The agricultural sector is a very unique sector in economics because it displays characteristics in terms of the demand for and the supply of its goods not seen in any other sector. The principal characteristics of demand are that it is both income and price inelastic and it has high dependency on population and tastes which cause demand to be static in both the short and the long run. On the other hand supply is very volatile in the short run due to extraneous factors because supply is a biological process though in the long run due to technological advances we tend to observe an increasing trend. Also, because agricultural products are perishable and because the production period is long, supply will be inelastic so producers will have to supply in the short run even at very low prices. Another characteristic of supply is its atomistic structure and asset fixity. These basically imply that there will be a large number of insignificant producers and that most agricultural assets will be fixed. These have various implications for prices which are very unstable in the short run and in the long run present a declining trend. Similarly farm incomes tend to be unstable in the short run and converge in the long run though it must be noted that this is also due to extensive government subsidisation of agriculture.
In the short run demand in the agricultural industry is affected by the fact that it is income inelastic because of Engel’s law that basically states that with successive increases in income food consumption as a proportion of income declines. At this point it must be pointed out that consumption is different from expenditure unless all goods have the same price, in other words, the money a consumer spends on food (i.e. expenditure) may increase, remain stable or even decrease but his consumption will decrease as illustrated in the following diagram.
In the diagram we see that at low incomes consumers spend great amounts of their incomes on food however as incomes increase the proportion of income spent on food declines as consumers can now sustain themselves with the amount of food they have purchased and prefer other goods like televisions or computers. The above holds because the law of diminishing marginal utility for agricultural goods kicks in at a much earlier stage compared to other goods considering the fact that most agricultural goods have been found empirically to be inferior . This is because a person can only consume a specific amount of food so even if they switch to more expensive alternatives they will still represent a lower percentage of their income than before the increase.
Apart from being income inelastic demand is also relatively price inelastic. Price elasticity of demand is the change in quantity demanded as a result of a change in price which in the market for agricultural goods is relatively low. This is because after consumers have bought the goods they need no matter how much producers lower the prices they won’t consume more because excess consumption would lead to lower or even negative marginal utility. Also, the lack of substitutes and the fact that food occupies a low budget share will mean consumers are even less sensitive to price changes causing prices in agricultural prices to be very volatile in the short run without having a great effect in demand.
As a result demand for goods in the agriculture industry is fairly stable mainly because of low price and income elasticity. Even though income and price elasticity are essential stepping stones upon which to determine the demand for agricultural products in the short run there are other factors that play a significant role in the long run. One of these factors is population, the only way demand for agricultural produce can increase is if there is an increase in population as observed in the following diagram which shows the dependency between population and food.
Another essential element of demand in the long run has to do with knowing the food preferences and tastes of a region which are usually determined by its demographics. For example a wealthy region is more likely to demand expensive tropical fruit as opposed to a poorer one that will opt for the cheaper, seasonal ones. Finally like in demand for all products it is very important to know consumers tastes in order to determine what kind of products they will demand. However it must be noted that these factors only affect demand in the long run and tend to remain stable in economies that don’t experience rapid growth rates.
By combining what affects demand in the short run and in the long run we can deduce that demand for agricultural products is relatively stable in the long run seeing that consumers’, irregardless of changes in price and income, won’t demand above a fixed amount. Also the fact that food products don’t have any substitutes means consumers won’t be able to consume below a certain amount seeing that they need this food to survive. Thus demand for food will converge in the long run and be relatively stable as the only thing that can affect it in the long run is population increase or a change in taste which in most developed economies don’t occur.
On the other hand we have supply of agricultural goods which is subject to weather and disease in the short run that are factors that cant be controlled by the producer when deciding upon whether to supply or not. The above two factors mean that supply will be very unstable in the short run leading to prices and as a result incomes in the agricultural sector being very volatile as illustrated in the following diagram.
In the above figure we see that in a bad year where producers can get high prices for their produce very few of them are able to produce so even though they have achieved the desired price in the market disease and weather hinder the ability to obtain the profits of the higher price illustrated by the orange area. On the other hand in a good year where most of them can supply the price they get for their goods in the market is too low and thus most make very low profits. From the above we deduce that short run supply is relatively inelastic mainly because the goods are perishable and because the production period is too long. Also we see that farm incomes are usually very unstable especially considering the atomistic structure of the market which means that a single producer can’t affect the market in any way. In other words once a farmer has produced a certain amount of food he has to sell it because otherwise it would go off and he would have to incur higher costs per unit produced. At the same time bec ause agricultural goods take a relatively long time to produce, once a farmer has decided to produce he can’t withhold production if in the end food prices are too low making him unable to respond to changes in price either by increasing or decreasing his supply. This leads to the paradox of income in the agricultural sector where profits in a bad year are greater than profits in a good year. However this wouldn’t occur if the agricultural industry was faced with a relatively more elastic demand curve.
In the long run however supply experiences growth because it is subjected to improvements in technology. As a result if producers have examined weather conditions or diseases that cause their crops and subsequently their production to suffer they can inject technology to overcome these difficulties. As a result supply in the long run will expand. As a result in the long run prices face a downward trend because demand is constrained by Engel’s law and supply expands greatly. However producers will have slightly higher incomes in the long run as illustrated by the blue area in the diagram below.
Overall we see that the inelasticity that characterises both demand and supply in the agricultural sector means that even though in the short run both prices and incomes will be very volatile in the long run prices present a downward trend and incomes an upward one. The price instability is proven empirically by the fact that the all commodities price index is at +/-11.6% whereas the price index for manufactured goods is +/-4%. Similarly the price decline is illustrated empirically by the fact that the price for food has been found to have a -2.8% price change annually.