Download Agric Marketing Intro.

AGEC 452AGRICULTURAL
MARKETING
(II)
VERTICAL MARKETS
Derived Demand and Derived Supply
Retail
Market
Farm
Market
Consumer Demand (Retail Demand)
(Retail Supply ???)
(Farm Demand ???)
Producer Supply (Farm Supply)
Derived Demand and Derived Supply
 Earlier we discussed consumer demand in the retail market
and farm supply in the farm market.
 Obviously, there are buyers of farm raw products in the
farm market.
 This is called the derived demand.
 Likewise, there are sellers of consumer food items in the
retail market.
 This is called the derived supply.
Derived Demand and Derived Supply
Retail
Market
Primary Demand (Retail Demand)
Derived Supply (Retail Supply)
Derived Demand (Farm Demand)
Farm
Market
Primary Supply (Farm Supply)
What are the properties of the derived demand
and what are the properties of the derived supply
and what are their relationship?
Expressing Quantities on an Equivalent
Basis
 It is possible to directly compare demand curves at the
retail and farm levels of the marketing system only if we
express the quantities at one level in terms of quantities at
the other level.
 For example, if we want to compare the demand for
Wagashi with the farm-level demand for milk, we need to
know that it takes 9.9 pounds of raw milk to manufacture
one pound of Wagashi.
 Then, we can express quantities at both levels in terms of
either the farm-level equivalent or retail-level equivalent.
Derived Demand
P
Given our ability to
express demand in
terms of equivalent
quantity units, we
can draw demand
curves for the two
market levels on the
same diagram.
The difference between
these two demand curves
reflects the marketing costs
associated with each
quantity of product
demanded.
Primary Demand (Demand at
Retail Level, DR )
PR
PF
Derived Demand
(Demand at Farm
Level, DF )
Qs , Qd
Marketing Costs
Derived Supply
P
Likewise, the
difference between the
two supply curves
reflects the marketing
costs associated with
each quantity of
product supplied.
Derived Supply
(Supply at Retail
Level, SR )
PR
PF
Primary Supply
(Supply at Farm
Level, SF )
Qs , Qd
Marketing Costs
Marketing Margins: Marketing Cost
SR
P
SF
PR
Marketing Margin
It accounts for
the costs of a
collection of
services that is
rendered
between the
farmers and the
consumers.
PF
DR
DF
QR = Q F
QR must equal to QF
Qs , Qd
The Price of Marketing Services
 Marketing margin accounts for a collection of services that
is rendered. These services include the provision of:
 Labor
 capital
 land/facility/materials
 entrepreneurship
 As such, marketing margin accounts for:
 wages (as a return to labor)
 interest (as a return to capital)
 rent (as a return to land/facility/materials)
 "normal" profit (as a return to entrepreneurship)
 In other words, marketing margin is:
The Price of Marketing Services
Like prices of any other
commodities, the price
of marketing service is
determined by its
demand and supply
schedules.
price of
marketing
services
supply of
marketing
services
PMS
demand of
marketing
services
This equilibrium price of
marketing services is, in turn, the
marketing margin of the
agricultural market that we are
investigating.
QMS
quantity of
marketing
services
Marketing Service Demand Shifter
PMS
For a given market volume of the
underlying commodity (e.g.,
beef), there is a demand curve
for marketing services.
If there is an increase in market
volume of the underlying
commodity (e.g., beef), the
demand curve for marketing
services will shift to the right.
Thus, the equilibrium price of
marketing services will increase.
SMS
P"MS
P'MS
D"MS
D'MS
Q'MS Q"MS
That is, there will be an increase in the marketing margin in the
market of the underlying commodity (e.g., beef).
QMS
Marketing Service Supply Shifter
PMS
If there is an increase in the
cost of providing marketing
services (e.g., an increase in
the transport costs), the
supply curve of marketing
services will shift to the left.
S"MS
S'MS
P"MS
P'MS
Thus, the equilibrium price of
marketing services will
increase.
That is, there will be an increase in the
marketing margin in the market of the
underlying commodity (e.g., beef).
DMS
Q"MS Q'MS
QMS
Effects of a change in Marketing Margin
SR
P
 Consider the case where
transportation rates in the
marketing service sector
increase.
 Because transportation is an
important component of food
marketing, it means that the
marketing margin is increased.
 Obviously, the positions of some
supply and demand curves have
to change to make allowance for
the increased marketing margin.
SF
PR
PF
DR
DF
QR = QF
Which curves have
to be shifted?
Qs, Qd
Effects of a change in Marketing Margin
SR
P
Since we are holding constant
prices of other goods,
income, population, and
SPPD, no shift can occur in
the primary demand curve.
Similarly, since we are holding
constant the prices of inputs,
prices of alternative outputs,
and CAP, no shift can occur in
the primary supply curve.
Hence, the only way to make
room for the increased
marketing margin is to have:
SF
PR
PF
DR
DF
QR = QF
(1) the derived demand
curve shifts down (left),
(2) the derived supply
curve shifted up (left).
Qs, Qd
Effects of a change in Marketing Margin
SR
P
No shift can occur in the
primary demand curve.
No shift can occur in the
primary supply curve.
Hence, the only way to
make room for the
increased margin is to
have:
(1) the derived demand
curve shifts down (left),
(2) the derived supply
curve shifted up (left).
SF
P’R
PR
PF
DR
P’F
DF
Q’
Q
Qs, Qd
Thus:
the retail price rises,
the farm price falls, and
the market volume decreases.
Sharing the Burden: Equally?
With an increase in marketing margin:
the retail price rises,
the farm price falls, and
the market volume decreases.
 The marketing cost increase is shared by both:
 consumers (in the way of paying a higher retail price) and
 farmers (in the way of receiving a lower farm price).
 But, would the burden of marketing cost increases be shared
equally by the two groups?
 Not necessarily. The answer depends on the relative
magnitude of retail demand and farm supply elasticities.
Sharing the Burden: Elasticity Matters
 The more inelastic demand is in relation to supply, the
greater the impact on retail prices relative to farm prices.
 This is because since the retail quantity is less
responsive to a price change, the retail price must bear
most of the burden of the cost increase.
 On the other hand, the more inelastic supply is in relation to
demand, the greater the impact on farm prices relative to
retail prices.
 In this case, the farm quantity is less responsive to a
price change and, hence, the farm price takes most of
the heat.
In-Class Exercise 3a
 Consider the vertical market discussed in class. Suppose
there is a reduction in the transportation rate in the
marketing service sector.
 What would be the effect on the price of marketing
services?
 What would be the subsequent effects on the farm sector:
i.e., on the retail price, farm price, and market volume?
 Which of the two prices would be affected more by the
incidence?
Work Space for Exercise 3a
SR
P
SF
No shift can occur in the
primary demand curve.
No shift can occur in the
primary supply curve.
Hence, the only way to
adjust for the decreased
margin is to have:
PR
P’R
P’F
PF
DR
Q’
DF
Q
(1) the derived demand
curve shifts up (right),
(2) the derived supply
curve shifted down (right).
Qs, Qd
Thus:
the retail price falls,
the farm price rises, and
the market volume increases.
Effect of an Income Increase
SR
P
SF
 Let's examine how a
rightward shift in the
primary demand curve is
reflected through the
market channel and how
this shift affects the
marketing margin.
PR
PF
DR
DF
 The rightward shift in the
primary demand curve by
itself will pull the derived
demand curve to the right
by the same amount if the
original marketing margin
were to remain the same.
Q
Qs, Qd
It turns out that the equal-magnitude
shift in the derived demand curve, DF,
is an overkill. That is, the magnitude
of the DF shift has to be smaller than
the magnitude of the DR shift.
SR
The magnitude of the DF
shift has to be smaller
than the magnitude of
the DR shift. Why?
First, the rightward shifts in
the demand curves result in
a larger market volume.
P
SF
PR
PF
DR
DF
PMS
Q
Second, with increased market volume,
the price of marketing services must rise.
SMS
P"MS
P'MS
D"MS
D'MS
Q'MS
Q"MS
Qs, Qd
QMS
Finally, to allow for the increased
marketing margin, the derived
demand curve must shift back to the
left somewhat. (Remember the
previous example of the effects of an
increased marketing margin.)
Effect of an Income Increase
SR
P
The demand curves shift to
the right.
Market volume increases.
The demand for marketing
services shifts to the right.
SF
P'R
PR
P'F
PF
DR
Marketing margin increases.
DF
To allow for the increased
marketing margin, the derived
demand curve must shift back
to the left somewhat. That is, it
must not shift to the right as
much as did the primary
demand curve.
Q
Qs, Qd
Remember from the previous
problem that the increased
marketing margin will also shift the
derived supply curve to the left.
Effect of an Income Increase
SR
P
 With an increase in consumer
income:




retail price rises,
farm price rises,
market volume rises, and
marketing margin rises.
SF
P'R
PR
P'F
PF
DR
DF
 As before, the relative
magnitude of retail and farm
price increases depends on
the relative magnitude of
retail demand and farm
supply elasticities.
Q
Qs, Qd
The more inelastic the curve,
the larger is the price impact.
In-Class Exercise 3b
 Consider the vertical market discussed in class. Suppose
there is an improvement in the farm production technology.
What are the effects on the retail price, farm price, market
volume, and marketing margin?
 Hints:
 With the new technology, the primary supply curve will
shift to the right.
 The derived supply curve will follow suit, but by a
smaller magnitude (because it has to shift back to the
left somewhat due to increased marketing costs).
 With increased marketing costs, the derived demand
curve has to shift to the left as well.
Work Space for Exercise 3b: Technology
SR
P
The supply curves shift to
the right.
SF
Market volume increases.
PR
P'R
The demand for marketing
services shifts to the right.
PF
Marketing margin increases.
To allow for the increased
marketing margin, the derived
supply curve must shift back to
the left somewhat. That is, it
must not shift to the right as
much as did the primary supply
curve.
DR
P'F
DF
Q
Qs, Qd
Remember from the previous
problem that the increased
marketing margin will also shift the
derived demand curve to the left.
Work Space for Exercise 3b:
Technology
SR
P
SF
 With an improved technology:




retail price falls,
farm price falls,
market volume rises, and
marketing margin rises.
 As before, the relative
magnitude of retail and farm
price decreases depends on
the relative magnitude of
retail demand and farm
supply elasticities.
PR
P'R
PF
DR
P'F
DF
Q
Qs, Qd
The more inelastic the curve,
the larger is the price impact.