Assignment-4

Shirishma karki
Case Study on India Shedding tears over Onion Prices

Q.N.1.What factors affected the supply of onions during the period of December 2010 to January 2011?

 During the period of December 2010 to January 2011,There are various factors that affected the supply of onions. These factors ranged from natural
demand and supply forces to man-made forces. Some of the factors are pointed below:

a. Erratic and extended Monsoon in Maharashtra and heavy downpour and prolonged humid climate in Maharashtra further deteriorated the
condition. Untimely heavy shower in Southern India also plays major role that affected the supply.
b. At normal supply situation Government fixed minimum export price above market clearing price and below world price. But government did
not sharply increase the minimum export price as a immediate response to the supply shortage which affected the domestic supply.
c. As onions are perishable goods so it requires special type of structure and huge area for the storage. Due to lack of proper storage facilities
onions are subjected to the excessive postharvest storage losses. On top of that prolonged monsoon and heavy shower made it difficult to
store the onions for longer period of time. Hence, supply became limited in the subsequent months after the harvesting period.
d. Increase in price of onions
e. Supply shortage artificially created by hoarders in anticipation of higher prices in ensuring periods.
f. Fungal Diseases in Maharashtra results in low production of onion. As Maharashtra is largest producer of onions in India low production of
onions affected the supply of onions.
g. Governments' delayed policy response towards the supply shortage about which was reported priorly.

Q.N.2. What factors had affected the demand for onions? Which of these are long –run in nature and which are short- run?
During December 2010 to January 2011 due to the sharp rise in the price of onions the consumer started to reduce the consumption of the onions
which affected the demand in the market. The various factors affected the demand of onions which are of long-run and short run in nature. They are listed
below:

a. Taste and preference: Most Indians are accustomed to taste of the onion and it is used in their food on daily basis. Onions are a popular
ingredient in Indian cooking, and the Indian consumer's taste for onions varies little over time. It is long run in nature.
b. Consumer's Income level: India is one of the world’s fastest growing countries, with an average GDP growth rate of 8 to 9%. Improvements
in income levels of consumer have been causing changes in dietary habits in favor of protein-rich foods, fruits, vegetables, pulses, milk, etc.
Dietary changeshave led to increased consumption of various agricultural products, including onions.Over a brief interval, the aggregate
national income changes little, and onions constitute a relatively small portion of family expenditures in any case; hence changes in income
have little effect on demand of onions.It is long run in nature.
c. Size of population: The population of India is growing rapidly and as a result consumption of commodities including. Onion also increases.
However, population changes are slow and consumption changes are also slow. The slowness of the process of change means there is time to
adjust the market demand and supply. So, it is long run in nature.
d. Seasonality: When it comes to certain seasons the price of onion will increase. December-January is wedding season in India. Major festivals
like Christmas, New Year's Eve and MakarSankrantietc falls in these months. During these festive seasons the demand for onions increases.
It is seasonal increase in demand so it is short run in nature.
e. Expectation: Expectation also played an important role on the demand front. In anticipation of a further rise in the price of onions,
consumers also tried to safeguard their interest by demanding more onions than their normal requirement and storing them. It is short run in
nature.
f. Government Intervention: To increase the export of onions to the international market government fixed minimum export price above the
market clearing price and rise the domestic price . Due to which sellers sold the onions at higher price and consumers have to buy onions at
higher price. This caused the decreases in domestic demand of onions. It is long run in nature.

Q.N.3.What perception have you formed regarding supply and demand curves for onions in the short-run compared to the medium and long-run?
How were these curves affected by the situations depicted in the case, and what was their impact on the market?
 Demand and supply can behave differently in short run and long run. In the market for goods and services, quantity supplied and quantity
demanded are often relatively slow to react to changes in price in the short run, but they react more substantially in the long run.The longer time period
allows for the adjustment. Demand tends to be more price inelastic in short- run as consumers don't have time to find alternatives. In the long-run
consumers become more aware of the alternatives so demand curves tends to be more elastic. Similarly, supply curve is inelastic in short-run and more
elastic in long run. In short-run demand and supply curves are steep. A supply curve is usually upward-sloping, reflecting the willingness of producers to
sell more of the commodity they produce in a market with higher prices. Any change in non-price factors would cause a shift in the supply curve, whereas
changes in the price of the commodity can be traced along a fixed supply curve. A demand curve is almost always downward-sloping, reflecting the
willingness of consumers to purchase more of the commodity at lower price levels. Any change in non-price factors would cause a shift in the demand
curve, whereas changes in the price of the commodity can be traced along a fixed demand curve.

Regarding the supply and demand curves for onions in the short-run demand and supply curves are relatively inelastic. Due to non-availability of
many close substitute of onions and due to Indians being accustomed to the taste of onions and being more depended on the onions for various purpose a
small change in price does not have a large effect on the quantity demanded. Since none of these factors contributes significantly to the demand for
onions, it can be assumed that the consumers' aggregate demand curve does not shift up or down. When the supply of onion fails in short run,supply and
demand of the onions are relatively inelastic. Thus, the supply curve shifts leftwards which results in rise in price of onions substantially.

By contrast, in long run it takes time for consumer to change their consumption habits. Supplier is allowed to adjust its production level. When supply
of onion fails in long run, supply and demand of onions is more elastic. Thus, the same size shift in supply curve causes smaller increase in the price.

It is shown in the figure below:

Q.N.4. Consumer adjusted the demand for onions due to substantial increase in the price of onions. Many households that had been using two
onions a day reduced their consumption to one. Can this adjustment be described as a movement along the demand curve or a shift in the demand
curve?

Movement along demand curve can be defined as graphical representation of change in demand for a commodity due to change in its own price other
things remaining constant. If price changes demand too changes. The change in demand is graphically shown by movement from a point to another point
of same demand curve .Whereas the shift in the demand curve is when a determinant of demand other than price changes. It occurs when demand for
goods and services changes even though the price didn't. The demand curve may shifts to the left and the right. Any changes that raises the quantity that
buyers wish to purchases at any given price shifts the demand curve to the right. Any change that lowers the quantity that buyers wish to purchase at any
given price shifts the demand curve to the left.
 In the above case, consumer adjusted the demand for onions due to substantial increase in the price of onions. There is change in demand of onions due
to the change in the price of the onions remaining other things constant. The consumer reduced the consumption of onions in a day from 2 to 1 due to the
sharp rise in the price of onions. So, this adjustment can be described as a movement along the demand curve. A change in the price of the onions causes
the movement along a specific demand curve, and it typically leads to some change in the quantity demanded, but it does not shift the demand curve. For
shift in demand curve the whole demand curve should move to the right or left resulting from a change in individual income, taste and preferences etc.
The demand curve would be relatively steep, and only big amount of price change could possibly deduct the consumption of onions.

The figure below shows the movement along the demand curve due to the change in price:

Q.N.5 Were speculative activities affecting demand for or supply of onions?

Basically, speculators can take both buyers position and sellers' position in the market. Thus, speculation activities affect both supply and demand of
onions markets.
1. Traders as buyers in the market:
For traders in the buyer's position, if they expect higher price of onions in the future, they will tend to buy immediately, which increases the
demands of onions and shifts the demand curve to the right. On the contrary, the buyers will buy fewer. If they expect the price of the onions to fall
in the future which decreases the demand of onions and shifts the demand curve to the left.
2. Traders as sellers in the market:
As for traders in the suppliers' position, if they expect higher price of onions in the future, they will tend to store onions right now in pursuit
of higher profit in the future, this activity will reduce the supply of onions in market and shift the supply curve to the left. Vice versa, the suppliers
will tend to sell more onions if they expect a decrease in onions price in the future, which increase the supply of onions and shift the supply curve
to right.

In the given case scenario, traders did take the advantage of apparent mismatch of demand and supply. The demand-supply gap, which would have
been minor, was widened by speculative activities and hoarding by intermediaries. In anticipation of a further rise in the price of the onions,
consumers also tried to safeguard their interest by demanding more onions than their normal requirement and storing them. Those families that
usually used only 2kgs of onions in a month bought 5kgs in anticipation of additional increases in onion prices, further accentuating the shortage of
onions in the market.

Q.N.6 What type of market structure do the participants in the onion market face? Justify your answer.
The participants in the onion market operate in close to perfectly competitive markets. Under perfect competitions there are large numbers of
buyers and sellers in the market and all are engaged in the buying and selling of the homogenous products at a single price prevailing in the market.
To the consumer onion is deemed similar whether it has been purchased from seller 1 or seller 2. To the buyer it does not make any difference.
Onions is such product where buyer cannot differentiate in terms of packaging or branding of product. The price is determined by market forces
which is demand and supply. In onion market the firms are free to enter and exit the market. If someone wishes to grow onions it is not something
very difficult to do. There is not too much high barriers of entry to it and similarly there is not too high cost to exit from the market. If someone
wishes to stop producing onions, he may just stop producing it and may be sell off his land or put it to some other alternative use. Since there are
 large numbers of buyers and sellers, individual firms have no control over the prices. Buyers and sellers are price takers instead of price makers.
They have to accept the price determined by the forces of market demand and supply. As a price taker, individual firms in a perfect competition
will sell their product at the equilibrium price. Buyers and sellers are well aware about the prices of onions. So it is concluded that onion market
operate closely to perfect competition market. As we know, Perfect competition market is abstract and theoretical model however onion market
comes closest to exhibiting perfect competitions because it is characterized by many small producers with virtually no ability to alter the selling
prices of the onions.

Q.N.7 Why did the government intervene in the onion market when onion prices registered a sharp rise?

In India onion is considered to be almost an essential item. Onions are part of the even the poorest people meal. So onions played important role in
Indian politics. The sharp rise in the price of onions is considered as politically sensitive issue. The stakeholders were blaming each other for the
situation with no explanation of the created shortage. The sharp rise in onions occurred due to the market inefficiency and mismatch demand and supply
of the onions. So, in order to address the market inefficiency Governments intervene in the onion market. The government tries to combat these inequities
by voluntarily suspending the export the onions in international markets. It also double the minimum export price to discourage the exports of onions and
it also eliminate the import tax on onions. The government intervene in the onion market when onion registered a sharp rise because of the following
reasons:

a. To promote general economic fairness.

b. To maximize total welfare. Due to supply shortage consumer and producer surplus was decreasing which ultimately decreases the total welfare.
c. To correct the market failure.
d. To achieve more equitable distribution of income and wealth.
e. To bring price down to desirable level.
f. As sharp rise in onion is considered as politically sensitive issue which may cause political instability. So in order to prevent political instability
government intervene in onion market.
g. To ensure smooth demand and supply of the onions.
Q.N.8 In January 2011, the government intervened in the onion market to bring prices down to Rs35. Was this an attempt to enforce a price
ceiling or a price floor? How did it clear the market?

During December 2010 to January 2011 the price of onion rises sharply. It was hue and cry over the onion price across the country. The
stakeholders were blaming each other for the situation. When the price rises sharply the government doubled the minimum export price to
discourage the exports. They even voluntarily suspended the exports of onions to the international market.Government also eliminate the import
tax. However, the price ruled steady. To bring price down to desirable level, the government intervened directly in the market by fixing the price at
maximum price of Rs35. It was an attempt to enforce a price ceiling. Price ceiling is a legal maximum on the price at which a good can be sold.
The government ordered NAFED to supply onion at the price of Rs35 which is far below the market prices at that time. It was a binding price
ceiling on the competitive onion market imposed by the Indian government.
Due to the binding price ceiling imposed by government, a shortage of onions arises. Binding price ceiling caused the forces of supply and
demand to move the price towards the equilibrium price, until the market price equals the price ceiling. At this price the quantity of onions
demanded exceeds the quantity supplied which creates the shortage. Market clearing is the state at which quantity supplied is equal to quantity
demanded. Due to the binding price ceiling at Rs 35 imposed by the government it was unable to attend the state of market clearing which results
in shortage of onions. To clear the market the government ended up rationing onions by limiting the supply to 2kg per person at the time of
distribution by the NAFED. As the supply of onions at this price was below the cost of procurement, the government compensate the NAFED for
30% of the losses it was estimated to have incurred by selling onion at cheaper rate.

Q.N. 9 From time to time, the government announces minimum export prices. Do they constitute ceiling or floor prices? Who is expected to
benefit from these prices? Explain using a diagram.
 Minimum export price is the price below which the exporters are not allowed to export any commodity from India. Minimum export price is
imposed to keep a check on internal price rise, sufficient domestic availability and production disruptions. It is a quantitative restriction to trade.
Minimum export price involves fixing price floor below which an exporter shall not sell the product to an overseas customer. So, minimum export
prices constitute floor prices.If the minimum export price is fixed below the world price and above the domestic price then it will be beneficial for
the farmers. It will provide lucrative prices to the farmers and encourage the export of onions and maximizes foreign exchange for the country. It
increases the quantity demand for export.However, it affects the supply in the domestic market. If the minimum export price is fixed above the
world price then it will reduce the demand for export and will be more beneficial for the domestic suppliers.
Before minimum export price sellers are better off and buyers are worse off. Producer surplus is greater than the consumer surplus. After the
imposition of minimum export price consumer surplus increased and producer surplus decreased and the total surplus also increased.
It is further explained in the figure below:
Q.N.10.Who pays the price for the government’s interventions in the onion market?
 When the price rises sharply the government doubled the minimum export price to discourage the exports. They even voluntarily suspended
the exports of onions to the international market. Government also eliminate the import tax. However, the price ruled steady. To bring price down
to desirable level, the government intervened directly in the market by fixing the price at maximum price of Rs35.The government ordered NAFED
to supply onion at the price of Rs35 which is far below the market prices at that time. It was a binding price ceiling on the competitive onion
market imposed by the Indian government. Due to the binding price ceiling at Rs 35 imposed by the government it was unable to attend the state of
market clearing which results in shortage of onions. To clear the market the government ended of rationing onions by limiting the supply to 2kg per
person at the time of distribution by the NAFED. As the supply of onions at this price was below the cost of procurement, the government
compensate the NAFED for 30% of the losses it was estimated to have incurred by selling onion at cheaper rate, implying an increasing on
taxpayers. Price ceiling is always on the favor of the buyers. But shortage of the onions arises and suppliers have to adopt the rationing
mechanism. Rationing mechanism is rarely desirable as it waste buyer's time. Government is also incurring 30% losses. Every stakeholders should
pay price for the government's intervention in the onion market.

Q.N.11 Explain the impact of market forces and the government’s intervention in the form of a price ceiling on the onion market using a
diagram.
To bring price down to desirable level, the government intervened directly in the market by fixing the price at maximum price of Rs35. The
government ordered NAFED to supply onion at the price of Rs35 which is far below the market prices at that time. It was a binding price ceiling
on the competitive onion market imposed by the Indian government. When the government imposed a binding price ceiling on onion market, a
shortage of the onions arises, and the sellers have to ration the scarce onions among the large number of potential buyers. Binding price ceiling
caused the forces of supply and demand to move the price towards the equilibrium price, until the market price equals the price ceiling. At this
price the quantity of onions demanded exceeds the quantity supplied which creates the shortage. So, the the government ended up rationing onions
by limiting the supply to 2kg per person at the time of distribution by the NAFED. The rationing mechanisms that develop under price ceilings are
rarely desirable. Long lines are inefficient because they waste buyer's time. Price ceiling cause deadweight loss to the society.It creates the situation
of black market as the quantity demanded exceeds supplied. The buyers is willing to pay the price a for the commodity above the price ceiling
which results in black market.
It is further explained in the figure below:
Q.N .12.Should the government continue to subsidize onion prices in the event of a large supply shortage or should it incur large investment
expenditures to construct scientific cold storage facilities to provide long-run stability in onion prices?

 Subsidizing onion price in supply shortage is a short run solution for the problem. Government is ready incurring 30% losses, which puts
tremendous burden on tax payers.

Government should think about long term benefits and invest more into infrastructure of cold and more sophisticated storage plants for onions as well as
perishable goods. As in the case pointed out cost for setting up shortage is Rs.6000/- for per mt shortage capacity ( excluding the cost of land ) and
country requires tremendous storage capacity. So, long run solution of supply side problem setting up storage capacity is the most appropriate solution.