Why the Price of Agriculural Products Are More Volatile?

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Summary

Agricultural products like fresh vegetables, wheat, and corns are considered as “necessaries” in our daily life and have no close substitutes in the short run. The amount consumers spend on basic foodstuffs occupied only a small proportion of our total income. Demand for foodstuffs and demand for raw agricultural commodities like grains and soybeans which are often use as inputs for final products (derived demand) are therefore inelastic and not responsive to changes in prices although changes in supply often result in price fluctuations in agricultural market. However, demand and supply for manufactured products will be more elastic especially if the products are luxurious, consumers require to use up a big proportion of their income to acquire them and markets exists many close substitutes. When additional cost of producing one more unit of output is low and there are spare capacity and raw material, firms will respond to changes in prices and shift resources to make additional outputs in order to maximize revenue. This report uses important concepts of price elasticity of demand and supply, income elasticity of demand as well as Cobweb Cycle theory to analyze and understand the economic market forces behind the price volatility of agricultural products. The macroeconomic effects from Asian Financial Crisis 1997-99 contributed to price declines in most international commodity market. Substantial fluctuations in market prices of cocoa and coffee reported in 1983-1997 confirmed the price of agricultural products is more volatile if compared with manufactured products.

Contents

Summary …………………………………………………………………………………...1

1. Introduction ……………………………………………………………………….. 3

1.1 Definition and Characteristics of agricultural products…. ………………………… 3 2.Price Elasticity of Demand…………………….……………………………………4
2.1 Determinants of Price Elasticity of Demand ……………………………………….5
2.2 Availability of close substitutes……………………………………………………..5
2.3 Proportion of income spent on the product………………………………………….5
2.4 Time horizon ………………………………………………………………………..5

3. Price Elasticity of Supply………………………………………………………… 6
3.1 Amount of additional costs ………………………………………………….7
3.2 Time Horizon ……………………………………………………………………….7

4. Income Elasticity of Demand ……………………………………………………… 8
4.1Necessity and luxury…………………………………………………………………8

5.Macroeconomic Impacts……………………………………………………………..9
5.1 Demand side shocks ……………………………………………………………….10
5.2 Supply side shocks………………………………………………………………….11
6.Cobweb Cycle Theorem ……………………………………………………………12

7.Conclusion ………………………………………………………………………….13

References …………………………………………………………………………………..14

1. Introduction

This report seeks to understand the reasons why prices of agricultural products

are more volatile than the manufactured products, especially in short run. Brown and

Gibson (2006, p.4) has commented that the prices of agricultural commodities are fluctuating

as much as fifty percent which is not happening to manufactured products. They have

observed the price of cocoa fluctuated between sixty percent (69%) and one hundred

Seventy percent (170%) and the prices of Robusta coffee has fluctuated from forty

percent (40%) to one hundred ninety-five percent (195%) of its average price between 1983 to

1997.

1.1Definition and Characteristics of Agricultural Products

Agricultural products, as defined by the United States Department of Agriculture (USDA 2007), refer to a wide range of products from unprocessed bulk commodities like soybeans, feed corn, wheat, rice, sugar, coco, coffee, unprocessed tobacco, fruits, fresh vegetables, raw rubber and raw cotton to highly-processed high-value food and beverages like sausages, bakery goods, ice cream, beer and wine, and condiments sold in retail stores. The significant...
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