The objective of this chapter is to review elements of demand theory, relating them to the demand for agricultural commodities. An understanding of demand concepts is important because it helps to explain price behavior. A common approach is to think in terms of retail-level demand by consumers of final products such as the demand for fluid milk at retail, but in studying prices of agricultural commodities, it will also be necessary to consider demand at the farm level, i.e., the derived demand for commodities. Both topics are covered in this chapter.

The basic unit of demand theory is the individual...

This chapter reviews the concepts of own-price, cross-price, and income elasticities of demand. Interrelationships among these coefficients, as suggested by the underlying demand theory, are described. The concepts oftotal elasticityandflexibilitycoefficients are also introduced.

Definition

The concept of a demand function or a demand schedule was discussed in Chapter 2. It provides a description of the relationship between price and the quantity buyers are willing and able to buy, other factors held constant. Price theory suggests an inverse relationship between price and quantity, but the inverse relationship by itself says nothing about the responsiveness of quantity demanded...

In this chapter, we explain supply concepts, with special emphasis on the supply of farm commodities. The production of farm commodities has unique features that require the underlying economic principles be adapted to these features. The basic economic principles of supply analysis can also be applied to marketing and processing firms that supply foods to final consumers. Thus, attention is focused first on the theoretical basis of supply functions and related elasticity concepts. Then, we discuss the factors that shift the level of the supply function, with an emphasis on the supply of farm commodities. Finally, we cover some special...

This chapter is about the determination of product prices and hence about the economic forces influencing price behavior. How a particular product’s price behaves, in terms of the level and frequency of change, may differ with the structure of the market for that product. Themarket structuredepends on such characteristics as the number of buyers and sellers, their size distribution, barriers to entry in the industry, and the degree of product differentiation.

Economists’ commonly classify markets by assuming many buyers and then differentiating among markets by the number and distribution of sellers. In this context, markets may be classified...

Price theory in its simplest form assumes that many buyers and sellers meet directly. Equilibrium prices are determined by the market demand and supply schedules, which aggregate the behavior of these buyers and sellers. Although farmers and consumers sometimes do meet directly in farmers’ markets, most foods move through a complex processing/distribution system. Indeed, the product on the grocery store shelf may be far different than the original farm commodity; the commodity is just one of many inputs used to produce the retail product. Thus, it is not surprising that the price of bread in a bakery is much higher...

Specific lots of an agricultural commodity can differ in terms of characteristics such as size, color, moisture level, protein and fat content, fineness of fibers, and proportion of defects or impurities. Wheat is sometimes viewed as a generic commodity, but there are in fact numerous varieties and grades of wheat, with varying attributes. For example, hard red spring wheat is milled into flours for making breads, while soft wheats are milled into flours for cookies and crackers.

Changes in the prices of different grades, attributes, and classes of a commodity tend to be correlated, but price differences exist among the...

An important attribute of individual lots of agricultural products is their location, and thus one should not be surprised that prices of a commodity vary regionally. The price of a particular grade of corn in Ames, Iowa, need not be—indeed probably will not be—the same as the price of the same quality corn in Batavia, New York. Likewise, the price of raisins in the United States will generally not be the same as it is in Japan. This chapter discusses the factors that cause prices to differ among regions, within and among countries, and that cause these relative...

Agricultural product prices vary substantially more through time than the prices of most industrial products and have different time-series properties than do the prices of volatile financial assets that are also traded in competitive markets. For example, Hull writes, “[For IBM stock] . . . our predictions for the future should be unaffected by the price one week ago, one month ago, or one year ago. . . . the probability distribution of the price at any particular future time is not dependent on the particular path followed by the price in the past” (2009 : 259f). In contrast, the...

This chapter focuses on the general level of farm prices, not on the prices of individual commodities. Measures of the general, or average, level of prices attempt to aggregate over the diverse behavior of individual price changes. Price movements can be visualized as a swarm of insects, with the individual insects changing positions relative to each other but with the group as a whole either rising or descending. Averages, represented by price indexes, help identify the underlying general movements in prices.

Changes in the general level of farm prices have political as well as economic consequences. For example, a rising...

The principal mechanisms used to establish, or “discover,” prices and their economic effects are discussed in this chapter. The termprice discoveryis used to denote the institutional mechanisms by which buyers and sellers arrive at specific prices and other terms of trade. It involves the mechanics of pricing rather than the theory of price determination (covered in Chapter 5). Price discovery mechanisms evolve in response to changes in the economy and may influence price behavior. Price discovery is not a costless process; pricing mechanisms can influence the quality of information and the way it is transferred; and alternative price...

Markets for futures contracts are important pricing institutions for many of the major farm commodities in the United States and increasingly in other countries. These markets provide an opportunity for producers, inventory-holders, and users of commodities to shift the risk of adverse price movements and to forward price commodities. Futures markets also offer an opportunity to speculate and perhaps profit from changes in prices. This chapter focuses on the behavior of futures prices and the relationship of futures to cash prices. We begin with a discussion of markets for contracts. Then, basic models of price determination are introduced. The prices...

The general function of futures markets is to facilitate various types of resource allocation through hedging and through the provision of forward prices. This chapter discusses both the hedging and price discovery roles, and in the process, some issues related to price behavior are also discussed.

In an uncertain world, economic activity has risks. For example, a farmer who commits seed, land, and other resources to wheat production is subject to yield and price risks. Actual yields may be below expected yields, and likewise, the price expected at planting time may not be realized at harvest time. A variety of...

The termprice analysisrefers to the quantitative study of price behavior, especially demand-supply-price relationships. Much of price analysis is applied econometrics, but quantitative analyses may range from the construction of tables and graphs to the use of a variety of advanced mathematical tools such as mathematical programming and simulation models. No attempt is made here to survey all available quantitative methods. We discuss some of the issues in linking empirical studies to the concepts discussed earlier in the book.

The two reasons most frequently given for engaging in price analyses are (1) to estimate specific coefficients (parameters) such as...

This chapter provides a basis for using and evaluating the results of price analyses based on regression techniques. As noted in Chapter 14, an important component of evaluating results is how well the results fulfill the research objectives. The discussion in this chapter must necessarily be rather general, however, because we cannot cover specific research applications in detail. But we do provide general insights into the appraisal of empirical price analyses.

The first section discusses the interpretation of regression results, which includes an implicit evaluation of results. A second section explicitly covers major issues related to the adequacy of models....

This chapter illustrates four applications of price analysis that follow naturally from the material covered in this book. The examples do not, of course, cover the full range of possible applications, but we hope that they provide some additional insights that will be useful to the reader. Although this book has stressed the complexities of agricultural product markets, the first two examples show that relatively simple tools can be useful. The last two examples show how analysts have dealt with some of the complexities of agricultural markets.

The profitability of storing grain and hedging in futures depends, in part, on...