This chapter brings together the basic ideas of consumer demand, and the production and cost concerns. This chapter will enable students to understand how price is determined in a market and the role of price.
2. Supply and demand
Price is determined by how much of a product
people are willing and able to sell (supply)and
how much other people are willing and able to
buy(demand).
The potential profit from a product is
determined by two critical factors: supply and
demand.
Supply and demand have a great deal to do with
market size and product prices, both of which
should be of interest to an agribusiness manager
3. Supply and demand
Supply is the quantity of a given product that is
available at a specific time and price.
Demand is the quantity of a product that is needed
at a specific time and price
The supply and demand of a product is
determined by several factors but price is the
primary determinant.
4. Supply and demand
Consumer driven market
Consumers are ultimately the determinant of
agribusiness marketing success.
Commodities or services may be available but if
the consumer chooses not to buy and does not
submit to persuasion, there will be no sale.
In a market economy, every scarce commodity
commands a price, and that price is market
determined by the product’s demand and supply
curves.
5. Supply and demand
Consumer driven market
In a democratic system, producers have the right
to produce and market goods and services for
personal profit. Similarly, consumers have the
basic right to refuse to buy goods and services.
The better producers can get to know the
consumer, the better chance they have of offering
superior and successful products.
6. Understanding Consumer Demand
For the consumers, the lower the price, the more
consumers are likely to buy and consume.
For the producers, the lower the prices paid for
inputs and the higher the price paid for the final
product, the larger the firm’s profits.
The price of final products is of interest to
consumers just as much as the price of inputs or
materials needed to make products is of great
interest to producers.
7. Understanding Consumer Demand
Profit equation
Profit = total revenue – total cost
Π = TR –TC
Profit is the difference between price paid (total
revenue) and cost of product (total cost).
The objective of the firm is to make the difference
between TR and TC as large as possible by
raising TR, lowering TC, or doing both.
8. Understanding Consumer Demand
Total revenue (TR) = price per unit (Py) X
quantity sold (Y)
TR = Py X Y
It is important for firm managers to remember the
main goal of the firm is to increase long-term
profits, not just increase the quantity of products
sold.
If the selling price is too low or costs are too high,
increased sales could result in a large loss.
9. Understanding Consumer Demand
A good part of the success in trying to increase
profits comes from knowing the relationships
between total revenue and levels of price and
quantity.
High levels of the total revenue can be reached by
selling just one unit if the price is high enough
and someone is willing to pay for it.
11. Understanding Consumer Demand
This same total revenue goal can be reached by
selling a large number of the products at a more
reasonable price.
There are several in-between prices and quantities
that can give the same total revenue.
Price and quantity always move in opposite
directions, the level of total revenue does not
remain the same. This is shown in the next table
13. Understanding Consumer Demand
(Plot a graph)
Putting prices and quantity on a graph shows a
line sloping or going downward and to the right
on the page. This means the higher the price, the
lower the quantity sold.
It shows the law of demand.
This law states that consumers buy less of a good
as the price rises and more as the price goes
down.
14. Understanding Consumer Demand
The consumer directs what is produced by what
he or she purchases.
consumers always seek the highest level of total
happiness from the collection of goods they
consume.
When choosing each additional good to consume,
they always pick the one that gives them the
greatest addition to the overall total level of
happiness.
15. Understanding Consumer Demand
The amount of satisfaction received from
consuming each additional unit of a product
decreases as more is consumed.
Decreasing satisfaction for individual products
makes consumers demand a wide selection or
variety of products to increase their total
satisfaction.
16. Understanding Consumer Demand
If a change in the ‘’ own price’’ of an item brings
a change in the number of units sold, then there
has been a change in quantity demanded.
However, if price remain the same and the
quantity sold changes, this means a shift in
demand.
17. Understanding Consumer Demand
The factors that cause this movement of the
demand schedule include the following:
Price of substitute goods
Price of complements
Income
Population
Taste and preference
Seasonality.
18. Understanding Agribusiness Supply
Production Process
Production is the use of inputs to create an
output that has economic value.
The production process is how an
agribusiness combines the various inputs to
create an output.
19. Understanding Agribusiness Supply
When agribusinesses decide to produce an
output they must make four major production
decisions:
What to produce? What products and services
can this business profitably offer?
How to produce? What is the best combination of
inputs to use in producing the output?
How much to produce? What is the correct
amount of output to produce that will increase the
firm’s long term profits?
When to produce? What is the correct time to
produce the output or to offer the service?
20. Understanding Agribusiness Supply
The Efficiency of Agricultural Markets
Marketing efficiency is measured by comparing
output and input values. Output values are based
on consumer valuation of a good, and input values
(costs) are determined by the values of alternative
production capabilities.
Therefore, markets are efficient when the ratio of
the values of output to the value of input
throughout the marketing system is maximized.
21. Understanding Agribusiness Supply
The Efficiency of Agricultural Markets
Pricing efficiency is concerned with the accuracy,
precision, and speed with which prices reflect
consumers’ demands and are passed back through
the market channels to producers. Pricing
efficiency is thus affected by rigidity of marketing
costs and the nature and degree of competition in
the industry.
22. Understanding Agribusiness Supply
The Efficiency of Agricultural Markets
A process is technically efficient when the
maximum or highest output per unit is obtained at
all levels of input use.
Technological changes can be evaluated to
determine whether they will reduce marketing
costs per unit of output.
This must be done first. Once this efficiency is
reached the manager can turn his or her attention
to reaching economic efficiency.
23. Understanding Agribusiness Supply
The Efficiency of Agricultural Markets
A process is economically efficient when the
level of output reaches the highest profit. The
primary reason for firms to increase their
marketing, technical and pricing efficiency is the
expected income improvement; for society, the
basic goal of economic efficiency requires
marketing, technical and pricing efficiencies.
24. Understanding Agribusiness Supply
Determination of Economic Efficiency
It is important to know that maximum profit does
not happen at the point where input efficiency is
highest or where the highest output occurs.
Maximum profit is measured by the cost of inputs
compared with the revenue earned by selling
outputs.
26. Understanding agribusiness supply
Price Quantity supplied
$5.00 1000
$4.50 900
$4.00 800
$3.50 700
$3.00 600
$2.50 500
$2.00 400
$1.50 300
$1.00 200
$ 0.50 100
Law of supply
Table 2.3 shows the relationship between selling price and quantity supplied.
(plot in a graph)
27. Understanding Agribusiness Supply
Price is not the only factor that will affect
supply. The non price determinants of supply
are:
Changes in the price of other goods.
Expectations of future selling price
Number of sellers in the market
Changes in production costs
28. Characteristics of Agricultural Supply
Little control over how much is produced once
the process is under way.
Uncontrollable factors control supply
For commodities such as grains, unless imported,
the supply is fixed between harvests regardless of
price.
Once the crop is planted, quantity supplied will
not change much in response to price changes.
But small changes in supply will cause very large
changes in price.
29. Characteristics of Agricultural Demand
Unlike supply, domestic demand for agricultural
commodities is usually stable from year to year.
There may be seasonal changes for a product
from year to year, but overall demand remains the
same.
This is because consumer demands for food are
largely a function of habit.
30. Characteristics of Agricultural Demand
A closer look at food demand leads to several
interesting facts.
First, the demand for specific food products tends
to be price sensitive. This means a change in price
will cause the quantity sold to change. The
availability of substitutes causes this response.
Second, the demand is less sensitive to price the
closer one gets to the farm level because there are
few substitutes for farm-produced commodities.
31. Role of price
Consumers by showing a willingness to pay a
certain price for an item, show that they are
getting at least as much satisfaction from the
consumption of a good as they could get from the
consumption of another good available at the
same price.
If the price is lowered, more consumers will feel
this way, and the quantity demanded will go up.
Producers operate in much the same way.
32. Role of price
Limited amount of money to invest to produce
items demanded by consumers.
By paying a certain price for an input, producers
show that it is worth at least that much to them in
the production process.
Willingness to pay for the input really depends on
how much they think the consumers are willing to
pay for their products.
33. Role of price
In this way, the producers’ demand for inputs, or
materials, depends on the consumers’ demand for
the firm’s products.
The demand for tractors, feed, dairy cows,
processing plants, e.t.c. comes in part from the
consumer demand for retail food items.
For example, the demand by farmers for fertilizer,
in part, comes indirectly from the consumer’s
demand for chicken.
34. Price Determination and Price Discovery
Changes in price cause the quantity demanded or
the quantity supplied to change along the supply
or demand schedule.
Change in other factors with the price held
constant cause the demand and supply curves to
shift.
At the same price, more or less quantity would be
demanded or supplied depending on the change.
35. Price Determination and Price Discovery
Price is determined by the interaction of supply
and demand. When a supply curve for a product is
shown in the same graph as the demand curve for
that same product, price is determined where the
two curves cross.
This is called price determination
37. Price Determination and Price Discovery
An important point to note is that where the
curves cross supply and demand is in balance, the
quantity supplied by the marketers of the product
just equals the quantity demanded by the
consumers of the product. There is neither a
surplus of product in the market, nor is there a
shortage.
38. Price Determination and Price Discovery
In the real world, a supply-and-demand curve
does not exist, they are estimated.
Any attempt to determine price by these methods
will not truly reflect what is going on in the
marketplace.
That brings us to price discovery.
Sellers and buyers haggle over price. Not an exact
process. All about negotiation.
39. Price Determination and Price Discovery
Neither party has complete information about
supply, demand, or the factors which affect either
one.
Whether the agreed-on price is above or below
the general price level for similar transactions in
other parts of the country depends on the
following:
Amount, quality and timeliness of the information
available to both parties.
Bargaining ability of each participant.
40. Price Determination and Price Discovery
One can see that information plays an important
role in being successful in the price discovery
process.
The price discovery process usually works very
well, meaning there are few transactions at prices
very much above or below the current market
price.
Some people are better at bargaining over price
than other people.
41. Price Determination and Price Discovery
It is important that marketers know and
understand the difference between price
determination and discovery.
Both are important because price sets both the
size of the market and the amount of profit
possible.
Price determination helps researchers understand
the long-term effects of changes in the
marketplace, and price discovery helps
agribusiness managers set prices for day-to day
operations.
42. Law of one price
The law of one price state that when markets are
operating normally, there should be only one
common price for each product in a market, after
adjusting for the cost of storage, transportation,
and processing.
If prices differ by more than the cost of storage,
transportation, and processing, then price is “out
of line’’.
43. Law of one price
When this happens, there is an economic
incentive to shift from an area of low prices to
another area where prices are being paid. The
process of capturing extra profits in settings
where prices are “out of line is called arbitrage
Anytime prices are higher than justified by the
costs of storage, transportation, and processing,
someone will try to capture the extra profits.
By so doing, they will keep the markets in
balance.
44. Law of one price
Time: For the current and future markets to be in
balance, the cost of storage should be just equal to
the difference between the current price and the
future price.
Distance: For two distance separated markets to
be in balance, the cost of transportation should be
just equal to the difference in price between the
two locations.
45. Law of one price
Form: For markets separated by different product
forms to be in balance, the cost of changing form
should be just equal to the difference between the
price paid for raw commodity and the price
received for the processed product.
In this way, the law of one price keeps markets in
balance that are separated by time, distance, and
form. There is a natural tendency for markets to
move toward the balance defined by the law of
one price
46. Agricultural Price Patterns
The prices of many agricultural commodities
show patterns over time. These patterns relate to
the biological nature of food production and slight
variations in consumption.
Those patterns that happen yearly are called
seasonal price patterns.
Patterns that repeat longer than a year are called
price cycles.
47. Agricultural Price Patterns
Seasonal price patterns are caused by the
seasonality of production and consumer demand.
For grains, fruits and vegetables there is usually
only a single crop year, while demand is constant
throughout the year.
This difference in supply and demand produces
the pattern of prices throughout the year.
49. Agricultural Price Patterns
A graph of monthly prices would show price is
lowest at harvest time, followed by a slow rise
each month afterward. The price is highest just
before the next harvest.
The increase in price each month after harvest is
the market’s method of rewarding someone who
stores part of the annual crop to meet year round
demand.
50. Agricultural Price Patterns
Price cycles go beyond one year. They also have
their origin in the biological nature of production,
as do seasonal patterns. In these cases the biology
does not permit a rapid adjustment in supply
adjustment patterns.
A full cycle of rise and fall for pigs may take 3.5
to 4 years, while for cattle it may take as long as
11 to 12 years.
51. Agricultural Price Patterns
Knowing where you are in the price cycle is
critical to planning./ producers do not wish to
expand output at the peak of the price cycle
knowing they might face a pattern of falling
prices for years. But they might consider
expanding if they were at the bottom or on an
upward swing of the price cycle.