Demand, supply and producer’s surplus of agri-commodities: nature and determinants of demand and

supply of farm products

Demand & Supply

Price is derived by the interaction of supply and demand. The resultant market price is dependant upon both of
these fundamental components of a market. An exchange of goods or services will occur whenever buyers and
sellers can agree on a price. When an exchange occurs, the agreed upon price is called the "equilibrium price",
or a "market clearing price" . This can be graphically illustrated as follows: ( Figure 3)

In figure 3, both buyers and sellers are willing to exchange the

quantity "Q" at the price "P". At this point supply and demand are in
balance or "equilibrium". At any price below P, the quantity
demanded is greater than the quantity supplied. In this situation
consumers would be anxious to acquire product the producer is
unwilling to supply resulting in a product shortage. In order to ration
the shortage consumers would have to pay a higher price in order to
get the product they want; while producers would demand a higher
price in order to bring more product on to the market. The end result
is a rise in prices to the point P, where supply and demand are once
again in balance. Conversely, if prices were to rise above P, the
market would be in surplus - too much supply relative to the
demand. Producers would have to lower their prices in order to clear
the market of excess supplies. Consumers would be induced by the
lower prices to increase their purchases. Prices will fall until supply
and demand are again in equilibrium at point P.

A market price is not a fair price to all participants in the marketplace. It does not guarantee total satisfaction on
the part of both buyer and seller or all buyers and all sellers. This will depend on their individual competitive
positions within the market. Buyers will attempt to maximize their individual well being within certain
competitive constraints. Too low a price will result in excess profits for the buyer attracting competition.
Likewise sellers are also considered to be profit maximizers. Too high a price will likewise attract additional
producer competition within the market. Therefore, there will exist different price levels where individual
buyers and sellers are satisfied and the sum total will create a market or equilibrium price.

When either demand or supply changes, the equilibrium price will

change. For example, good weather normally increases the supply of
grains and oilseeds, with more product being made available over a
range of prices. With no increase in the quantity of product
demanded, there will be movement along the demand curve to a new
equilibrium price in order to clear the excess supplies off the market.
Consumers will buy more but only at a lower price. This can be
illustrated graphically as follows: (see Figure 4.)

Likewise a shift in demand due to changing consumer preferences

will also influence the market price. In recent years there has been a
shift in demand on the part of overseas Canadian wheat buyers
toward the Canada Prairie Spring varieties, away from the Hard Red
Spring varieties. A decline in the preference for Hard Red Spring
wheat shifts the demand curve inward, to the left, as illustrated in
figure 5.
With no reduction in supply, the effect on price results from a movement along the supply curve to a lower
equilibrium price where supply and demand is once again in balance. In order for prices to increase producers
will have to reduce the quantity of hard red spring wheat brought to the market place or find new sources of
demand to replace the consumers who withdrew from the marketplace due to changing preferences or a shift in
demand.

Changes in supply and demand can be short run or long run in

nature. Weather tends to influence market prices generally in the
short run. Changes in consumer preferences can have either a short
run or long run effect on prices depending upon the goods or
services, for example whether they are luxuries or necessities. A
luxury good may enjoy a short term shift in demand due to changing
styles or snob appeal while necessities tend to have stable or long
run demand curves. Another major factor influencing market prices
is technology. A major effect of technology in agriculture is to shift
out the supply curve rapidly by reducing the costs of production on a
per unit basis. At the same time if total demand does not increase
sufficiently to absorb the excess goods produced at lower costs, the
long run impact of technology on the market place will be to lower
prices. The rapidly shifting supply curve coupled with a slower
moving demand curve has generally contributed to lower prices for
agricultural output when compared to prices for industrial products.

What is a Surplus?

A surplus is the amount of an asset or resource that exceeds the portion that is utilized. A surplus is used to
describe many excess assets including income, profits, capital, and goods. A surplus often occurs in a budget,
when expenses are less than the income taken in or in inventory when fewer supplies are used than were
retained. Economic surplus is related to supply and demand.
A surplus isn't always a positive outcome. In some cases, when a manufacturer anticipates a high demand for a
product that it produces and makes more than it sells during that time period, it can have a surplus inventory
which may, if it's deep enough, lead to a financial loss for that quarter or year. When the surplus is of a
perishable commodity, such as grain, it could result in a permanent loss.

An economic surplus is also known as total welfare. An economic surplus is related to money, and it reflects a
gain in the expected income from a product. There are two types of economic surplus: consumer surplus and
producer surplus.

Consumer surplus occurs when the price for a product or service is lower than the highest price the consumer
would pay. For example, think of it as an auction: a buyer walks into an auction with a set price limit he or she
will not exceed. Consumer surplus occurs if the buyer is able to purchase the product at a lower cost than this
limit, which is seen as a gain. An example of consumer surplus in business and the global economy is oil prices
- as the price per barrel drops below what the consumer is used to paying, the consumer profits with a surplus.

Producer surplus occurs when goods are sold at a higher price than the lowest price the producer was willing
to sell for. In the same auction context, an auction house or auctioneer might set a low price for an item and start
the bidding there, a price the house is not willing to go below. Producer surplus occurs if the auctioneer sells an
item for a higher price than this low limit; for example, if buyers continue to bid for an item, raising the price
until it is finally sold. This means the producer is making more money than expected.

Definition:  Producer surplus is defined as the difference between the amount the producer is willing to supply
goods for and the actual amount received by him when he makes the trade. Producer surplus is a measure of
producer welfare. It is shown graphically as the area above the supply curve and below the equilibrium price.
Here the producer surplus is shown in gray. As the price increases, the incentive for producing more goods
increases, thereby increases the producer surplus.

Description: A producer always tries to increase his producer surplus by trying to sell more and more at higher
prices. However, it is simply not possible to increase the producer surplus indefinitely since at higher prices
there might be very little or no demand for goods.

Example of Producer Surplus

Say a producer is willing to sell 500 widgets at $5 each and consumers are willing to purchase these widgets for
$8 each. If the producer sells all of the widgets to consumers for $8, it receives $4,000. To calculate the
producer surplus, subtract the amount the producer received by the minimal amount it was willing to accept, in
this case, $2,500. The producer surplus is $1,500, or $4,000 - $2,500. It is not static and may increase or
decrease as the market price increases or decreases.
Demand & Supply
This page reviews the basic economic concepts of demand and supply. The
discussion also challenges us to consider how these basic economic concepts
relate to agriculture and how they can help managers in their decision making.

The previous discussion emphasized the trend of advancing technologies:  production, information/communication and
transportation technologies.  The discussion also addressed increasing consumer income and suggested that the increase in
consumer income is a result of advancing technology (the technology that consumers use in their careers/industries).  The
following paragraphs reviews the determinants of demand and supply, price and market.  The discussion then turns to the
implications and opportunities due to trends in technology.

Demand and Supply

In a market where price is not controlled, market price for a product or service is determined by the interaction
of demand and supply; that is, the consumers' willingness and ability to buy the product, and the sellers' willingness and ability
to produce and sell the product.  The next several sections review these two basic economic concepts.
.
Determinants of Demand

The level of demand for a product is determined by the following factors:

 Consumer tastes and preferences -- is the consumer interested in Product A or Product B.

 For example, will the consumer prefer a food product wherein the consumer can identify who, where, and how
the underlying agricultural commodities were produced, or will the consumer be satisfied with a food product without
knowing who, where or how it was produced?

 Number of buyers in the market

 An increased number of interested buyers or consumers will lead to an increased demand for the product.

 What is the market?  Does the market include all persons in the world or only those who can effectively buy the
product? What impact do advances in information and transportation technologies have on the number of buyers in
the market?

 Consumer income
 Will an increase in the consumer's income lead to more consumption of the product (then the product would be
considered a normal product) or less consumption of the product (then the product would be considered
an inferior product)?
 What might cause a consumer's income to increase?  Note that this question assumes the consumer also is a
producer and that production and sales generates the income with which this individual can then consume.

 Increased productivity due to advancing production technology?

 Increased productivity due to learning about the availability and application of production technology? 
  Increased price for the product the consumer is producing?  More people are buying the product the
consumer is producing thereby generating more income for this consumer to spend on other consumer
products?

 Price of related goods, such as substitutes, complements, or independent (with no impact)

 For example, as the price of fuel rises, I am less interested in buying a vehicle that has low-gas mileage. Fuel
complements the vehicle and a rising fuel price diminishes my demand for a vehicle that gets few miles to a gallon
and increases my interest in (demand for) a vehicle that gets better gas mileage. In this example,
fuel complements a vehicle.
 Another example:  "As the price of labor increases, I am less interested in hiring additional workers and more
willing to invest in equipment that reduces the number needed workers." My demand for equipment increases while
my demand (quantity demanded?) for labor decreases as a result of increasing labor costs. In this example,
equipment is a substitute for labor.
 Does information and transportation technology increase the number of substitute products that consumers can
consider?

 Consumer expectations of the future

 For example, buy more now if I think the increase in the price of this non-perishable product will be greater than
the cost of storing the product.

 Another example:  "I will not replace my computer now even though it is getting old; I expect that information
technology (IT) will continue to advance thereby lowering costs of future IT equipment . Accordingly, I will use my
current computer that is adequate for now and plan to replace it with a computer in the future that has even more
capability than the computer currently on the market." This expectation about IT lowers demand for computers that
are currently on the market and raises demand for future computers."

Determinants of Supply

The level of supply for a product or service is determined by the following factors.

 Resource or input costs

 For example:  an increase in the cost of livestock feed will cause me to sell the livestock at an earlier time and
at a lower weight thereby reducing my output of "pounds of livestock."

 Production technology
 An advance in the technology used to produce a product will lead to an increase in the production of that
product; as food processing became more automated,

 What impact is production technology having on the quantity of the goods available in your market?

 Taxes and subsidies

 A supplier will reduce production if the cost of production rises as the result of a tax or other government-
imposed cost on the production process
  A supplier will increase production if a government program subsidizes the producer's income or otherwise
pays a portion of the supplier's production cost.

 Price of other goods the supplier could produce

 How does this relate to opportunity cost?

 Supplier's expectation about the future

 Expectation about future price of product, which reflects expectations about future demand and future supply of
the product.

 How might the supplier's expectation about future communication and transportation technologies
influence the supplier's concept of future prices?

 Expectation about total cost of production which reflects expectations about future cost of inputs and future
production technology.

 Number of sellers/suppliers in your market

 What impact is information and transportation technology having on the number of sellers in your market?

An increase in the demand for your product without an increase in supply will lead to a higher market price for your product.

An increase in supply of your product without an increase in demand will lead to a lower market price for your product.

What can a business owner do to influence demand or supply?  How do these strategies relate to the topics discussed in
the  changing agriculture  industry?  How do these strategies relate to the topics discussed in  managing  a business?
 
Relationship between Determinants and Market Price

It is important to distinguish between "change in demand" and "change in quantity demanded," and to distinguish between
"change in supply" and "change in quantity supplied."

A "change in demand" or a "change in supply" means one of the determinants of demand or supply has changed. This shift in
the demand or supply will lead to a change in the market price.

A "change in the quantity demanded" or a "change in the quantity supplied" means the consumers or producers are responding
to a change in the market price. For example, a change in consumer preferences (a determinant of demand) will cause a
"change in demand." This will impact the market price for the product. In response to the difference market price, producers will
alter the amount they produce; that is, a "change in quantity supplied."

Note the distinction between these four concepts (change in demand, change in supply, change in the quantity demanded, and
change in the quantity supplied) as well as their relationships.

 
Defining the Product Market

When applying the concepts of demand and supply to a situation, carefully define the market being analyzed. For example, the
market for a renewable fuel is different than the market for the vehicles that will use the fuel, and the market for the crop that will
be used to produce the fuel.  These are three distinct markerts with three distinct supply and demand relationships, and three
distinct sets of determinants of supply and demand.

However, there will be relationships among the markets; for example, the supply of vehicles that use renewable bio-based fuels
will impact the demand for the fuel; that is, as the supply of the vehicles increase, the price for the vehicle should decrease thus
causing the demand for the fuel to increase. Restated, the price of the vehicle (a related product) is a determinant of demand for
the fuel. The vehicle and fuel are distinct markets, but they are related and thus influence one another.

A market can also be defined by time; for example, what is the demand and supply for a product during June and what is the
demand and supply for that product December.

It is critical that the "market" be carefully defined, otherwise, there is a risk that the analysis will be confused and incorrect.

Impact of Technology

Several determinants of demand and supply are impacted by production, communication and transportation technologies.  As
these technologies continue to advance, what can we expect will be the impact on demand and supply within many of our
product markets and our geographic markets?

The focus of this page is on relating the trend of advancing technologies to the "implications" of those advances.  The
relationship is discussed in terms of determinants of demand and supply.  Some of the implications may be viewed as negative,
while other implications maybe considered positive.

Opportunities due to the Trends in Agriculture

The trends in agriculture, to a large extent, are the result of advancing technologies.  These may be best understood if
addressed in terms of determinants of supply.

 Production technology -- more output is produced, that is, the supply is increased and there is a downward pressure on
market price as long as the demand for the product is not increasing.

 Information technology -- suppliers can learn about the interest (demand?) of more consumers; consumers can learn
about the availability of additional products.

 Transportation technology -- combining an awareness of potential buyers with the ability to deliver to them, producers
begin to recognize an opportunity for additional demand. Thus information and transportation technologies have added
 consumers to the producer's market.  Consumers can use a similar combination of information and transportation to
increase the number of suppliers they can access.

Producers who have added consumers feel good. Other producers who had been serving those consumers in the past now feel
there are more suppliers in their market (and there are).  These producers who are now competing with new producers would
consider this change to be negative.  But is this second group of producers willing to try attracting consumers from new markets
as well?

Similarly, consumers who now have to compete with additional consumers for the same products may be frustrating, but can
these consumers now enter other markets as well?