of the adjustment lag
of variable factors.

There are two approaches to estimation of agricultural supply response; indirect structural
form approach and direct reduced form approach.

(A) Indirect structural form approach

This approach involves derivation of input demand function and supply function from the
available data, information relation to production function, and individuals’ behaviours. This
approach is more theoretically rigorous but fails to take into account the partial adjustment in
production and the mechanism used by farmers in forming expectations. This approach
requires detailed information on all the input prices. Moreover, the agricultural input markets
are not functioning in a competitive environment in India, particularly land and labour
markets. Market intervention in delivering material inputs to the farmers is a common
practice. It is difficult to get information on price at which the inputs are supplied to the
farmers. Keeping in view these aspects, most of the previous studies have chosen second
approach; “Direct reduced form approach”.
 (B) Direct reduced form approach

In this approach the supply response is directly estimated by including Partial Adjustment
and Expectations Formation. This is also known as Nerlovian Model. Most of the existing
studies on the agricultural supply response in India and abroad have applied the Nerlove
method. According to Nerlove, desired output can be expressed as a function of expected
price and exogenous shifters:

where, Q* t is desired output, P* t is expected price, Z t is a set of exogenous shifters such as

technology change, weather condition, etc.

Actual output may differ from the desired ones because of the adjustment lags of variable
factors. Therefore, it is assumed that actual output would only be a fraction δ of the desired
output.

where, Qt is actual output in period t, Qt-1 is actual output in period t-1, and δ is adjustment
coefficients. Its value lies between 0 and 1.

The farmers’ expected price at harvest time can be observed. So, we have to formally
describe how decision makers form expectations based on the knowledge of actual and past
price and other observable information. We may think that farmers maintain in their memory
the magnitude of the mistake they made in the previous period and learn by adjusting the
difference between actual and expected price in t-1 by a fraction λ

Putting the value of P*t and Q* t from equation 2 and 3, in equation 1, the equation 1
becomes

where, A0 is a d λ, A1 is b d λ, A2 is (1- d) +(1- λ), and A3 is c d.

20
This model is estimated from variables measured in levels and, should the suspicion of non-
stationarity be confirmed, as it happens with most economic series, the statistical significance
of the t tests of the estimated regressions lose sense. It is here where the use of advanced
econometric methodologies becomes relevant. For this particular case, the suitable
techniques are the general co-integration methodology and the ECM. The ECM allows
examining existence of long-run and short-run relationship among variables. All the used
variables are stationary and so the results are consistent. Instead of consistent results, the
ECM also considers the partial adjustment and the mechanism used by farmers in farming
expectations which are the fundamental in the analysis of agricultural supply response. In the
next section we show that partial adjustment model is nested within the ECM.

(C) Error Correction Model and Partial Adjustment Model

Let us take two variables Q and P and assume that both are integrated of order 1. The long-
run relationship between them can be expressed as:

Given that Qt and Pt are cointegrated, say of order 1, the term ut will be stationary and an
ECM-type representation exists for these two variables (Granger´s Representation Theorem),
which is expressed as:

Putting the value of ut-1 from equation 5,

21
Compare equations (9) and (4). They are identical after ignoring exogenous additional
variables - only if the term involving Pt is omitted from the ECM specification, which shows
that the partial adjustment model is nested within the ECM model, which constitutes a more
general specification of the problem.

22
EMPIRICAL METHODOLOGY

(A) Model

Agricultural supply depends on both output and input prices. An increase in output prices
increases profit and increase in profit provides incentive to farmers to produce more.
Similarly, an increase in input prices increases cost of production and increase in cost is
disincentive to produce more. Thus, real output price, that is, output over input price ratio
positively affects the agricultural production. Except for real output prices, there are several
factors that affect agricultural production. Manmingi (1997) subsumed these factors under
four different categories: rural infrastructure, human capital, technology, and agroclimatic
conditions. All rural infrastructure services such as irrigation facilities, accessibility of roads,
markets facilities, farmers access to credit, agro extension services, availability of fertilizer,
high yields variety seeds and pesticides, communication, and transport facilities are expected
to positively affect agricultural output through its effect on productivity and cost of
production. Education, agricultural extension, agricultural research and other technological
progress are supposed to have positive effect on agricultural production by improving
efficiency and reducing cost. Among the agroclimatic factors, soil quality and the intensity
and regularity of rainfall are likely to be most decisive for the supply response.

We cannot incorporate all of these factors due to non-availability of data and quantification
problems (some variables such as soil quality cannot be quantified). Considering these
problems, long-run supply response is estimated using variables indicated in equation 10
below:

where,

Yt = is the dependent variable in year t. Agricultural output was used as dependent

variables in this study. Agricultural output is measured by agricultural value added
output(AGDP) at constant prices (1999-2000) in crores of rupees

TOTt = represents real output price in year t. Agricultural terms of trade was used to measure
the relative prices. Agricultural terms of trade is ratio of prices received by farmers to
prices paid by farmers. It captures changes in producer prices, intermediate input

23
 costs, real exchange rates, and world market prices. Agricultural terms of trade was
calculated using the following formula:

TOT= IPD for agricultural sector / IPD for non-agricultural sector

where,

IPD for agricultural sector = implicit price deflator for agricultural sector.

IPD for non- agricultural sector = implicit price deflator for non-agricultural sector.

IRRt = is irrigation ratio in year t. Irrigation ratio is the share of total irrigated land in the
total cropped area. It was calculated as a proxy for rural infrastructure.

Techt = indicates technology in year t. Previous studies have used either trend variable or
irrigation ratio or total factor productivity index to capture technological improvement.
Use of time trend as a technology is very old pattern. It also catches up effects of all
other variables so when we already incorporated other variables, use of time trend is not
viable. Likewise, productivity index captures the effect of improvement in technology,
efficiency, rural infrastructure and weather. Use of high yield variety of seeds per
hectare is the most appropriate variables for indicating technology but data related to
this is not available for a long period so we used consumption of fertilizers (measured
in kilogram) per hectare as a technology variable in this study.

AARt = represents annual average rainfall in year t. To incorporate weather condition in the
model average annual rainfall (measured in millimeter) was used.

et = is error term

Cointegration and error-correction techniques are applied in this study. These techniques are
believed to overcome the problem of spurious regressions and to give consistent and distinct
estimates of long-run and short-run elasticities that satisfy the properties of the classical
regression procedure. This is because all variables in an ECM are integrated of order zero, I
(0). Spurious regression and inconsistent and indistinct short-run and long-run elasticity
estimates are major problems exhibited by traditional Adaptive Expectation and Partial
Adjustment models (Hallam & Zanoli, 1993; McKay et al, 1998). Co-integration and ECMs
have been used in agricultural supply response analysis in other countries by a number of
researchers, namely Hallam & Zanoli, (1993); Townsend (1997); Schimmelpfennig et al.

24
(1996); Townsend & Thirtle (1994); Almu et al. (2003); McKay et al.(1998); Thiele (2003);
and Avasola (2006).

One major use of the co-integration technique is to establish long-run equilibrium

relationships between variables. However, two conditions must be met for co-integration to
hold. First, individual variables should be integrated of the same order. Second, the linear
combination of these variables must be integrated of an order one less than the original
variables (Engle & Granger, 1987). In other words, if the variables under consideration are
integrated of order one, or I (1), the error term from the co-integrating relationship should be
integrated of order zero, I (0), implying that any drift between variables in the short run is
temporary and that equilibrium holds in the long run.

If deviation from the long-run equilibrium path is bounded or co-integration is confirmed,

Engle & Granger (1987) show that the variables can be represented in a dynamic error-
correction framework. Therefore, in this paper, like similar studies elsewhere, supply
response is modeled in two stages. First, a static co-integrating regression given by equation
(10) is estimated for Indian agriculture and tests for co-integration are conducted. Second, if
the null for no co-integration is rejected, the lagged residuals from the co-integrating
regression are imposed as the error correction term in error correction model. An error
correction model is shown below:

where, ∆ represents first differencing, λ measures the extent of correction of errors by

adjustment in Yt. βi measures the short-run effect on supply or short-run elasticities when the

variables are measured in logarithm, while αi measure the long-run price elasticities. ut is
error term.

(B) Estimation Procedure

Each of the series is tested for the presence of a unit root by estimating an Augmented
Dickey Fuller (ADF) equation both with and without the deterministic trend. The number of
lags in the ADF equation is chosen by using LR, AIC, and SBIC tests. After verifying that
variables are stationary or not, we took first lag difference of all series and again estimated
ADF equation both with and without the deterministic trend. The final stage is to test for

25
cointegration. We test for cointegration by using Engel Granger two-step procedure. In this
approach, first we estimated long-run relationship if all variables are integrated in same order
and obtained residuals. The residuals of this relationship is tested for the presence of a unit
root. If the test reported presence of unit root in residuals, the variables used in long-run
relationship are not cointegrated and if the test rejected null hypothesis, the variables used in
long-run relationship are cointegrated.

(C) Selection of States

The study also focuses on whether there is difference in the supply response among highly
agricultural based, medium agricultural based, and low agricultural based states. For this
purpose, we divided all states into three categories. For classification, first we estimated the
share of agricultural income in total state’s income for each state10 for the 3 base years 1980-
81, 1990-91, and 2000-01, respectively (see Table 2). After then we categorized these states
into three categories as mentioned above. The criterion used was, those states which have
more than 30 percent agricultural share are highly agricultural based, which have less than 30
and more than 20 percent are medium agricultural based, and which have less than 20 percent
agricultural share are low agricultural based states. Through this procedure finally we have
chosen 14 states in which four states (Bihar, Hariyana, Punjab, and Uttar Pradesh) belong to
the first category, six states (Andhara Pradesh, Karnataka, Madhya Pradesh, Orissa,
Rajasthan, and West Bangal) belong to second category, and four states (Gujarat, Kerala,
Maharashtra, and Tamil Nadu) belong to the third category.

(D) Period of Study

The study covered time span from 1970-71 to 2004-05 for all India level analysis and from
1980 to 2005 for regional analysis. The year 1970-71 is chosen as base year because Indian
agriculture has made significant growth since late 60s. Further, during seventies agricultural
and rural development was given more importance. Despite these, one more reason to leave
50s and 60s is during these periods Indian economy faced many structural changes. Due to
these changes agricultural output has more variation in this period than study period (1970-
71 to 2004-05). The year 2004-05 was chosen as the end period of the study because the
published data on which this study is based is available up to 2004-05.

10
Northeast, small such as Goa etc, and new states were excluded in this procedure.

26
At the beginning period of Green Revolution, there were substantial inequalities in
agricultural production among states of India (Das and Barua, 1996). Due to these
inequalities, there might have occurred differences in supply response among states and
results may be biased. To avoid this biasedness, the year 1980-81 is chosen as base for
regional analysis.

(E) Data Source

Data related to agricultural gross value of output was collected from various issues of
National Account Statistics published by Central Statistical Organization, Government of
India, New Delhi. Gross sown area, and gross irrigated area were taken from Agricultural
Statistics at a Glance (2007) published from Directorate of Economics and Statistics,
Ministry of Agriculture, Government of India. Consumption of fertilizers was also collected
from Agricultural Statistics at a Glance (2007). Average annual rainfall was calculated from
monthly journal Agricultural Situation of India published by Directorate of Economics and
Statistics, Ministry of Agriculture, Government of India. All the state level data for each
variable are taken from various issues of Fertilizers Statistics published by Fertilizers
association in India, New Delhi, and www.indiastat.com.

Table 2: Share of Agricultural Income in total income for all major states

Name of state 1980-81 1990-91 2000-01

SNDP ANDP/SNDP*100 ANDP SNDP ANDP/SNDP*100 ANDP SNDP ANDP/SNDP*100
ANDP
Andhra Pradesh 315705 732395 43.11 441689 1358012 32.52 2141924 7707692 27.79
Bihar 302911 634922 47.71 396613 1025327 38.68 1347880 3136296 42.98
Gujarat 243408 654742 37.18 268421 1083915 24.76 921900 6257500 14.73
Haryana 163026 303195 53.77 257704 571921 45.06 936612 2888511 32.43
Karnataka 239327 558736 42.83 303450 911210 33.30 1852057 6213241 29.81
Kerala 129384 382273 33.85 176135 526234 33.47 544822 3396268 16.04
Madhya Pradesh 306072 701244 43.65 478591 1110721 43.09 1108250 4309917 25.71
Maharashtra 374908 1516258 24.73 546770 2722382 20.08 2125238 13671250 15.55
Orissa 161736 344269 46.98 148966 434470 34.29 521155 2027161 25.71
Punjab 215618 444925 48.46 357434 750493 47.63 1516910 3663590 41.41
Rajasthan 202801 412571 49.16 385419 847260 45.49 1111879 4566369 24.35
Tamil Nadu 177319 721816 24.57 271417 1242299 21.85 1393387 8045255 17.32
Uttar Pradesh 699614 1401182 49.93 957778 2277965 42.05 3317322 9168983 36.18
West Bengal 264060 959400 27.52 392967 1445781 27.18 1902846 7825403 24.32
Note: ANDP = State net domestic product from agriculture, and SNDP = State net domestic product.
Source: State domestic product, EPW research foundation

27
RESULTS AND DISCUSSION

(A) Descriptive Statistics

Table 3 shows the mean value of all variables (used in absolute form) for all India and each
category of states; high, medium, and low agricultural based states. From this table, the
situation of agriculture in each category of states can be compared. The mean value of
agricultural TOT is higher for medium agricultural based states in comparison both high and
low agricultural based states. The mean value of agricultural TOT is almost same for high
and low agricultural based states. The mean values of technology and irrigation ratio are the
highest for highly agricultural based states. This shows that high agricultural based states are
better in terms of infrastructure and technology than the other two groups of states. Tables 4
and 5 describe the descriptive statistics (all variables are used in natural logarithmic form in
order to be consistent with the variables used in the statistical analysis) and correlation
matrix, respectively.

Table 3: The Mean Values of Selected Variables

Group AGDP (In Rs TOT IRR TECH (in Kg AAR (in mm)
Crore) per Hectare)
All India 290805.1 95.12 32.78 53.75 1257.9
Category of States
High 63813.98 96.05 65.78 100.26 876.2
Medium 73381.17 103.35 29.83 65.01 1277.7
Low 44758.65 93.07 25.32 72.75 1285.3
Note: 1. All variables are in absolute measure.

28
 Table 4: Descriptive Statistics

Variables AGDP TOT IRR TECH ARR

All India (Period: 1970 – 2004)
Mean 12.54 4.55 3.47 3.82 7.13
Std. Dev. 0.30 0.075 0.20 0.63 .09
Maximum 12.99 4.77 3.73 4.57 7.28
Minimum 12.05 4.44 3.14 2.61 6.89
High Agricultural Based States (Period: 1980-2004)
Mean 11.05 4.56 4.18 4.56 6.77
Std. Dev. 0.18 0.05 0.106 0.31 0.14
Maximum 11.33 4.66 4.31 4.93 6.94
Minimum 10.73 4.47 3.99 3.81 6.51
Medium Agricultural Based States (Period: 1980-2004)
Mean 11.18 4.64 3.38 4.09 7.15
Std. Dev. 0.22 0.053 0.17 0.429 0.08
Maximum 11.48 4.76 3.67 4.65 7.31
Minimum 10.77 4.55 3.05 3.23 6.97
Low Agricultural Based States (Period: 1980-2004)
Mean 10.69 4.53 3.22 4.24 7.15
Std. Dev. 0.21 0.05 0.12 0.32 0.13
Maximum 10.97 4.62 3.40 4.65 7.50
Minimum 10.35 4.44 3.02 3.56 6.88

Table 5: Correlation Matrix

Variables AGDP TOT IRR TECH ARR

All India (Period: 1970 – 2004)
AGDP 1.0000
TOT -0.19 1.0000
IRR 0.98 -0.23 1.0000
TECH 0.96 -0.33 0.98 1.0000
ARR 0.020 -0.004 -0.09 -0.08 1.0000
High Agricultural Based States (Period: 1980-2004)
AGDP 1.0000
TOT 0.38 1.0000
IRR 0.95 0.46 1.0000
TECH 0.96 0.38 0.95 1.0000
ARR 0.003 -0.09 -0.05 0.04 1.0000
Medium Agricultural Based States (Period: 1980-2004)
AGDP 1.0000
TOT 0.31 1.0000
IRR 0.96 0.27 1.0000
TECH 0.96 0.33 0.97 1.0000
ARR 0.13 0.27 -0.02 0.09 1.0000
Low Agricultural Based States (Period: 1980-2004)
AGDP 1.0000
TOT 0.25 1.0000
IRR 0.86 0.29 1.0000
TECH 0.85 0.36 0.86 1.0000
ARR 0.33 -0.10 0.13 0.09 1.0000

29
 (B) Test of Stationarity

Before doing estimation, we test for the presence of stationarity of all the variables in the
model for both India and regional level. We used Augmented Dickey Fuller test both with
trend and without trend. Table (6) shows the results of ADF test, we found all variables are
non-stationary for each category; all India level, highly agricultural based states, medium
agricultural based states, and low agricultural based states.

(C) Order of Integration

The test for the order of integration is the next step in co-integration analysis. If a series is
integrated, it accumulates past effects. This means that perturbation to the series does not
return to any particular mean value. Therefore, an integrated series is non-stationary. Order
of integration of such a series is determined by the number of times that it must be
differenced before it is actually made stationary. It follows that if two or more series are
integrated of the same order then a linear relationship can be estimated. Examining the order
of integration of this linear relationship is similar to testing for the null hypothesis that there
is no co-integration against its alternative that there is co-integration. In this section, an
attempt is made to determine the order of integration of the variables. Table (7) showed that
all variables are integrated of order 1 or I (1). The first lag difference of each of the series is
tested for the presence of a unit root by estimating an Augmented Dickey Fuller (ADF)
equation both with and without the deterministic trend. The results are given in tables from 5
to 8. All the tables show that first lag difference of each series is stationary. This means that
all the series are integrated of order one for all India, and also at the regional level, high,
medium, and low agricultural based states.

30
 Table 6: Results of ADF Test

Variables With Trend Without Trend

All India Level
AGDP -3.427 (-4.325) -0.565 (-3.709)
TOT -2.108 (-4.306) -2.138 (-3.696)
IRR -0.364 (-4.316) -2.077 (-3.702)
TECH -1.312 (-4.306) -1.306 (-3.696)
AAR -4.253 (-4.306) -4.331 (-3.696)
High Agricultural Based States
AGDP -3.427 (-4.325) -0.565 (-3.709)
TOT -2.108 (-4.306) -2.138 (-3.696)
IRR -0.364 (-4.316) -2.077 (-3.702)
TECH -1.312 (-4.306) -1.306 (-3.696)
AAR -4.253 (-4.306) -4.331 (-3.696)
Medium Agricultural Based States
AGDP -2.020 (-4.380) -1.366 (-3.750)
TOT -1.791 (-4.380) -1.786 (-3.750)
IRR -3.839 (-4.380) -1.469 (-3.750)
TECH -1.825 (-4.380) -2.226 (-3.750)
AAR -4.268 (-4.380) -4.250 (-3.750)
Low Agricultural Based States
AGDP -1.817 (-4.380) -0.979 (-3.750)
TOT -2.368 (-4.380) -2.611 (-3.750)
IRR -1.697 (-4.380) -0.997 (-3.750)
TECH -2.190 (-4.380) -1.877 (-3.750)
AAR -3.019 (-4.380) -3.063 (-3.750)
Note: The value given in parentheses indicates t-statistics

31
 Table 7: Results of ADF Test

Variables With Trend Without Trend

All India Level
∆AGDP -4.446 (-4.325) -4.528 (-3.709)
∆TOT -5.285 (-4.306) -5.378 (-3.696)
∆IRR -5.634 (-4.316) -4.983 (-3.702)
∆TECH -4.135 (-3.572) -3.780 (-3.702)
∆AAR* -7.273 (-4.316) -7.295 (-3.702)
High Agricultural Based States
∆AGDP -5.029 (-4.380) -4.822 (-3.750)
∆TOT -4.538 (-4.380) -4.722 (-3.750)
∆IRR -5.071 (-4.380) -4.683 (-3.750)
∆TECH -4.870 (-4.380) - 3.856 (-3.750)
∆AAR -4.721 (-4.380) -4.799 (-3.750)
Medium Agricultural Based States
∆AGDP -4.112 (-3.600) -4.025 (-3.750)
∆TOT -4.931 (-4.380) -5.068 (-3.750)
∆IRR -4.295 (-3.600) -4.239 (-3.750)
∆TECH -5.885 (-4.380) -5.385 (-3.750)
∆AAR -5.210 (-4.380) -5.102 (-3.750)
Low Agricultural Based States
∆AGDP -3.822 (-3.600) -3.825 (-3.750)
∆TOT -5.108 (-4.380) -4.881 (-3.750)
∆IRR -4.512 (-4.380) -4.573 (-3.750)
∆TECH -6.090 (-4.380) -6.004 (-3.750)
∆AAR -3.849 (-3.600) -3.963 (-3.750)
Note: The value given in parentheses indicates t-statistics

(D) Test of Cointegration

The main objective of this section is to determine whether the variables are integrated of
order zero, or in short, whether they are co-integrated. If co-integration is confirmed, a non-
spurious long-run equilibrium relationship exists. When this is combined with ECM, whose
variables are I (0), consistent estimates of both long-run and short-run elasticities is evident.
Residual-based, proposed by Engle & Granger (1987) was employed to test for co-
integration. The residual-based procedure is known as a single-equation approach. We have
seen in Table (7) all selected variables are integrated of same order, I (1). So, we can
estimate long run relationship among variables represented by equation (10) and if residual
of estimated equation becomes stationary then we can say that equation (10) or long run
relationship among variables is cointegrated.

In this study first we examine the long-run relationship or cointegration separately between
pairs of variables (further it is indicated by bivariate analysis in this study); for example
agricultural output with agricultural terms of trade, agricultural output with irrigation ratio,

32
agricultural output with technology, and agricultural output with annual rainfall. The
bivariate analysis has also been done for each category. The results are given in tables from
8 to 11. Table 8 shows that agricultural output is cointegrated with only irrigation ratio for
all India level. This means that there is a long-run relation between agricultural output and
irrigation. Tables 9, 10, and 11 indicate that agricultural output is separately cointegrated
with irrigation ratio and technology for high, medium, and low agricultural based states
respectively. This reveals that the long-run relationship between agricultural output and
irrigation ratio and between agricultural output and technology exist in each category of
states.

Table 8: Bivariate Analysis for All India

-2
Relation Estimated Equation R dw-stat ADF test Interpretation
between of
variables residuals
AGDP Agdp = 15.99 - .76 tot 0.01 0.049 -0285 No Cointegration
& (5.14) (-1.11) (-2.649)
TOT
AGDP Agdp = 7.15 + 1.55 irr* 0.95 1.775 -5.691 Cointegration
& (34.46) (26.01) (-2.646)
IRR
AGDP Agdp = 10.79 + .46 tech* 0.91 0.656 -0.844 No Cointegration
& (114.29) (18.76) (-2.649)
TECH
AGDP Agdp = 11.85 + .07 arr -0.02 0.0466 -0.592 No Cointegration
& (-2.650)
AAR

Table 9: Bivariate Analysis for High Agricultural Based States

-2
Relation Estimated Equation R dw-stat ADF test Interpretation
between of
variables residuals
AGDP agdp = 4.71+1.39tot*** 0.10 0.269 -1.516 No Cointegration
& (1.45) (1.95) (-2.660)
TOT
AGDP agdp = 4.31 + 1.61irr* 0.89 2.41 -5.815 Cointegration
& (9.39) (14.67) (-2.660)
IRR
AGDP agdp = 8.56 +.54 tech* 0.91 1.89 -4.564 Cointegration
& (56.91) (16.58) (-2.660)
TECH
AGDP agdp = 11.49 - .04 aar 0.04 0.116 -1.208 No Cointegration
& (3.53) (-0.14) (-2.660)
AAR

33
 Table 10: Bivariate Analysis for Medium Agricultural Based States
-2
Relation Estimated Equation R dw-stat ADF test Interpretation
between of
variables residuals
AGDP agdp = 5.14 + 1.30 tot 0.05 0.236 -1.346 No Cointegration
& (1.32) (1.55) (-2.660)
TOT
AGDP agdp = 7.01 + 1.23 irr* 0.91 2.145 -5.179 Cointegration
& (27.78) (16.52) (-2.660)
IRR
AGDP agdp = 9.14 + 0.49 tech* 0.91 1.479 -3.667 Cointegration
& (71.80) (16.08) (-2.660)
TECH
AGDP agdp = 10.61 + .05 aar -.0.04 0.125 -0.760 No Cointegration
& (1.46) (0.08) (-2.660)
AAR

Table 11: Bivariate Analysis for Low Agricultural Based States

-2
Relation Estimated Equation R dw-stat ADF test Interpretation
between of
variables residuals
AGDP agdp = 5.68 + 1.10 tot 0.02 0.575 -0.451 No Cointegration
& (1.43) (1.26) (-2.660)
TOT
AGDP agdp = 5.92 + 148 irr* 0.72 1.325 -2.772 Cointegration
& (9.94) (8.01) (-2.660)
IRR
AGDP agdp = 8.26 + 0.57 tech* 0.70 1.17 -2.700 Cointegration
& (26.19) (7.72) (-2.660)
TECH
AGDP agdp = 4.65 + 0.53 aar 0.08 0.185 -1.171 No Cointegration
& (1.36) (1.76) (-2.660)
AAR
Note: 1. The value given in parentheses indicates t-statistics.
2. Superscript *, **, and *** show level of significant at 1 %, 5 %, and 10 % respectively

After examining the bivariate relationship, we moved to examine multivariate relationship

showed by equation (10). In this equation we used irrigation ratio as a proxy for
infrastructure and consumption of fertilizer as a proxy of technology. But both are highly
correlated with each other. This casts doubt of multicollinearty in equation (10). So we
estimated equation (10) without incorporating consumption of fertilizer and again estimated
equation (10) without incorporating irrigation ratio for removing the problem of
multicollinearty. Thus we estimated three equations for each category. The tables from 12
to 15 show results. They indicated that model 1(original equation 10), model 2 (without

34
incorporating technology variable in equation 10), and model 3 (without incorporating
irrigation ratio in equation 10) are cointegrated for each category.

Table 12: Multivariate Analysis for All India

Variables Model 1 Model 2 Model 3

Constant 2.13 (1.49) 2.22 (1.65) 4.59 (2.55)

TOT 0.14 (0.84) 0.16 (1.19) 0.57** (3.10)
IRR 1.65* (5.02) 1.58* (30.10)
TECH -.02 (-.21) 0.48* (21.89)
AAR 0.39* (1.49) 0.39* (3.61) 0.34** (2.27)
-2
R 0.96 0.96 0.93
dw-stat 1.245 1.232 0.87
ADF test for -2.953 -2.895 -2.164
residuals (-2.647) (-2.647) (-2.647)
Interpretation Cointegration Cointegration No Cointegration

Table 13: Multivariate Analysis for High Agricultural Based States

Variables Model 1 Model 2 Model 3

Constant 7.33 (4.35) 4.66 (2.86) 9.01 (5.91)

TOT -0.12 (-0.50) -0.27 (-0.99) 0.04 (0.15)
IRR 0.69*** (1.92) 1.67* (13.38)
TECH 0.33** (2.87) 0.54* (14.75)
AAR -.01 (-0.14) .06 (0.61) -0.06 (-0.65)
-2
R 0.92 0.89 0.91
dw-stat 2.34 2.43 1.91
ADF test for -5.809 (-2.660) -5.883 (-2.660) -4.627 (-2.660)
residuals
Interpretation Cointegration Cointegration Cointegration

Table 14: Multivariate Analysis for Medium Agricultural Based States

Variables Model 1 Model 2 Model 3

Constant 3.55 (1.52) 1.86 (0.98) 8.16 (3.67)

TOT -0.07 (-0.30) -0.04 (-0.15) -0.11 (-0.36)
IRR 0.92* (3.22) 1.26* (17.67)
TECH 0.14 (1.21) 0.50* (14.64)
AAR 0.35** (2.04) 0.43** (2.65) 0.12 (0.63)
-2
R 0.93 0.93 0.90
dw-stat 2.04 2.19 1.41
ADF test for -4.915 -5.295 -3.528
residuals (-2.660) (-2.660) (-2.660)
Interpretation Cointegration Cointegration Cointegration

35
 Table 15: Multivariate Analysis for Low Agricultural Based States

Variables Model 1 Model 2 Model 3

Constant 2.09 (0.79) 0.12 (0.05) 3.75 (1.27)

TOT 0.04 (0.10) 0.26 (0.59) -0.001 (-0.00)
IRR 0.83** (2.80) 1.40* (8.12)
TECH 0.27** (2.26) 0.55* (7.58)
AAR 0.41** (2.93) 0.43** (2.86) 0.41** (2.55)
-2
R 0.81 0.78 0.75
dw-stat 2.149 1.90 1.54
ADF test for -5.185 -4.686 -3.879
residuals (-2.660) (-2.660) (-2.660)
Interpretation Cointegration Cointegration Cointegration
Note: 1. AGDP is dependent variable in each Model
2. The value given in parentheses indicates t-statistics.
3. Superscript *, **, and *** show level of significant at 1 %, 5 %, and 10 % respectively

From the bivariate analysis, we have seen that agricultural output is not cointegrated with
agricultural TOT. This means no long run equilibrium relationship could exist between
agricultural output and agricultural TOT. And from multivariate analysis we have seen that a
long run equilibrium relationship showed by equation 10 exists. This shows that the impact
of agricultural TOT on agricultural output works in combination with non-price factors
(technology, irrigation and annual rainfall).

(E) Error correction model

After long-run relationships between agricultural output /gross sown area and the variables
predicting it are confirmed, ECM is developed. Results are reported in Tables from 16 to 19.
According to Hallam & Zanoli (1993), a high R2 in the long-run regression equation is
necessary to minimize the effect of a small sample bias on the parameter estimates of the co-
integrating regression, which may otherwise be carried over to the estimates of the error-
correction model. From Table 16 (All India level), agricultural output is impacted positively
by technology, irrigation ratio and annual rainfall. Agricultural terms of trade gives a
negative relation but the coefficient is not statistically different from ‘zero’ at 5% level. All
variables except agricultural TOT have expected sign. Only coefficient of annual rainfall is
statistically significant at one percent level and other coefficients are not statistically
significant at 5 percent level. All selected variables together explained 69 percent of variation
in agricultural output. The error-correction term in this equation is also significant and has
the required sign. It shows that 0.48 of the deviation of the agricultural output from its long

36
run equilibrium level is corrected each year. Similarly, in test of cointegration in multivariate
case, here also we estimated ECM without incorporating technology (model 2) and irrigation
ratio (model 3). Model 2 also shows that agricultural supply elasticity is not statistically
different from ‘0’. This model also indicated that remaining factors (irrigation ratio and
annual rainfall) have positive effect on agricultural output. The error-correction term in the
model is significant and has the required sign. It shows that 48 percent of the deviation of the
agricultural output from its long run equilibrium level is corrected each year.

From Table 17 (High Agricultural Based States), it is inferred that only ‘technology’ is
significantly explaining output. Here also, the supply elasticity is insignificant. The negative
sign of coefficients of irrigation may be due to multicolinearity between technology and
irrigation ratio. This argument is strongly supported by model 2 where we found positive and
statistically significant coefficient of irrigation ratio. The models 1, 2 and 3, explained 42, 32,
and 35 percent variation in agricultural output, respectively. The error correction term in each
model is statistically significant and has required sign.

The results of the ECM for medium and low agricultural based states are given in Table 18
and 19, respectively. The results from these two groups also indicated that irrigation ratio
and annual rainfall are significant variables affecting positively. Supply elasticity is
significant and negative. The error correction term in each model for both categories is
statistically significant and has the required sign.

Table 16: Results of ECM for All India

Variables Model 1 Model 2

Constant 0.02 (2.37) 0.02 (2.86)

∆TOT -0.18 (-1.25) -0.18 (-1.31)
∆IRR 0.29 (0.08) 0.05 (0.15)
∆TECH 0.03 (0.35)
∆AAR 0.32* (5.52) 0.33* (5.81)
Error correction -0.48 (-3.68) -0.48* (-3.74)
-2
R 0.69 0.70
dw-stat 2.600 2.582

37
 Table 17: Results of ECM for High Agricultural Based States

Variables Model 1 Model 2 Model 3

Constant 0.01 (1.39) 0.02 (1.97) 0.01 (1.08)

∆TOT -0.33 (-1.28) -0.14 (-0.50) -0.46 (-1.71)
∆IRR -0.08 (-0.26) 0.21 (0.61)
∆TECH 0.21***(1.83) 0.25** (2.11)
∆AAR -0.02 (-0.33) 0.02 (0.46) -0.02 (-0.38)
Error correction -0.80* (-3.56) -0.67** (-2.97) -0.70* (3.43)
R-2 0.42 0.32 0.35
dw-stat 2.059 2.055 2.363

Table 18: Results of ECM for Medium Agricultural Based States

Variables Model 1 Model 2 Model 3

Constant 0.003 (0.20) 0.01 (0.550) 0.02 (1.11)

∆TOT -0.59** (-2.27) -0.64** (-2.65) -0.37 (-1.35)
∆IRR 0.81*** (2.15) 0.90** (2.48)
∆TECH 0.10 (0.90) 0.22 (1.56)
∆AAR 0.42* (4.10) 0.49* (5.13) 0.35** (2.73)
Error correction -1.05* (-4.58) -1.10* (-5.04) -0.62* (-3.11)
-2
R 0.60 0.64 0.44
dw-stat 1.68 1.749 2.036

Table 19: Results of ECM for Low Agricultural Based States

Variables Model 1 Model 2 Model 3

Constant 0.02 (1.51) 0.02 (1.22) 0.02 (1.73)

∆TOT -0.54 (-1.84) -0.41 (-1.30) -0.49*** (-1.90)
∆IRR 0.08 (0.28) 0.16 (0.51)
∆TECH -0.06 (-0.36) -0.10 (-0.75)
∆AAR 0.44* (3.96) 0.38* (4.03) 0.44* (4.70)
Error correction - 0.55** (-2.28) -0.42*** (-2.06) -.42** (-2.84)
-2
R 0.61 0.58 0.67
dw-stat 1.982 2.005 2.186
Note: 1. ∆AGDP is dependent variable in each Model
2. The value given in parentheses indicates t-statistics.
3. Superscript *, **, and *** show level of significant at 1 %, 5 %, and 10 % respectively.

(F) Short-Run and Long-Run Elasticities

The coefficients of ECM model indicate short-run elasticites and the coefficients of estimated
equation (10) represent long-run elasticities. The short-run and long-run agricultural output
elasticities with respect to terms of trade are shown in Table 20. Both short-run and long-run
supply elasticities with respect to TOT are not statistically significantly different from zero.
However, the supply elasticity with respect to TOT is positive and statistically significant in

38
the study of Palanivel (1996). The results also indicate that elasticities of technology,
irrigation ratio, and annual rainfall are positive for both short-and long-run period. Turning to
regional level analysis, the short-run and long-run supply elasticities are insignificant for low
and high agriculture based states, whereas it is significant and negative for medium
agricultural based states. The non-price factors’ elasticities for these three groups of states
are also positive and relatively more than agricultural TOT.

Table 20: Aggregate Agricultural Elasticities w.r.t. Agricultural TOT

Level Short Run Long Run

All India -0.18 0.14
High -0.34 -0.12
Medium -0.59** -0.02
Low -0.54 -0.04
Note: Superscript** indicates 5 % significant level

From this analysis, it is inferred that price is not a significant factor explaining output
growth. The analysis confirms that both irrigation and technology are relatively more
important for higher agricultural growth.

39
THE CAUSES OF LOW SUPPLY RESPONSE

The issue of agricultural supply response is a very important one as it has an impact on
growth, poverty, and environment (Mamingi, 1997). The success of any structural adjustment
programs depends on size of agricultural supply response. The size of agricultural supply
response should improve after removing some of the constraints that farmers were facing
before. India also has removed many constraints from agrarian system and provided many
incentives to farmers. Land reform, massive public investments in irrigation and rural
electrification, strengthening of agricultural research and extension services, expansion and
improvement of the transport network, especially rural roads, development of rural credit
institutions are some steps which were initiated by Indian Government for improving
agriculture since Independence. But still the supply response for Indian agriculture is low.
Hence the question is “why is supply response low” becomes a big issue. In this section, we
summarize some of the discussion from the earlier literature to support low or no response.

Low supply response means that farmers’ aim is not to maximize profit. One reason
attributable to it is that farmers in India are largely subsistence farmers. This is supported by
a fact that 78 percent farmers are small and marginal farmers in India. So, finally we can say
that subsistence farming is one of the causes of low supply response.

Despite this there are many constraints, which caused low supply response in Indian
agriculture. These are lack of an integrated farming approach, weak agriculture research and
extension network, restrictions on agricultural trade and processing, inadequate public
expenditure on rural infrastructure. Due to these constraints Indian farmers do not like to stay
in farming. The 59th round NSSO report reported that 40 percent farmers do not like to stay
in farming but they have no other alternatives.

40
CONCLUSION AND SUGGESTIONS

The study reexamined agricultural supply response for Indian agriculture. The study also
verified that whether there is difference in the supply response among highly agricultural
based, medium agricultural based, and low agricultural based states. In this study, we found
that all selected variables have unit root and integrated of order one. The bivariate analysis
confirmed that no cointegration between agricultural TOT and agricultural output. The non-
cointegratedness indicates that no direct long-run relationship exists between TOT and output
level in Indian agriculture. The multivariate analysis confirmed that relationship between
agricultural output and all other selected variable is cointegrated. This shows that the impact
of agricultural TOT on agricultural output works in combination with non-price factors
(technology, irrigation and annual rainfall). The study also indicated that aggregate
agricultural output elasticity with respect to agricultural TOT is very low and not statistically
different from 0. This means supply response is price inelastic. There are several reasons for
this. One, small and marginal farmers constitute higher proportion; two, lack of an integrated
farming approach; three, weak agriculture research and extension network; four, restrictions
on agricultural trade and processing; and five, inadequate public expenditure on rural
infrastructure. This short-run supply response is lower than the long-run response and the
reason could be that the use of primary factors that account for about 70 to 85 percent of the
cost of agricultural production in developing countries cannot be changed in the short run
(Binswanger, 1993; Thiele, 2000). The study also confirmed that there is a difference in the
supply response among high agricultural based, medium agricultural based, and low
agricultural based states. The results of this study also suggested that non-price factors are
comparatively more important for higher agricultural growth.

The study confirmed that price and non-price factors are not substitute for each other. They
are complementary. So, a strategy that combines both price and non-price factors is crucial
for policies promoting agricultural development. Besides, farmers’ accessibility to output and
input markets, strengthening of agricultural research and extension removing restrictions on
agricultural trade within country, and improving rural infrastructure especially irrigation,
transport, education, and health facilities, are some of the factors that would lead to increase
in response.

41
Certain limitations of this study should be borne in mind. This study relies on a partial
equilibrium analysis for the agricultural sector. In the long run, the dynamics of agricultural
supply are likely to depend to a large extent on the ability of the sector to attract additional
production factors from other sectors, an effect that cannot be captured in a partial
equilibrium framework. Despite this, another limitation is that the study covered a short time
period especially for state level analysis. To account for the effects of intersectoral factor
movements on agricultural supply, an analysis based on dynamic general equilibrium
framework would give more meaningful results.

42
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45
Point-by-Point Reply to Comments of Reviewers

Reviewers' comments Reply/action taken

Reviewer #1:
1. Relevance:
1.1 The subject of research is relevant to
India. Policy makers need to know whether
the policies they frame are having the
desired impact. Though previous
researchers have gone into the issue of how
agriculture has responded to policy
initiatives, the use of Cointegration
analysis is an addition to knowledge.
Cointegration analysis brings out the long
term relationships and takes care of the
problem of spurious regression in time
series data. As such the study has
implications for policy formulations.

2. General Necessary change has been made in the revised

2.1 There are a number of typos. The ms.
author should be asked to eliminate these.
2.2 The paper does not have a separate As suggested, the limitation of study has
section on the limitations of the study. This been mention in separate section.
is important as findings would have to be
seen within these constraints. Future
researchers using better analytical tools
developed in future will be able to
appreciate the work
2.3. The paper does not have a section on As suggested, scope of further study has
indications for further research work. This been mention in the end of the revised ms.
is necessary as no researcher is able to
address all the issues in one work. Such an
indication can help further knowledge in
this area.
3. Abstract The change has been made accordingly.
3.1.1. It is stated that the "present
study…. is a better approach" . It has not
been elaborated as to better than which
approach/s and why.
3.1.2. "But still the supply response for The sentence has been corrected
Indian agriculture is low." This statement accordingly to reviewer.
assumes that there is standard for supply
response and so the actual is lower than
that. May be it would be better to take the
position that increasing the supply response

46
is desirable. Or, the author should state
what it is lower than.
3.1.3. "..to see if the response has been
better at the all India level". Perhaps the
same could be seen at the state levels, as
the work does study state level data.
Yes, same could be seen at the state levels.
But the study emphasis that whether there
is difference in the supply response among
highly agricultural based, medium
agricultural based, and low agricultural
based states.

3.1.4. Only one of the results of the All major findings have been mentioned in
study has been given in the abstract. Is it the revised ms.
the most important according to the author?
Ideally all the major findings should be
mentioned in the abstract. It is not clear
whether this is because of a word
constraint.
3.1.5 "the study indicated that Some explanation have been added in
aggregate agricultural output elasticity with revised ms.
respect to agricultural TOT is very low and
not statistically different from 0". Some
explanation why this might be so would
add to the research finding.
4. Para (I) Introduction: It has now been clearly explained in the revised
4.1. The objective of the paper is not very ms.
clearly stated. "The present study is an
attempt to find supply response through
better approach….. and to see if the
response has been better at the all India
level". Is it another attempt to prove what is
the starting point ie., the supply response is
low? And, if the supply response is low at
the state level, would the all India level
supply response be any different?
Objectives of the study should be clearly
stated; and the observations should be
classified accordingly to map with the
objectives.

4.2. " This casts doubts on the validity of The sentence has been corrected
their results." Casting aspersions about the accordingly to reviewer.
validity of previous studies without a
complete discussion and elaboration is out
of place in academic writings. It is possible
the authors of these papers would have
indicated the limitations

47
4.3. The author found one study related to This study has been discussed in literature
India using the ECM but has not taken the review so we have not taken the trouble to
trouble to discuss this. discuss this here. This is also because of
reason that word limit constraint.
5. Para (II) Literature review The sentence has been corrected
5.1. The author has expressed his accordingly to reviewer.
"surprise" that Jai Krishna and Rao (1965,
1967) found traditional regression models
give satisfactory results "if not superior
results …….". Such criticisms should be
justified as academic papers should avoid
casting aspersions at previously published
work. The author should also remember
that as the methods of analysis improve,
the researches work also improves.

5.2. Palanivel (1995) found that the This study have been discussed in the
elasticity of aggregate agricultural output revised ms.
with respect to TOT is positive and
statistically significant. Since the author's
work has revealed the opposite, a detailed
discussion of this paper in the section of
discussions of results is necessary
5.3. The literature review, inter alia, is a The necessary correction has been done in
discussion to indicate the gap in the revised ms.
existing literature. The concluding lines
seem to indicate that the Cointegration
analysis has been adopted only because
"most of the other studies have followed
the same methodology given by
Nerlov….." !
5.4. The study also seems only to "probe" This study is not probing earlier result
earlier results instead of trying to fill gaps while trying to fill gaps in existing
in existing literature literature. To reflect it in ms the necessary
correction has been done in revised ms.
5.5. The main reason for the present study In the section of theoretical framework and
is that Cointegration analysis is a better approaches used, we discussed about the
tool than the methodology used in earlier methodology of previous work.
work; especially the problem of spurious
regression. But, there is no discussion on
the methodology of previous work.
6. Methodology This has been cleared in the revised ms.
6.1. The study of the all India level is
based on data for 1970-71 to 2004-05. It is
not clear why regional level study is
restricted to 1980-2005.

48
7. Results and discussions: This has been incorporated in the revised ms
7.1. The findings show that agricultural following the suggestion of the reviewer.
output at the All India level is cointegrated
with only irrigation ratio. But at the
regional level, there is a long run
relationship between agricultural output
and irrigation ratio and between
agricultural output and technology. Since
the All India level is an aggregation of the
regional level data, this should be discussed
in detail.
8. Conclusions: Some explanations have been added in the
8.1. The conclusion of the study is that revised ms.
the "aggregate agricultural output elasticity
with respect to agricultural TOT is very
low and not statistically different from 0".
There is no discussion of why this is so.
The author should give his views on this.
Recommendations:
The paper can be accepted subject the
author addressing the points raised.

49