Agricultural Marketing For 4th Agricultural Economics Students

CHAPTER THREE
Agricultural Product Prices
Price
Price refers to the amount of money charged for a product or service, or the sum of the values
that consumers exchange for the benefits of having or using the product or service. Price of
products are important variables in the product mixes. Traditionally price has operated as the
major determinants of buyer choices. This is still the case in poorer nations and with commodity-
type products. When you see something attractive, you will be interested to know its price. As
you remember from microeconomics course, price is probably the first and most important
determinant of demand from consumers’ viewpoint. From consumers’ side, price represents
consumers’ cost. Conversely, price is important variable for the firm as it is the main determinant
of the firm’s revenue. A consumer buys a product if she expects to derive satisfaction that is
equal to the cost of appropriating the product. Price is also one of the most flexible elements of
the marketing mix. Unlike product features and channel commitments, price can be changed very
quickly. At the same time, pricing and price competition is the number-one problem facing many
marketers.
Although non-price factors have become more important in recent decades, price still remains
one of the most important elements in determining market share and profitability of firms.
Nevertheless, many manufacturing firms do not handle pricing well as they make some common
mistakes because, pricing is too cost-oriented; price is not revised often to capitalize on market
changes; price is set independent of the rest of the marketing mix rather than as an intrinsic
element of market. It is not also varied enough for different product items, market segments,
distribution channels, and purchase occasions.
Cost - oriented Pricing Method
Markup Pricing
Some firms including most retailers and wholesalers - set prices by using a markup - a dollar
amount added to the cost of products to get the selling price. For example consider that a retail
shop buys a kilo of sugar for 4.50 Birr from Metahara Sugar Factory. To make a profit, the retail
shop obviously must sell the sugar for more than 4.50 Birr. If it adds 50 cents to cover operating
expenses and provide a profit, we say that the retail shop is marking up the item 50 cents.

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 Agricultural Marketing For 4th Agricultural Economics Students

Markups, however, usually are stated as a percentages rather than dollar or Birr amounts.
Markup means percentage of selling price that is added to the cost to get the selling price. Thus,
the markup for the above item can be calculated as:

Markup

For the above example;

Selling price (revenue) = 5.00 Birr

Buying price (cost) = 4.50 Birr

( 5 . 00 − 4 .50 )
x 100 %
Markup = 5.0

0. 50
x 100%
= 5.0
= 10 %
Deciding the level of the markup
Many middlemen select a standard markup percent and then apply it to all their products. This
makes pricing easier. Sometimes if the firm is selling a number of products, spending time to
find the best price for each item in stock might not pay. The easiest way is to develop a standard
markup which is sufficient to cover the firm’s operating expenses and provide a reasonable
profit. But what is the basis for setting this standard markup?
A standard markup is related to gross margin - it is usually set close to the firm’s gross margin. It
is also important to study the markups at different levels in the marketing channel. Different
firms in a channel often use different markups.
A markup chain - the sequence of markups firms use at different levels in a channel - determines
the price structure in the whole channel.
For example, the farmer’s selling price of wheat grain becomes the cost for a flourmill firm. The
flourmill’s selling price of wheat flour becomes a baker’s cost. The Baker’s selling price of bread
to a retail shops becomes the retailer’s cost. And this cost plus a retail markup becomes the retail
selling price of bread to final consumer. Each markup should cover the costs of running the
business and leave a profit.

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 Agricultural Marketing For 4th Agricultural Economics Students

Selling price to Selling price of one Selling price of bread Selling price
flourmill quintal of wheat flour that uses quintal of
120 Birr = 100% 150 Birr = 100% flour 200 Birr = 100% 250 Birr = 100%

Markup - 15 Birr = Markups - 30Birr = Markup - 50 Birr = Markup - 50 Birr

12.5 % 20% 25% = 20%

Cost of producing one Cost of one quintal of Retailer cost of

Cost of one quintal of
quintal of wheat wheat 120 Birr = bread 200 Birr
flour 150 Birr = 75%
105 Birr = 87.5% 80% = 80%

Farmer flourmill Baker Retailer

Markups and Profits

Some people including many traditional retailers think high markups means big profits. Often
this is not true. A high markup may result in a price that is too high - a price at which few
customers will buy. And you cannot earn much if you do not sell much - no matter how high
your markup. But many retailers and wholesalers seem more concerned with the size of their
markup on a single item than with their total profit. And their high markups may lead to low
profit - or even losses.

Some retailers and wholesalers, however, try to speed turnover to increase profit even if this
means reducing their markups. They realize that a business runs up costs over time. If they can
sell a much greater amount in the same time period, they may be able to take a lower markup and
still earn higher profits at the end of the period.

An important idea here is the stock turn rate - the number of times the average inventory is sold
in a year. The higher the stock turn rate the higher will be the total profits at the end of the year
even if the markup may be lower.

For example a firm (Firm A) that sells a 100,000 Birr value of items with stock-turn rate of say 2
- two times a year – requires 50,000 Birr worth of inventory. Another equivalent firm (Firm B)
with this 50,000 Birr may attain a stock-turn rate of say 5, if that firm reduces its markups. This

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means the later firm can sell a 250000 Birr value per annum. Assume further firm A has a
markup (gross profit) of 20 cents from each one Birr sales revenue while firm B has 15 cents.
The total gross profit of firm A will then be 20,000 Birr (0.2x100, 000) per annum but it will be
37500 Birr per annum for that of firm B. Thus, by reducing markups and hence prices of
products, it is possible to maximize sales revenue and be able to increase total profits.

Reducing markups to increase profit works especially if reducing price increases percentage
sales by more than the reduced percentage price. In other words, total revenue increases when
price declines if the price elasticity of demand of the item under consideration is elastic. That is
the percentage increase in quantity sold is greater than the percentage decline in price. In the
above example, firm B by reducing price by 25% (from 20 cents to 15 cents) is able to increase
its sales revenue by 150% (from 100,000 Birr to 250,000 Birr revenue).
Average cost Pricing

Average cost pricing means adding a reasonable markup to the average cost of a product. A
manager usually finds the average cost per unit by studying past records. Dividing the total cost
for the last year by all the units produced and sold in that period gives an estimate of the average
cost (the cost per unit output) for the next year.

Total fixed cost - is the sum of those costs that are fixed in total no matter how much is
produced. Among these fixed costs are rent, depreciation, managers’ salaries, property taxes and
insurance. Such costs stay the same even if production stops temporarily. Fixed costs do not vary
with the amounts of output.

Total variable cost - on the other hand is the sum of those changing expenses that are closely
related to output - expenses for raw materials, packaging materials, labor costs, sales
communications, etc. At zero output level, total variable cost is zero. As output increases, so do
variable costs.

Total cost - is the sum of total fixed and total variable costs. Changes in total cost depend on
variations in total variable cost since total fixed cost stays the same. The pricing manager usually
is more interested in cost per unit than total cost because prices are usually quoted per unit.

For example a company incurred the following costs last year.

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 Agricultural Marketing For 4th Agricultural Economics Students

Total Fixed overhead expenses (FC) -------------- 30000

Total Labor and material expenses (VC) --------- 32000

Total costs (TC) -------------------- 62000

Average cost (per unit cost) - is obtained by dividing total cost by the related quantity (that is the
quantity that causes the total cost).

AC =
AC - average cost
TC - total cost (fixed cost plus variable cost)

Average fixed cost (per unit fixed cost) - is obtained by dividing total fixed cost by the related
quantity.

Average variable cost (per unit variable cost) - is obtained by dividing total variable cost by the
related quantity.

If the company produced 40,000 items in that time period the average cost is 62,000 divided by
40,000 units or 1.55 Birr per unit.

Q - total quantity sold = 40000

AC = or

To get the price, the firm decides how much profit per unit to add to the average cost per unit. If
the firm considers 45 cents a reasonable profit for each unit, it sets its price at 2.00 Birr.

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 Agricultural Marketing For 4th Agricultural Economics Students

Accordingly if the firm sells, say, 40000 units in the next period too the total profit will be 18000
Birr.

Average cost pricing is simple. But it can also be dangerous. It is easy to lose money with
average cost pricing. For instance in the above example if the firm sells only 20000 Birr, the
average cost can be calculated as follows:

Total Fixed cost --------------------------------- 30000

Total Variable Cost ------------------------------ 16000

Total cost ------------------------------------------ 46000

Average cost will then be

AC =

It the firm continues to sell its product for 2.00 Birr assuming that the average cost is just 1.55
Birr per unit, the firm will lose 30 cents from each unit sold and will incur a total lose of 6,000
Birr.

The basic problem with the average cost pricing approach is that it does not consider cost
variations at different levels of output. But, average costs may decline or increase as the level of
output increases. Therefore, it is important to develop a better understanding of the different
types of costs a marketing manager should consider when setting a price. If a firm’s marketing
department develops the cost function of the firm, it can efficiently use Average Cost Pricing.
Break-even Pricing

Another method considered in setting price is break-even pricing. This pricing system is
sometimes called target profit pricing. Break-even analysis evaluates whether the firm will be
able to break-even - that is cover all its costs - with a particular price. This is important because a
firm must cover all costs in the long run or there is not much point being in business. Break-even
point is the level of quantity at which the firm’s total cost will just be equal to its total revenue.
In other words, it is that quantity that makes profits zero. Break- even pricing is setting price to

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 Agricultural Marketing For 4th Agricultural Economics Students

break even on the costs of making and marketing a product, or setting price to a make a target
profit.

As shown in Figure 2.2, the TFC is constant at 20,000 Birr irrespective of the level of output i.e.,
whether the firm produces nothing or produces 100 tons; the total fixed cost remains the same. It
is horizontal line and will remain so as long as the firm does not increase or reduce its scale or
size.

TR
Total cost and total revenue (in thousands)

TC

Profit area
45

30 Break – even point

20 TFC

10 Loss area

80
Quantity of output

Figure 2.2 Break – even point

Total cost, however, varies with the level of output. When the output is zero, variable cost is zero
and total cost is equal to total fixed cost. But at any other output levels, the total cost grows with
the level of output. In the above example, the total cost is assumed to be straight line. That is the
total cost increases by a constant amount for each additional unit of output which can be
measured by the slope of the total cost curve.

The total revenue (TR) curve is also assumed to be straight line and it will be so in reality as long
as the firm sells its product at constant price. Thus, the total revenue curve is upward slopping
and is straight line. The total revenue curve will be more flat if the selling price is lower and will
be steeper when the selling price rises. The difference between the total revenue and total cost at

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a given quantity is the profit or loss. If total cost lies above total revenue curve, the firm incurs a
loss. The firm will make a profit if the total revenue lies above the total cost curve. However, the
firm would be at break – even point, if it could sell 80 tones. At this point TR just equals TC. It
is a point where TR curve intersects TC curve. The point gives us the breakeven TC, TR and
quantity of output. The breakeven price can be calculated by dividing TR by that breakeven
quantity.

The graphical presentation of break-even point is helpful to understand the idea. How can we
compute break-even point? The break-even point, in units can be found by dividing total fixed
costs (TFC) by the fixed cost contribution per unit the assumed selling price minus the average
variable cost (AVC).

The derivation break-even point is as follows:

Breakeven point is the point where Total Revenue (TR) is just equal to total cost (TC).

TR = TC or; (1)

It is a point where the difference between TC and TR is zero.

TR – TC = O

Total revenue is equal to quantity of output sold (Q) times price of output (PQ)

TR = (2)

Total cost is the summation of Total Fixed Cost and Total Variable Cost

TC = TFC + TVC (3)

As mentioned previously Average Variable Cost (AVC) is total variable divided by total output.

Thus, TVC can be expressed as

TVC = (4)

Substituting equation (4) in equation (3), the total cost will be expressed as

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 Agricultural Marketing For 4th Agricultural Economics Students

TC = TFC + AVC x Q (5)

Substituting equation (5) in to equation (1) gives the condition at break-even

TR = TFC + AVC x Q

Substituting in place of TR

Solving for Q to obtain break-even quantity

PQ x Q – AVC x Q = TFC

Q (PQ – AVC) = TFC

TFC
Qb=
PQ − AVC

Qb is break-even quantity which is the ratio of total fixed cost to the contribution of fixed cost
per unit.

(PQ – AVC) is the per unit contribution of the fixed cost

It is the unit contribution of fixed cost because if the item is sold at price (P Q) and incurred a unit
variable cost (AVC), the difference is what is left after the unit variable cost is paid which is the
unit contribution of the fixed cost. When we divide this per unit contribution of the fixed cost
into the total fixed costs that must be covered, we have the break-even quantity.

To illustrate the formula, let us assume that the average variable cost per unit is 80 cents and the
price per unit is 1.2 Birr. If the total fixed cost is 30,000 Birr, the break-even output will then be:

30000
Qb = = 75000 unit
0.4

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From this you can see that if the firm sells 75000 units, it will exactly cover all its fixed and
variable costs. If it sells even one more unit, it will begin to show a profit - in this case, 40 cents
per units - because all the fixed costs are already covered and the part of revenue formerly going
to cover fixed costs is now all profit.

If we multiply the break even quantity - 75000 units - by the unit selling price (1.20 Birr), we get
90000 Birr - the break-even revenue or cost. The importance of computing the break-even
quantity is that we can accept the proposed price if it is possible to sell sufficiently large quantity
that exceeds the break-even quantity. This is because, as mentioned above, any more sells
beyond the break-even quantity increases profit (assuming both the TR and the TC curves are
linear). If the break-even quantity, however is above the existing demand the manager must
reject the proposed price because any less realized sells below the break-even quantity incur a
loss. It is often useful therefore, to compute break-even quantity for each of several possible
prices and compare the quantity for each price to the likely demand at the price.

So far in our discussion of break-even point, we have focused on the quantity at which total
revenue equals total cost - where profit is zero. We can also vary this approach to see what
quantity is required to earn a certain level of profit. The analysis is the same as described above
for the break-even quantity, but the amount of target profit is added to the total fixed cost. Then,
when we divide the total fixed cost plus profit figure by the contribution from each unit, we get
the quantity that will earn the target profit.

Let us assume the firm sets a target profit of П. Then

π =TR−TC

In the previous sections, we have

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 Agricultural Marketing For 4th Agricultural Economics Students

If in the previous example, the firm sets a target profit of say 10,000 Birr, the quantity that will
have to be sold to meet the target profit will then be:

TFC = 30000 Birr

PQ = 1.20 Birr

AVC = 0.80 Birr

The firm can then assess the market situation to make sure that it is possible to sell 100,000 units
at the targeted price of 1.20 Birr to achieve the targeted profit.

Example

Suppose a firm incurs an average variable cost of 5 Birr. The total fixed cost is equal to 60,000
Birr. The firm wants to produce output 90,000 units. What price the firm should set to get the
targeted profits of 12,000 Birr.

The firm can meet the targeted objective of earning 12,000 Birr if it is able to sell its output at a
price of 5.8 Birr. It is important to note here the assumption behind the stated break – even
analysis. The analysis presupposes that the firm can sell any quantity at the specified price. That
is, it is implicitly assumed that the firm faces a perfectly horizontal demand curve at that
particular price. It also assumes that the average variable cost is constant at any particular level
of output. In other words, whether the firm sells 10 units or 100,000 units, the average variable
cost remains constant at 80 cents.

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Demand and Supply Analysis of Farm Products

Definition and determinates of demand
3.2 Demand
Quantity demanded refers to the amount that consumers are willing and able to purchase at a
given price over a given period (e.g. a week, or a month, or a year). They do not refer to what
people would simply like to consume.
- The demand for products & services is a central issue in the study of economics. It is
important to distinguish b/n demand & effective demand. Demand represents the desire
to engage in a certain activity or to purchase a given good or service. Effective demand
couples that concept with the ability to pay for such goods & services. E.g. we may all
want a jaguar car, but not all of us can afford to pay for it.
- A large no of factors can cause changes in demand. Generally such factors can be
grouped as follows:
1. A Δ in population (providing the per capita purchasing power remains unchanged).
2. A Δ in the incomes or purchasing power of people.
3. A Δ in the tastes & preferences for particular products.
4. A Δ in the relative costs of products w/c are substitute for each other.
5. A Δ in the expectation of buyers as to the future levels of prices.
 The 1st two factors would generally either increase or decrease the demands for all
products
 The next two factors would largely affect shifts in demand among individual
commodities.
 The last factor could affect either the general or the specific demand situations.
The relationship between demand and price
Law of demand The quantity of a good demanded per period of time will fall as price rises and
will rise as price falls, other things being equal (ceteris paribus).
 People will feel poorer. They will not be able to afford to buy so much of the good with
their money. The purchasing power of their income (their real income) has fallen. This is
called the income effect of a price rise.
 The good will now cost more than alternative or ‘substitute’ goods, and people will
switch to these. This is called the substitution effect of a price rise.

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The demand curve

Consider the hypothetical data in Table 2.1, which shows how many kilograms of potatoes per
month would be purchased at various prices. Columns (2) and (3) show the demand schedules
for two individuals, Tracey and Darren. Column (4) by contrast, shows the total market demand
schedule. This is the total demand by all consumers. To obtain the market demand schedule for
potatoes, we simply add up the quantities demanded at each price by all consumers: i.e. Tracey,
Darren and everyone else who demands potatoes.
Table 2.1 The demand for potatoes (monthly)

NB Demand schedule for an individual A table showing the different quantities of a good that
a person is willing and able to buy at various prices over a given period of time.
Market demand schedule A table showing the different total quantities of a good that
consumers are willing and able to buy at various prices over a given period of time.
The demand schedule can be represented graphically as a demand curve. Demand curve is
graph showing the relationship between the price of a good and the quantity of the good
demanded over a given time period. Price is measured on the vertical axis; quantity demanded is
measured on the horizontal axis. A demand curve can be for an individual consumer or group of
consumers, or more usually for the whole market. It slopes downward from left to right: they
have negative slope. This indicate the lower the price of the product, the more is the person
likely to buy.
Figure 2.1 shows the market demand curve for potatoes corresponding to the schedule in Table
2.1. Point E shows that at a price of 100p per kilo, 100 000 tonnes of potatoes are demanded each
month. When the price falls to 80p we move down the curve to point D. This shows that the
quantity demanded has now risen to 200 000 tonnes per month. Similarly, if the price falls to 60p

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we move down the curve again to point C: 350 000 tonnes are now demanded. The five points on
the graph (A–E) correspond to the figures in columns (1) and (4) of Table 2.1.
P ric e (p e n c e p e r k g )

Market demand for potatoes (monthly)

E
100

D
80

C
60

B
40

A
20
Demand

0
0 100 200 300 400 500 600 700 800
Quantity (tonnes: 000s)

Fig 2.1 Market demand for potatos (monthly)

Other determinants of demand
Price is not the only factor that determines how much of a good people will buy. Demand is also
affected by the following.
Tastes: the more desirable people find the good, the more they will demand. Tastes are affected
by advertising, by fashion, by observing other consumers, by considerations of health and by the
experiences from consuming the good on previous occasions.
The number and price of substitute goods (i.e. competitive goods or goods considered by
consumers to be alternatives to each other e.g. Coffee & Tea): the higher the price of substitute
goods, the higher will be the demand for this good as people switch from the substitutes.
The number and price of complementary goods. Complementary goods are those that are
consumed together: cars and petrol, shoes and polish. The higher the price of complementary
goods, the fewer of them will be bought and hence the less will be the demand for this good.
Income. As people’s incomes rise, their demand for most goods will rise. Such goods are called
normal goods. There are exceptions to this general rule, however. As people get richer, they
spend less on inferior goods, such as cheap margarine, and switch to better quality goods. N.B
Normal goods Goods whose demand increases as consumer incomes increase. Inferior goods
Goods whose demand decreases as consumer incomes increase.

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Distribution of income. If national income were redistributed from the poor to the rich, the
demand for luxury goods would rise. At the same time, as the poor got poorer they might have to
turn to buying inferior goods, whose demand would thus rise too.
Expectations of future price changes. If people think that prices are going to rise in the future,
they are likely to buy more now before the price does go up.
Movements along and shifts in the demand curve
A demand curve is constructed on the assumption that ‘other things remain equal’ (ceteris
paribus). In other words, it is assumed that none of the determinants of demand, other than price,
changes. The effect of a change in price is then simply illustrated by a movement along the
demand curve: for example, from point B to point D in Figure 2.1 when the price of potatoes
rises from 40p to 80p per kilo.

What happens, then, when one of these other determinants does change? The answer is that we
have to construct a whole new demand curve: the curve shifts. If a change in one of the other
determinants causes demand to rise – say, income rises – the whole curve will shift to the right.
This shows that at each price more will be demanded than before. Thus in Figure 2.2 at a price of
P, a quantity of Qo was originally demanded. But now, after the increase in demand, Q1 is
demanded. (Note that D1 is not necessarily parallel to D0.) If a change in a determinant other than
price causes demand to fall, the whole curve will shift to the left.

An increase in demand

P
P r ic e

D0 D1

O Q0 Q1
Quantity

Fig 2.2 shift in demand curve

To distinguish between shifts in and movements along demand curves, it is usual to distinguish
between a change in demand and a change in the quantity demanded. A shift in the demand

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curve is referred to as a change in demand, whereas a movement along the demand curve as a
result of a change in price is referred to as a change in the quantity demanded.
Demand function
We can represent the relationship between the market demand for a good and the determinants of
demand in the form of an equation. This is called a demand function. It can be expressed either
in general terms or with specific values attached to the determinants.
Simple demand functions. Demand equations are often used to relate quantity demanded to just
one determinant. Thus an equation relating quantity demanded to price could be in the form:
Qd a bP………………………………… (1)
For example, the actual equation might be: Qd 10 000 200P
More complex demand functions. In a similar way, we can relate the quantity demanded to two
or more determinants. For example, a demand function could be of the form:
Qd a bP cY dPs ePc………………………………….. (2)
Where Qd = quantity demanded
p = price of the good
Y= income
Ps= price of substitute good
Pc= price of complement
Demand Elasticties
- Demand elasticity is a central concept in the analysis of market. Elasticity is the %age in
one variable given a %age change in another variable. E.g. the own- price elasticity is
the %age change in the quantity demanded given a %age change in own price.
Percentage change in quantity demanded
Price elasticity of demand = ---------------------------------------- = ∆Qx P1
Percentage change in price ∆P Q1

The price elasticity of demand tells us the percentage change in quantity demanded resulting
from a 1% change in price. Price elasticity is usually expressed in positive or absolute values.

E.g. The original price (P1) and Quantity demanded (Q1) of a given product were 5br/kg and 20
kg respectively. As a result of the increment of the price from 5br/kg to 10 br/kg, the demand has
declined to 15 kg. So the price elasticity of demand (Ed) for the above case is given as

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∆Qx P1 =5x5 = 25 = 0.25

∆P Q1 5x20 100

So according to our result, for every 1% change in price, there is a 25% change (decline) in
quantity demanded. When the price elasticity of demand is greater than 1, demand is said to be
elastic. That is, consumers respond a lot to a price change. When the price elasticity of demand is
equal to 1, demand is unit elastic. That is, for every increment in the price, there is an equal and
opposite change in quantity demanded. When the price elasticity of demand is less than 1,
demand is inelastic and this shows that consumers do not respond much to a change in price.

Determinants of Price Elasticity of Demand; - There can be many factors that influence the
price elasticity of demand. But the major factors are

1. Existence of substitutes: the more substitutes available for a product, the more elastic is
its demand
2. Nature of the product: the demand for luxuries is relatively elastic as compared with
that of necessities
3. Importance of the product in the consumer's total budget: the greater the portion of
the consumer's budget to a product, the more elastic is the demand for that product.

Price elasticity of demand and Total Revenue

Total revenue (TR) is equal to price times quantity sold.

 If demand is elastic, a large increase in price causes a relatively larger decline in quantity
demanded and this will finally cause for a fall in TR. But the vice versa is true if there is
a large decline in price for this demand elastic commodity.
 If demand is inelastic, a large rise in price causes a relatively small reduction in Quantity
demanded and this makes total revenue to increase .The vice versa is true if there is a
large decline in price for this demand inelastic products.

Demand forecasting; - This is involved with the estimation of the future demand of a given
product on the basis of the past and present demand data. This forecasting is helpful in that it

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helps the producer to decide how much to produce and hence how much input to use so as to get
maximum profit without wasting the inputs and the outputs. Forecasting can be done in different
ways. But the most commonly used techniques are the following.
Least square method: In forecasting demand using this technique, the trend of demand in the
last few years (mostly not less than 5 years) is determined by a linear trend equation derived
from the previous demand situation. It is given by the linear relationship as Y= a + bT where Y
is the dependent (influenced variable) and T is the independent variable (influencing variable).
From this equation the coefficient a and b can be determined to know the trend of the demand.
Example
T Y TY T2
0 10 0 0
1 13 13 1
2 14 28 4
3 17 51 9
4 18 72 16
5 18 90 25
6 19 114 36
7 20 140 49
8 22 176 64
9 23 207 81
10 22 220 100
11 24 264 121
12 24 288 144
13 25 325 169
Where T=time N= number of observation
Y= demand
__ __

∑ T =91 ∑ Y =269 T=6.5 Y= 19.21

The coefficient “b” can be calculated by using the following formula
∑ TY −n T̄ Ȳ =1998−14 (6 .5 X 19 . 21 )=1 . 097
∑ T −n T̄ 2 819−( 14 )(6 .5 )2
2

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a= Y −bT =19 . 21−1 . 097 x 6 .5=12 .08

So the trend equation now becomes Y= 12.08 + 1.097 T
This means for each additional units of time, the demand will change by 1.097 and hence the
demand for the coming year can be determined by substituting the appropriate value of T in the
equation.
This trend analysis approach can also be used to forecast both output and input prices and hence
input costs can also be forecasted by using the same approach.
Note; - In order to use this forecasting technique, we should have at least a minimum of a five
years time series data on the issue under consideration.
Chain ratio method: the potential sale of a product may be estimated by applying a serious of
factors to a measure of aggregate demand. For example, a given dairy producing and processing
enterprise can estimate the demand for dairy products (potential sale of dairy products) for the
coming few years in the following way.
1. Total no of population in the region ……………… 1, 000,000
2. proportion of consumers of product X ………………. 0.5
3. Total no of consumers of product X ……………….500,000
4. average annual amount of consumption ………… 20 Kg / consumer
5. Total amount of consumption of product X in a year ...10, 000,000
Once the total amount of consumption of product X in a year is obtained, then it can be
multiplied by the annual growth rate of population to estimate the potential demand in each year.
So if 10,000,000 is the total annual consumption of the product by all the consumers and if 2% is
population growth rate, then the potential sale for each year can be
Year 0 …………………….10, 000,000
Year 1 …………………….10, 000,000 + 2/100X 10,000,000 = 10,200,000
Year 2……………………..10, 200, 0000 +2/100X 10,200,000 = 10,404,000

Supply;-is defined as the ability and willingness of producers/suppliers to provide a certain

amount of products to the market.

The quantity that producers supply is also affected by a number of factors, the most important
being:

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 Agricultural Marketing For 4th Agricultural Economics Students

1.Price of the goods/products on the market; As the price of the products/commodities

increase, the supply of that specific commodity will also increase.

2.Price of inputs/costs of production; - as the price of inputs /cost of production increases, the
supply of the product which requires this inputs will decline.

3. Technological factors; - As there are more technologies to improve the production/supply of

a product, the supply of that product also increases.

4. Storage possibilities; - As there are more storage possibilities, the supply of a product also
increases.

Market Equilibrium Price; - is the price level where quantity demanded is equal to quantity
supplied. It is also called market clearing price because all the commodities provided for market
are sold in the market since the demand is there. This point of market equilibrium is shown by
the following graph.

Fig. Position of market Equilibrium

As can be seen in the above figure, the equilibrium position is achieved at the point where supply
equals to demand. The price level at this intersection point is called equilibrium price and the
quantity at this level is called equilibrium quantity.

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 Agricultural Marketing For 4th Agricultural Economics Students

2.4 Elasticity
Price elasticity of demand
When the price of a good rises, the quantity demanded will fall. That much is fairly obvious. But
in most cases we will want to know more than this. We will want to know by just how much the
quantity demanded will fall. In other words, we will want to know how responsive demand is to
a rise in price.

We call the responsiveness of demand to a change in price the price elasticity of demand If we
know the price elasticity of demand for a product, we can predict the effect on price and quantity
of a shift in the supply curve for that product.
Figure 2.8 shows the effect of a shift in supply with two quite different demand curves (D and
D’). Curve D’ is more elastic than curve D over any given price range. In other words, for any
given change in price, there will be a larger change in quantity demanded along curve D’ than
along curve D.
Market supply and demand
S2
S1

b
P r ic e

P2

c
P3
a
P1 D'

D
O Q3 Q2 Q1
Quantity

Fig 2.8 Market supply and demand

Assume that initially the supply curve is S1, and that it intersects with both demand curves at
point a, at a price of P1 and a quantity of Q1. Now supply shifts to S2. What will happen to price
and quantity? In the case of the less elastic demand curve D, there is a relatively large rise in
price (to P2) and a relatively small fall in quantity (to Q2): equilibrium is at point b. In the case of
the more elastic demand curve D′, however, there is only a relatively small rise in price (to P3),
but a relatively large fall in quantity (to Q3): equilibrium is at point c.
Measuring the price elasticity of demand

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 Agricultural Marketing For 4th Agricultural Economics Students

What we want to compare is the size of the change in quantity demanded with the size of the
change in price. But since price and quantity are measured in different units, the only sensible
way we can do this is to use percentage or proportionate changes. This gives us the following
formula for the price elasticity of demand (PεD) for a product: percentage (or proportionate)
change in quantity demanded divided by the percentage (or proportionate) change in price.
Putting this in symbols gives:
PεD %QD / %ΔP
Where ε (the Greek epsilon) is the symbol we use for elasticity, and  (the capital Greek delta)
is the symbol we use for a ‘change in’. e.g. Thus if a 40 per cent rise in the price of oil caused the
quantity demanded to fall by a mere 10 per cent, the price elasticity of oil over this range will be:
-10%/40% 0.25
Interpreting the figure for elasticity
The sign (positive or negative) indicates as p and Qd are negatively related.
The value (greater or less than 1)
If we now ignore the negative sign and just concentrate on the value of the figure, this tells us
whether demand is elastic or inelastic.
Elastic: This is where a change in price causes a proportionately larger change in the quantity
demanded. In this case the value of elasticity will be greater than 1, since we are dividing a larger
figure by a smaller figure.
Inelastic: This is where a change in a price causes a proportionately smaller change in the
quantity demanded. In this case elasticity will be less than 1, since we are dividing a smaller
figure by a larger figure.
Unit elastic: Unit elasticity of demand occurs where price and quantity demanded change by the
same proportion. This will give elasticity equal to 1, since we are dividing a figure by itself.
Determinants of price elasticity of demand
The price elasticity of demand varies enormously from one product to another. But why do some
products have a highly elastic demand, whereas others have a highly inelastic demand? What
determines price elasticity of demand?
The number and closeness of substitute goods. This is the most important determinant. The
more substitutes there are for a good, and the closer they are, the more will people switch to

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 Agricultural Marketing For 4th Agricultural Economics Students

these alternatives when the price of the good rises: the greater, therefore, will be the price
elasticity of demand.
The proportion of income spent on the good. The higher the proportion of our income we
spend on a good, the more we will be forced to cut consumption when its price rises: the bigger
will be the income effect and the more elastic will be the demand. E.g. demand for salt and car.
The time period. When price rises, people may take a time to adjust their consumption
patterns and find alternatives. The longer the time period after a price change, then, the more
elastic is the demand likely to be.
Special cases
Figure 2.9 shows three special cases: (a) a totally inelastic demand (PεD0), (b) an infinitely
elastic demand (PεD )) and (c) a unit elastic demand (PεD 1).
 Totally inelastic demand. This is shown by a vertical straight line. No matter what
happens to price, quantity demanded remains the same.
 Infinitely elastic demand. This is shown by a horizontal straight line. At any price above
P1 in Figure 2.9(b), demand is zero. But at P1 (or any price below) demand is ‘infinitely’
large.
 Unit elastic demand. This is where price and quantity change in exactly the same
proportion. Any rise in price will be exactly offset by a fall in quantity.
Totally inelastic demand (PD = 0)
P
D

P2

P1

O Q1 Q

Fig. 9 (a) Totally inelastic demand (PεD = 0)

Infinitely elastic demand (PD
D = - )
P

P1 D

O Q1 Q2 Q

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 Agricultural Marketing For 4th Agricultural Economics Students

(b) Infinitely elastic demand (PεD = )

Unit elastic demand (PD
D = –1)
P

20

8
D

O 40 100 Q

(c) Unit elastic demand (PεD = –1)

The measurement of elasticity: arc elasticity
We have defined price elasticity as the percentage or proportionate change in quantity demanded
divided by the percentage or proportionate change in price. But how, in practice, do we measure
these changes for a specific demand curve? We have two methods. The first is called the arc
method. The second is called the point method (elasticity at appoint).
A common mistake that students make is to think that you can talk about the elasticity of a whole
curve. The mistake here is that in most cases the elasticity will vary along the length of the curve.
Take the case of the demand curve illustrated in Figure 2.10. Between points a and b demand is
elastic. Between points b and c, however, demand is inelastic.
Different elasticities along different portions of a demand curve
P
Elastic
a
demand
P1

b Inelastic
P2 demand

c
P3
D

O Q1 Q2 Q3 Q

Fig 2.10 Different elasticities along different portions of a demand curve

Normally, then, we can only refer to the elasticity of a portion of the demand curve, not of the
whole curve. There are, however, two exceptions to this rule. The first is when the elasticity just
so happens to be the same all the way along a curve, as in the three special cases illustrated in
Figure 2.9. The second is where two curves are drawn on the same diagram, as in Figure 2.8.
Here we can say that demand curve D is less elastic than demand curve D′ at any given price.
Note, however, that each of these two curves will still have different elasticities along its length.
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 Agricultural Marketing For 4th Agricultural Economics Students

Although we cannot normally talk about the elasticity of a whole curve, we can nevertheless talk
about the elasticity between any two points on it. This is known as arc elasticity. In fact the
formula for price elasticity of demand that we have used so far is the formula for arc elasticity.
Let us examine it more closely. Remember the formula we used was:
Proportionate ΔQ / Proportionate ΔP (where Δmeans ‘change in’)
The way we measure a proportionate change in quantity is to divide that change by the level of
Q: i.e. ΔQ/Q. Similarly, we measure a proportionate change in price by dividing that change by
the level of P: i.e. ΔP/P. Price elasticity of demand can thus now be rewritten as: ΔQ/Q÷ΔP/P.
But just what value do we give to P and Q?
Consider the demand curve in Figure 2.11. What is the elasticity of demand between points m
and n? Price has fallen by £2 (from £8 to £6), but what is the proportionate change? Is it −2/8 or
−2/6? The convention is to express the change as a proportion of the average of the two prices,
£8 and £6: in other words, to take the midpoint price, £7. Thus the proportionate change is −2/7.
Measuring elasticity using the arc method
10
Q P
P d = 
mid Q mid P
m
8 10 2
= 
15 7
7 P = –2 = 10/15 x 7/2
n
6 = 70/30
Q = 10 = 7/3 = 2.33
P (£) Mid P
4

2 Demand

0
0 10 15 20 30 40 50
Mid Q Q (000s)

Fig 11 Measuring elasticity using the arc method

Similarly, the proportionate change in quantity between points m and n is 10/15, since 15 is
midway between 10 and 20. Thus using the average (or ‘midpoint’) formula, elasticity between
m and n is given by: ΔQ/ average Q ÷ ΔP/ average P = 10/15 ÷ −2/7 = −2.33. Since 2.33 is
greater than 1, demand is elastic between m and n.
? Referring to Figure 2.11, use the midpoint formula to calculate the price elasticity of demand
between (a) P = 6 and P = 4; (b) P = 4 and P = 2. What do you conclude about the elasticity of a
straight-line demand curve as you move down it?
Price elasticity of supply (Pεs)
Price elasticity of supply The responsiveness of quantity supplied to a change in price. Figure
2.12 shows two supply curves. Curve S2 is more elastic between any two prices than curve S1.

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 Agricultural Marketing For 4th Agricultural Economics Students

Thus, when price rises from P1 to P2 there is a larger increase in quantity supplied with S2
(namely, Q1 to Q3) than there is with S1 (namely, Q1 to Q2). For any shift in the demand curve
there will be a larger change in quantity supplied and a smaller change in price with curve S2
than with curve S1. Thus the effect on price and quantity of a shift in the demand curve will
depend on the price elasticity of supply.

S1
P
S2

P2
P1

Q1 Q2 Q3 Q

Fig 2.12 Two supply curves with different price elasticities of supply
The formula for the price elasticity of supply (Pεs) is: the percentage (or proportionate) change
in quantity supplied divided by the percentage (or proportionate) change in price. Putting this in
symbols gives:
Pεs %ΔQs / %ΔP
In other words, the formula is identical to that for the price elasticity of demand, except that
quantity in this case is quantity supplied. Thus if a 10 per cent rise in price caused a 25 per cent
rise in the quantity supplied, the price elasticity of supply would be: 25%/10% 2.5 (elastic)
Notice that, unlike the price elasticity of demand, the figure is positive. This is because price and
quantity supplied change in the same direction.
Determinants of price elasticity of supply
The amount that costs rise as output rises. The less the additional costs of producing additional
output, the more firms will be encouraged to produce for a given price rise: the more elastic will
supply be.
Time period

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 Agricultural Marketing For 4th Agricultural Economics Students

• Immediate time period. Firms are unlikely to be able to increase supply by much immediately.
Supply is virtually fixed, or can only vary according to available stocks. Supply is highly
inelastic.
• Short run. If a slightly longer period of time is allowed to elapse, some inputs can be increased
(e.g. raw materials) while others will remain fixed (e.g. heavy machinery). Supply can increase
somewhat.
• Long run. In the long run, there will be sufficient time for all inputs to be increased and for new
firms to enter the industry. Supply, therefore, is likely to be highly elastic.
The measurement of price elasticity of supply
A vertical supply has zero elasticity. It is totally unresponsive to a change in price. A horizontal
supply curve has infinite elasticity. There is no limit to the amount supplied at the price where
the curve crosses the vertical axis. When two supply curves cross, the steeper one will have the
lower price elasticity of supply (e.g. curve S1 in Figure 2.12). Any straight-line supply curve
starting at the origin, however, will have an elasticity equal to 1 throughout its length,
irrespective of its slope. This demonstrates nicely that it is not the slope of a curve that
determines its elasticity, but its proportionate change.

Other supply curves’ elasticities will vary along their length. In such cases we have to refer to the
elasticity either between two points on the curve, or at a specific point. Calculating elasticity
between two points will involve the arc method. Calculating elasticity at a point will involve the
point method. These two methods are just the same for supply curves as for demand curves: the
formulae are the same, only the term Q now refers to quantity supplied rather than quantity
demanded.
Income elasticity of demand (YεD)
In practice there are just two other elasticities that are particularly useful to us, and both are
demand elasticities. The first is the income elasticity of demand (YεD). This measures the
responsiveness of demand to a change in consumer incomes (Y). It enables us to predict how
much the demand curve will shift for a given change in income. The formula for the income
elasticity of demand is: the percentage (or proportionate) change in demand divided by the
percentage (or proportionate) change in income. Putting this in symbols gives:
YεD %ΔQD / %ΔY

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 Agricultural Marketing For 4th Agricultural Economics Students

Thus if a 2 per cent rise in income caused an 8 per cent rise in a product’s demand, then its
income elasticity of demand would be: 8%/2% 4
The major determinant of income elasticity of demand is the degree of ‘necessity’ of the good. In
a developing country, the demand for normal goods expands rapidly as people’s incomes rise,
whereas the demand for inferior goods fall. Thus items such as meat and TV have a high income
elasticity of demand, whereas items such as vegetables and radio have a low income elasticity of
demand. Unlike normal goods, which have a positive income elasticity of demand, inferior
goods have a negative income elasticity of demand.
Cross-price elasticity of demand (CεDAB)
It is a measure of the responsiveness of demand for one product to a change in the price of
another (either a substitute or a complement). It enables us to predict how much the demand
curve for the first product will shift when the price of the second product changes. The formula
for the cross-price elasticity of demand (CεDAB) is: the percentage (or proportionate) change in
demand for good A divided by the percentage (or proportionate) change in price of good B.
Putting this in symbols gives:
CεDAB %ΔQDA / %ΔPB
If good B is a substitute for good A, A’s demand will rise as B’s price rises. In this case, cross
elasticity will be a positive figure. For example, if the demand for butter rose by 2 per cent when
the price of margarine (a substitute) rose by 8 per cent, then the cross elasticity of demand for
butter with respect to margarine would be: 2%/8% 0.25
If good B is complementary to good A, however, A’s demand will fall as B’s price rises and thus
as the quantity of B demanded falls. In this case, cross elasticity of demand will be a negative
figure. For example, if a 4 per cent rise in the price of bread led to a 3 per cent fall in demand for
butter, the cross elasticity of demand for butter with respect to bread would be: 3%/4%
0.75
The major determinant of cross elasticity of demand is the closeness of the substitute or
complement. The closer it is, the bigger will be the effect on the first good of a change in the
price of the substitute or complement, and hence the greater the cross elasticity – either positive
or negative.
Firms need to know the cross elasticity of demand for their product when considering the effect
on the demand for their product of a change in the price of a rival’s product or of a

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complementary product. These are vital pieces of information for firms when making their
production plans.

Government intervention to stabilize price

Setting of Price ceiling and price floor is important tools that government uses to stabilize price.
Government use floor price when it is thought that producers are in danger. FloorPrice plays a
significant role when it is set above equilibrium price.

Government intervention through price ceiling is done when it is thought that consumers are
hurt. Price ceiling work better when it is set below equilibrium price. The intervention of
government to correct market imperfection by using ceiling and floor prices can be illustrated by
using the following graph.

Price Ceilings and Floors

As can be seen in the above figure, the equilibrium price is achieved at the point of intersection
of demand and supply. But when there is market disequilibrium in the form of excess supply,
floor price (minimum legal price) above the equilibrium price will be charged to safeguard the
suppliers and this makes the original supply curve to shift upward and meet the demand curve at
the level of the floor price so as to create a new equilibrium level of supply which is of course
less than that of the original.

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 Agricultural Marketing For 4th Agricultural Economics Students

When there is market disequilibrium in the form of excess demand, ceiling price (maximum
legal price) below the equilibrium price will be charged to safeguard the consumers and this
makes the original demand curve to shift downward and meet the supply curve at the level of the
ceiling price so as to create a new equilibrium level of demand which is of course less than that
of the original.
So by using these strategies, government stabilize prices (market) when there is market
imperfection either in the form of excess supply or demand.
Producer’s surplus of farm products and Its Determinants
 In any developing economy, the producer’s surpluses of farm products play a significant
role. This is the quantity w/c is concern to non-farm population of the country.
 The marketing system is concerned with the producer’s surplus rather than the total
production.
 The knowledge of the producer’s, surplus helps the policy makers as well as the traders in
the following areas.
1) Formulation of sound price policy;
2) Development of proper procurement & purchased strategies;
3) Stabilization of agricultural prices;
4) Formulation of agricultural trade policy (Export and import);and
5) Development of transport & storage systems. Infrastructure policy
Many of the operations of marketing firms& the marketing systems organizational arrangements
can be explained only by considering the:
- nature of the initial raw product &
- It’s production.
Nature of farming
- The nature & structural of farm-sector is undergoing a multidimensional Δ es, however,
these Δ es LDC’s have a different tendency than those in DC’s.
- The structure of agricultural refers to the no., size, ownership, & specialization of farms.
1) Number of Farms
- The no of farms increase & consequently the size of the farm is decreased;
(fragmentation is another problem).
2) Ownership: - three types

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 Agricultural Marketing For 4th Agricultural Economics Students

 individual proprietorship- most farms by LDC’S

 partner ship – Joint – family (it is not registered as a share)
 corporations
3) Types:
-Family farms: mostly shown type of farm in LDC’s.
Labor, management & capital are contributed by the family member.
- Cooperative Farms
- Corporate Farmsthese types of farms are few in LDC’S
- State Farms
4. Diversified: most of LDC’S characteristics is diversified’ in nature.
 The Implication, i.e., l up to 4 & results in some very important marketing
considerations are:-
1. Much of the market arrivals are in relatively small lots.
2. Farmers by nature, & probably by necessity, primarily interested in production,& only
secondarily interested in marketing.
3. Changes are taking place in terms of trend toward specialization, increases in production,
market-orientation of farming etc. Owing to improvement in farm technology,
improvement in factor market, improvement in infrastructure, & Δ es in policy
environment.
The Nature of the Product:
1. Largely raw materials
- The processing takes place outside the farm sector (Value-added outside the farm
sector).
2. Bulky
- require more space for storage & transportation, so it costs increase.
3. Perishable
- require quick handling of product
4. Quality variations
- quality varies from state to state ( region to region) & like due to agro climatic,
managerial, technology condition.
Characteristics of the farm production:

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 Agricultural Marketing For 4th Agricultural Economics Students

1) The long-term trend in food production is upward.

2) The annual output variability of individual farm products is even greater that of total farm
output. This puts lot of stress on farm marketing firms, w/c are specialized in handling a
particular type of products.
3) Seasonality
- Lean season under utilizing pre-harvest this created in infrastructure, besides
seasonal fluctuations in price.
- Peak season over (during post-harvest season)
4) Growing Geographical concentration or specialization of farm production owing to the
various agro-climatic conditions &principle of comparative advantage.
- increases the distance b/n producer & consumer means increases the transportation cost.
- The marketing system must adjective to the Δ ing geographic production pattern.
5. There is no single cost of production for all farmers
- unit cost of product is absent in agriculture;
- farmers friendly price policy;
- Farmers costs of production are affected by climate, technology farm size & individuals
managerial skills. Consequently, the cost of producing a farm commodity varies widely
by regions, & among farmers. This result in varying profitability and farm incomes as
also creates problems for evolving farmer’s friendly agricultural price policy.
The Farm Marketing Problems
 Farmers have 2-basic problems i.e.,
-low & unstable prices for their product.
-low and unstable income for their product.
 The “farm problem” is usually associated with unstable &relatively low farm prices &
incomes. A related set of f’s problems can termed ‘the farm marketing problem.’ These
are several dimension for this problem:
1. Farmers are unable to adjust their production schedule to changing marketing situation.
Following are the reasons for this situation:
I. Farmers are small: independent units (no coordination);
II. Farming is to great extent dependent on weather & biological nature of reproduction;
III. It is not possible to quickly shut owing or turn on agricultural production.

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- this inability of farmers to adjust to Δ ing marketing situation results in:

high risk element in agriculture,&
- or leads to
high responsibility on marketing system for adjusting to Δ ing
farm supplies.
2. Farmers are unable to influence prices of their products
- Price takers (farmers find it difficult to improve their prices via independent or group-
activities. Further it is almost impossible to follow group approach to raise pries for their
products).
3. Farmers are a victim of a situation of cost-price squeeze.
Input-market are largely come from oligopoliy market. (Increase Price = cost to
farmers).
Product- markets are sold to competitive market (keeping the prices low).
Increasing cost & decreasing prices result in cost-price squeeze or decreasing farm
income.
4. Superior bargaining powers of buyer of farm products as compared with that farmers.
5. Δ ing market-efficiency in still anther component of marketing problem.
Farm marketing Questions
- Following are important marketing decision areas for farmers;-
1. What to produce & how to prepare it for sale?
2. When & where to buy & sell?
3. How much of the marketing job should be done by farmer himself (individually or
collectively)?
4. What can be done to expand market? -channel
5. Which marketing arrangements are desirable?
6. How can changes necessary to correct undesirable practices be selected?
Producer’s Surplus
The producer’s surplus is the quantity of produce w/c is, or can be, made available by farmer-
producers to the non-farm population.
- The producer’s surplus is of 2-types:-

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 Agricultural Marketing For 4th Agricultural Economics Students

1. Marketable surplus: the quantity of the producer w/c can (or should) be made available to the
market.
- It is a theoretical, ex-ante concept of producer’s surplus.
-The marketable surplus is the residual left with the farmers-producer from the total production,
after accounting for the on farm requirement of the product in terms of family consumption,
seed, feed, payment (kind) to labor, payment to artisans, etc.

- Thus may expressed as: m =p−c

b

2. Marketed surplus: is that quantity of the produce w/c the producer-farmer actually sells in the
market, irrespective of his requirements for on-from consumption.
- It is an ex-post concept, may be >, < or = marketable surplus.
Mb = production – on farm consumption requirement- marketable
Mt = production – quantity retained for on farm Consumption. - marketed
Mt = >=< Mb
I. Mt >Mb this situation is termed as distress sale.
- to meet cash needs (unavoidable);
- no capacity for storage;
- underestimation of on-farm consumption requirement;
- high price at the time of harvest.
II. Mb > Mt
- low prices at the harvest time;
- no demand (transportation, market., government restriction;
- better intention capacity of farmers;
- over estimation of on-farm consumption requirement.
III. Mb = Mt
- This situation is particularly observed in case of perishable commodities & non- food
crops.
Factors affecting (determinants) of Mt & /or Mb
- size of holding/size of herd/
- Area under the crop
- Production of the crop/livestock product

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- size & composition of family

- Price of the product
- Consumption habits .
- Natural of the commodity
- requirements for seed, feed, etc

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