Effect of Changes in Price on Agricultural Products

In this article we will discuss about the effect of changes in price on agricultural products.

I. The Reaction of Supply in the Long Period:

In the theoretical long period, when sufficient time is allowed for everyone to adopt themselves and their equipment completely to some antecedent change, the behaviour of agricultural producers differs little from unit of the manufacturer. In equilibrium, if there is perfect competition, the marginal unit of every factor of production of the same grade must get the same return in all occupations.

It follows that the price of every product must be equal to the AC in the marginal concern, including not only the prevailing prices for the hired factors of production, but also the normal rates of earning of the labour of the farmer and his family, interest on his capital and the rent of the land.

This being so, a rise in the demand for agricultural products relatively to industrial would increase the relative profitability of agriculture and result in the diversion of land, labour and capital from industry to agriculture, until the profitability of each occupation was again equal. Similarly, a relative fall in the price of agricultural products would produce a fall in output.

There is however, one difference in the response of agriculture and of industry, even in the long period. An increase in agricultural output is likely to bring into operation the tendency to diminishing returns and so raise costs, while an increase in industrial output may lead to increasing returns and thus lower costs.

If agricultural production is to be enhanced at the cost of industrial, cultivation will have to be intensified in agriculture and less fertile and less accessible land brought into use, since the land released from industry will be inadequate to provide farming space for the labour transferred. This will bring into force the tendency to diminishing returns.

If, however, labour is to be shifted from agriculture to industry, industry may obtain greater economies through large-scale production and so be able to supply a greater output at a lower cost. Thus, while an increase in agricultural output is likely to involve higher prices, an expansion of industrial output may result in lower prices.

II. Short-Period Supply Curves:

The perfect adjustment of output to prices assumed in the long-period analysis is never achieved in practice, as it would take a very long time, perhaps two generations, to work itself out, and prices are never stable for — so long.

In the short period, some adjustments only are possible, and the supply curve will consequently diverge from that in the long period. Moreover the reaction of output to price differs more markedly between agriculture and industry in the short period than in the long period.

There is no one short-period supply curve for agriculture. In the very, short period farmers can only change output by varying the proportion of their crops which they pick and sell, or. the rate of slaughtering of their livestock.

If prices are very low it may not be worthwhile to pick the strawberry crop, which will be left to waste on the land the non-perishable crops they can also vary their sales by storing the product in the hope of a subsequent increase in price.

In a rather longer period than this the farmer may be able slightly to increase the output of a few products by more intensive feeding or heavier manuring. Thus milk output shows an immediate but small increase if the cows are given more food.

The short period with which we mainly deal, is a rather longer period than these, in which the farmer is given time to plant more crops or breed more livestock, and in which it is possible for output to vary by a greater amount. There will be a substantial lag, in agriculture, between the decision to vary supplies and the actual appearance of the changed volume on the market, since both crops and animals take time to mature.

For crops the lag is usually at least 6 months from the time of planting, and planting can take place, in most countries, only at one season of the year.

For livestock it is generally considerably longer. Thus even for pigs, the most prolific farm animal the period of gestation between mating and the birth of piglets is 4 months, and pigs must be 4 to 6 months old for slaughter as pork and 8 months old for slaughter as bacon. For cattle the period of gestation is 8 months, while fat cattle are not slaughtered until about 2 years old, and heifers do not calf and start to supply milk until about 2½ years old.

Such a lag, of course, is not confined to agriculture. Sometime must elapse between the moment when a factory manager decides to expand output and the emergence of the new quantity of finished products from the manufacturing process. The difference is that, in agriculture, the lag is generally longer than in industry.

This short period merges by almost imperceptible changes into the true long period. In the middle-length period it is possible to increase the capital equipment represented by breeding stock and trees. Here, again, there is a lag in agriculture which is sometimes longer than that involved in an expansion of industrial equipment.

Livestock must mature before it can be bred from, which will take about 6 months for a pig and about 2 years for a cow or a mare. Again trees do not come into bearing for some years after they are planted; an apple tree will not produce much fruit until it is about 5 years old. Thus the longer the period, the more it is possible to change supply.

Difficulties of Control in the Short Period:

We must note a difference between agriculture and industry in the sensitiveness of the reaction of short-period production to price. Some farmers produce for self-consumption and not for market, and are therefore not affected at all by price changes. Even, however, when they do produce for market their reactions are different from those of manufacturers.

(1) A change in price can only affect the output which the farmer intends to produce. In industry, which is mainly a mechanical process, the entrepreneur can generally alter production by almost the exact amount that he intends. In agriculture, a biological process, the farmer can only rarely do so. He can plant a certain acreage of drops if the weather is not too unfavourable, or mate a certain number of animals.

He cannot, however, tell what yield he will obtain per acre, or, with certainty, what number of young animals will be born or will survive. The range of error may not be large for animal products in a temperate climate, but for crops, and for livestock in such areas as Central Australia, where extreme droughts kill large numbers at intervals, it is frequently considerable.

The total output of many crops varies more with the yield per acre, which the farmer cannot control, than with the acreage, which he can. Thus for potatoes in U.K., acreage varied, on the average of the 10 years before the war, by no more than 6% from year to year, whereas yield per acre fluctuated by 9%. Total production, which varied by 13% on the average, was thus more dependent upon yield than upon acreage.

Potatoes are perhaps an extreme example in such a temperate climate as U.K., but in areas subject to extreme droughts or cold yield may vary by far more than this. Thus, in Saskatchewan, one of the prairie provinces of Canada, the annual yield of wheat varied by 33% of the average from 1928-37, and in the drought year 1937 was not much over a 1/3 of that in the previous year, and less than 1/8 of that in the bumper year 1928.

(2) The farmer often pays less attention to price changes than does the industrialist. The assumption underlying most economic; analysis is that the entrepreneur, acts always in that way which he believes will give him the maximum profits. He is supposed constantly to examine anew the circumstances under which he is producing and selling, and to adapt his output and his methods when these circumstances change.

Now this assumption may not be so far removed from the facts in a large-scale undertaking, since the entrepreneur is a specialist in management and has the services of cost accountants. But it is certainly an ideal rather than a practice in small-scale undertakings, and especially in farming, where a large number of products are combined in the organization of the farm, and where weather plays such a large part.

The calculations required, if profits are to be maximized in the light of changing circumstances, are so many that the working farmer could not hope to make them all even if he were the most intelligent of managers. In fact, since the scope for large incomes is smaller in farming than in industry, the average level of intelligence is probably also lower.

As a result, traditional methods of production are even more important in agriculture than in industry, and only a few of the most enterprising farmers really adapt their output as rapidly as it would be most profitable for them to do.

“It would be a grave mistake to attribute the slow reaction of agricultural output to price changes mainly to the greater influence of tradition on the farmer than on the industrialist. There are also sound economic reasons for the differences. Even if the farmer we actuated entirely by the motive of maximizing his income in relation to the effort involved in producing it, and even if he were perfectly intelligent in all his decisions, yet intended agricultural output would still react differently to price changes from industrial output.”

Prime and Overhead Costs:

(1) The main reason for the difference lies in the low ratio of prime to overhead costs in agriculture. In the long period, as we know price must equal AC on the marginal farm, since, if the farmer or industrial entrepreneur is not covering his TC, he can dispense with as much of each of the factors of production as he wishes, and can himself change his occupation. In the shorter period this is not true.

Certain costs will have been incurred in the past, or must be paid in the present unless the farmer is prepared to go bankrupt. He cannot avoid these fixed costs if he ceases to produce or alters the amount he produces, so that they are irrelevant when he decides on his present output.

The only costs which affect his decisions on the volume of output are the variable costs, which are directly dependent upon the amount which he intends to produce and which can be decreased or avoided if he contracts output.

The division between variable and fixed costs depends upon the length of the period allowed. In the very short period the only costs which can be avoided are the expenses of marketing the produce, such as freight charges and middlemen’s commission, and the cost of casual labour employed in harvesting. These costs are, therefore, the only prime costs. All other costs will have been paid already or must be, incurred whatever the output and are thus overhead costs.

In the ordinary short period it would be possible to dismiss most of the hired labour, to buy no feeding stuffs for the milking cows or for the stock which is being fattened, and to do without fertilizers and fuel for the power driven machinery.

These items represent the most important variable costs, additional to those which were prime in the very short period, which will be incurred in producing one crop, or one batch of animals for sale. They are dependent upon the intended output and can be reduced if it is curtailed.

In the period of middle length there are costs which, while they are independent of output in the short period, can yet gradually be cut down and thus become prime in the middle period. These costs include the purchase of breeding stock, if they are bought, or the labour and feeding stuff’s used in rearing them, and the purchase of machines.

There remain some costs which are overhead in any except the long period. These are the expenses which have been incurred in buying the land, if the farmer owns it, in draining and fencing it and in setting up the farm buildings.

(2) There are the expected earnings of the farmer and his family. Here, too a distinction must be drawn. The farmer himself is essential to the farm, if it is to be worked at all, and his earnings, therefore, are definitely overhead costs excepts, in the long period. But it may be possible for some of his family to seek employment elsewhere, so that their earnings, while they will certainly be overhead costs in the very short period, will often be prime costs in. a longer period, when alternative jobs are available.

The earnings of the farmer and his family are not, even in the short period, on quite the same basis as other over- head costs. For, although the farmer cannot reduce his expenses by dispensing with his own or his family’s labour, he can vary the output by altering the amount of work they do.

(3) There is one further item, of a rather different nature, which must be considered here. If a farmer lets his land go out of cultivation it will grow weeds or even bushes, and involve him in the considerable extra cost of removing them, if he wishes to bring it back into cultivation. The importance he attaches to this expense will depend upon his expectation of a future recovery of prices.

If he hopes for such an Improvement, he will treat the extra cost of bringing uncultivated land back into cultivation as a sort of education from prime costs. In this agriculture is very different from industry, as if a machine is worked it usually deteriorates more than if it is left idle. Consequently, the value which the manufacturer places on such deterioration must be added to and not subtracted from prime costs.

It is difficult to estimate the relative importance of these various items of cost, as they differ so much from place to place and occupation to occupation. Generally speaking, however, it is true to say that the larger the undertaking and the more specialized, the more important are prime costs.

Large firms employ more labour relatively to the work done by the employer than do small, and specialized firms buy more costly raw materials than those which manufacture a product through all its stages. Farming is a small scale undertaking, which employs comparatively little hired labour, and quite frequently one farm performs all the stages of production. Prime costs are therefore relatively unimportant.

In the peasant countries, where all labour is family labour and farms are generally integrated, prime costs would certainly be very much less than half total costs, and probably less than a quarter. If we take industry, however, we find that, in Great Britain, 60 per cent of the value of gross output was represented by purchases of raw materials, and nearly 20 per cent by wages, making a total of 80 per cent prime costs and only 20 per cent overhead.

Variations in the proportion of prime costs to total costs affect output in two ways. First, they alter the number of farmers who wish to move out as price falls, and, secondly, they determine the changes in the amount produced by each farmers.

If price, falls, any entrepreneur, (agriculturist or industrialist) will stay in business so long total returns exceed prime costs by at least as much as he can earn elsewhere by his own labour and with the aid of the equipment which he owns or must pay for whatever he produces.

If the price decline affects all agricultural products the farmer’s equipment may well be practically useless outside agriculture, and alternative opportunities therefore small. It will consist, in the short period, partly of the land itself and of improvements to it in the form of drainage, fencing and fertilization, partly of the farm buildings and farm house, and partly of agricultural machinery and stock.

None of these are of much Use except in farming. In addition, the farmer himself, and any of his family who work with him, will have been trained to farming and have acquired skill which is of little value in other occupations. Moreover, if the price fall is not confined to agriculture, but is associated with a general industrial depression, the farmer and his family cannot be sure of obtaining any other work at all.

If that be so, the farmer will be prepared to go on working for a return only a little above prime costs. “Therefore, when prime costs are only a small part of total costs, price may fall very substantially before the farmer gives up. The shorter the period allowed, the fewer items will be included in prime costs and therefore the less likely is it that the farmer will give up his farm.”

When agricultural price rise relatively to other price, the obstacles to an increase in the number of farmers are rather different. Anyone who can raise the necessary capital and obtain some land can; become a farmer, but neither of these requirements can be met rapidly.

It is not easy for a new man to borrow money, and only land beyond the margin of cultivation, which, usually, requires considerable work to render it fit for farming, can readily be obtained. On the other hand, factories which wish to start, since they use less land, can generally divert any they need from agricultural uses. Thus; both for price decreases and for price increases, the number of farmers is only slowly adaptable to price changes.

Supply can vary more rapidly through changes in the amount produced by existing farmers, Once again, overhead costs are irrelevant to the farmer’s decision. He will only consider the relationship between, on the one hand, the receipts for his product and, on the other, his prime costs and the efforts he and his family will incur as he varies his output.

If prices fall, the entrepreneur will dispense with those marginal units of his hired factors of production which are least productive. He will not buy or hire any prime factor which costs more; than the now diminished value of the marginal unit of product that it contributes to total output. Where output is dependent upon purchased feeding-stuffs or fertilizers, the farmer will almost certainly use less and produce less intensively.

Generally speaking, since prime costs represent only a small part of total farming costs, the savings open to the farmer through decreasing output are small, so that it is not likely to contract much; this is especially true since prime costs per unit will often be rapidly reduce as farming becomes less intensive, and the scope for savings will-consequently diminish. Again, the longer the period allowed, the more important, will be prime costs, and the more is production likely to decrease as price falls.

Similarly, when price rises, there may be some expansion of output through the hiring of more prime factors. But, owing to the tendency to diminishing returns as labour, feeding stuffs or fertilizers are used more intensively, it will not be worth the farmer’s while to: increase production as much as he would if costs were constant.

In industry the position is very different Entrepreneurs can diminish costs considerably by cutting down output, since they can hire less labour and buy fewer raw, materials Indeed the amount produced in the short run is almost wholly dependent upon the quantity of prime factors hired, and is very little affected by the amount of work done by the entrepreneur.

(4) The Farmer’s Share in Output:

In farming, however, the amount of work done by the farmer and his family is very important. In peasant farming variations in output are brought about almost wholly by changes in the quantity of work done by to the farmer’s family.

The farmer will go on working until the satisfaction given him by the marginal unit of income that he obtains just compensates him for the marginal quantity of effort’ involved in producing that income. Now a reduction in the price of the things the farmer sells will reduce the marginal quantity of income earned by his last hour’s effort, but it is by no means inevitable that it will induce him to work less, since it will also have reduced the family’s whole income.

As a result they will have to reduce their consumption, so that the marginal utility to them of their last unit of income will be increased, being now spent on a more urgent need than before.

It is, therefore, certain that they will be prepared to work harder than before for an equal increase in income, and quite probably that they will work harder for a smaller marginal income, since this will now be the means of satisfying more urgent wants than those which were previously satisfied by the larger marginal income.

A family farm is thus quite likely to produce more, rather than less, as prices fall. The poorer it is to begin with, the more efforts will it be prepared to make to prevent a further cut in income. On the other hand, the poorer it was to begin with, the longer the hours that it probably worked.

And the longer hours it worked, the more irksome and the more tiring would be any further extension of these hours. Since these two tendencies oppose one another it is impossible to say whether a richer or poorer family is the most likely to increase output as price falls.

Similarly, if prices rise, the family may produce less, as it can obtain the same income tax before with a lesser expenditure of effort.

(5) The Reaction on Costs:

The report why a fall in price may lead to an increase in the output of a family farm is that, as a result of altering the farmer’s income, it reduces, in effect, the “costs” of the family labour by modifying the marginal incomes which are necessary in order to induce the family to work for varying amounts of time.

If a fall in price reduces these “costs” by more than the price decline, then output will expand. In discussing the effect of a price fall on the output of a farm with hired prime factors we tacitly assumed that the cost of these factors remained unchanged. The difference we found between the behaviour of a family farm with few prime costs and that of a farm with hired labour depends almost entirely on this assumption.

If, in fact, a fall in price were likely to reduce prime costs by as much as it lowered the “costs” of family labour, there would be no difference in the reaction of the two types farms.

It is, in most circumstances, reasonable to assume that a change in the prices of all agricultural products will alter the farmer’s willingness to work for a given marginal income more than it will alter prime costs. But it is not true, in general, that a fall in the price of agricultural products will leave agricultural prime costs entirely unaffected.

If the fall in price is the result of a shift in demand from agriculture to industry, and if the prime factors used in agriculture are entirely an specialized between agriculture and industry, then prime costs will not alter appreciably, since the factors dismissed from agriculture will at once be absorbed in industry. In fact, of course, labour is to a certain extent specialized, and some of the raw materials of agriculture; such as fertilizers, are not required in industry.

The fall in the demand for the prime factors will thus produce some decline in their price, before they will be transferred to other uses. For fertilizers, but not for wages, this decline may be a great as the fall in the price of the farmer’s output.

If the fall in price is not confined to agricultural products, but is general to all commodities, it will be difficult for any factors to find employment elsewhere, so that their prices will almost certainly fall.

Actually, however, costs rarely fall as fast as agricultural prices, largely owing to the stickiness of wages Normal wages, particularly in farming, are sometimes comparatively little above the amount the worker would receive in unemployment pay or poor relief if he wore out of work. In addition, wage-earners, especially in industry, often unite to prevent a reduction in wages. For both these reasons, costs, though they do decline in a depression, fall far less than prices.

“We may note a difference between industry and agriculture here. Wages are even more immobile in industry than they are in agriculture so that prime costs fall less in industry than in agriculture during a depression. This is a further factor tending to make the decline in agricultural output as price falls less than that of industrial.”

So far we have considered the adjustment of agriculture output as a whole to a change in the price of all agricultural products. We had that, although a decline in industrial prices tends to diminish output even in the short period, this is by no means universally true in agriculture The prime costs of hired factors form a much smaller part of total costs in agriculture than in most industrial undertakings, while these costs are usually reduced more, in time of depression, in agriculture than in industry.

Moreover, output is, in a number of farms, largely dependent upon the amount of work done by the farmer and his family, which may be increased rather than diminished when prices fall. Thus agricultural production, as a whole, is slow to adjust itself to price changes. There is clear evidence that this is so. During the world depression of prices from 1929 to 1932, while total world manufacturing production, as measured by the League of Nations, fell by 37 per cent, and non-agricultural primary production, by 31 per cent, agricultural production only fell by 1 per cent, Agricultural output as a whole, is comparatively little affected by prices in the short run.

Shifts of Supply within Agriculture:

Now we may consider the effect on the output of individual agricultural products of a decrease or increase in the price of that product only. In the long run, a fall or rise in the price of any product will lead to a decrease or increase in its output. The extent of the change must depend upon how rapidly costs alter as the scale of production is changed. Every commodity will be localized in the places most suitable, under all the circumstances, for its production.

If its output is increased, farmers must grow it in areas less suitable, either because of climate, soil or distance from the market, and must intensify existing cultivation, thereby, perhaps, obtaining less advantage from the diversification of farming. For this reason, an increase in the output of any product will result in higher costs, but, for the same percentage increase in output, costs are unlikely to rise as fast as they would have if all farm output were increased.

In the short run, however, individual farm products respond very differently to price changes than does agricultural output as a whole. The reason for this difference is that most farm products are produced together, and are generally joint products, or represent a composite demand for the factors of production. This intermingling of production, to begin with, complicates the former’s decisions. It is almost impossible for him to tell what are the marginal costs of any particular product.

Thus suppose beef prices fall. Should he decrease output? If he does, he will have less farmyard manure to put on his potatoes; and potato prices may have risen. In spite of the difficulties, however, there is no doubt that many farmers do respond to changes in relative prices Thus, in England, a rise in pig prices by 10% before the war increased pig numbers 21 months later by about 6%, and a rise in wheat prices had a very similar effect on the acreage of wheat planted a year later.

Agricultural output, as a whole, is insensitive to price changes, particularly in the short period, since the land capital equipment and acquired skill of agriculture arc of little value in industry, Individual farm products are generally sensitive to price, as a large part of the capital they need, and much of the skill, is almost equally useful in producing other products. This is particularly true on a mixed farm.

There the farmer and some of his workers will have had experience in growing many products and can, without great difficulty, vary the proportions in which they are produced. A good deal of the machinery used for wheat production is equally suitable for other cereals, and these can take the place of wheat in the rotation.

The sheds used for housing beef cattle can be adopted, though at some additional cost, for dairying, while dairy cows can be killed for beef if milk prices fall. It must be noted, however, that supply will alter more if the price of some product alters relatively to that of others which use the same equipment, than if the prices of both such products varied together. Thus wheat acreage in U.K. is rather more affected by changes in the price of wheat relatively to that of barley than to changes in the price of wheat relatively to any other individual product.

There are some farm products, of course, like coffee in Brazil, or cotton in some of the Southern United States, which are almost the only crops which can be grown in the district. Where this is so, output will respond to price changes in much the same way as does total agricultural output in countries of diversified farming.

Even on a specialized farm, however, the farmer can generally more easily learn to grow a new farm product than he can turn to industry, and much farm equipment can be adapted from product to product, so that a fall in the price of the specialized product alone will result in some diversion to the other farm products.

Apart from the such crops, the output of any individual farm product is generally as responsive to price in the short period, if not more so, as is the output of any individual industrial product. The capital equipment of agriculture is more adaptable between product and product than the capital equipment of industry, which compensates for the lesser degree of adaptability produced by the low level of prime costs in agriculture.