[Chris:] Right, what er we're going to do er, today is start er, supply, because we've dispensed with our, of demand we're now going to have a look at the nature of agricultural supply. What I'll do this morning is just give a general introduction to supply response, erm, and then er, on Friday, we'll start to develop erm, theoretical models of agricultural supply and response called a Nirdel supply and response model. The first thing to note about agricultural supply and response is that it is immensely complicated, alright. I think what we'll do, just start by writing up what we could describe as a sort of theoretical er, supply function. Right, so the quantity supplied right, let's just say, as a function of price of X, the prices of other products, Y, right, to N, prices of inputs one to N, er, what other things can we include? The number of firms supplying the industry, er, we'll go through these in a bit more detail in a moment, I'll just put them down. Size distribution R, technology used in production, T, stocks, weather, er, risk aversion, I'll go through all these later, I mean. The list of possible influences on supply is, is exhaustive, erm, and as a result any models of agricultural supply response tend to be very, very simple, and it's very easy to get a complicated model simply by looking erm, at why, one of these factors, disregarding er, any other, any other of these complications. Erm, but agricultural supply is complicated simply by the, the actual nature of supply in that you know, farmer has N, N products that he could produce. Alright, he could grow wheat, or he could grow, grow barley, possibly he could transfer into milk production, pig production, erm, so the prices of all those other commodities are going to be important. Er, this production of good X, likewise inputs, huge variety of inputs used in agricultural production, er, may again, er, will have ramifications on the supply of any one particular good. Right, but nevertheless, we can say that if the price of X rises, right, it's likely that the constant of X is going to rise. Right, it simply serves its purpose, right, higher prices will mean greater revenue, and if other things remain constant then that means more profit. So we've got, as I say, we could hypothesize a, er positive relationship between knowing the price and er, quantity supplied. However, [LAUGHTER] just to complicate things [] at a very early level, it's often observed that agricultural products have what's called a perverse supply response, in that there's a negative relationship between prices and output. Can you think of a reason why that, that might be the case? Why if prices fall, right, should output rise, or might it rise, any ideas?
[speaker002:] Because er, to produce more output you have to have a bigger stock, and therefore the price goes up, so you produce more, decreasing not quite so much, and keep a greater percentage than you did last year, so that for cows, as the price goes up you've got to counteract it again, cows this year, and try to sort of, keep my, get my herd bigger and bigger, and profitable.
[Chris:] That's right, so instead of, so if er, say if the price of erm, yes, say, meat went up, erm, so the price of beef, beef went up, you may want to increase the size of your beef herd, how do you increase the price of your beef herd, well you, you don't sell as, as many cows to the slaughterhouse as you might otherwise would, you know, would do, because you want to increase your herd for, for later years. Alright, so what's coming now is this idea of time is very important in agricultural supply response. Right, if we want to increase the long run output we may have to reduce short run output. Okay yes, that is er, very good, very good example. If you think of it the other way when, what happens when a price, when a price falls, alright, if farmers er, assume that price fall will be sustained over a number of periods, then they think, right well in order to achieve the same level of income, right, as I did previously, if prices have fallen, I'm going to have to increase my output. Right, the sort of the agricultural treadmill process, this is often referred to er, in that price reductions lead to increases in output as farmers try to maintain some satisfactory level, level of income. And this an argument that's often put forward by the National Farmers Union, and other agricultural lobby groups, essentially erm, er,, it's saying to sort of er, the European Community when they're price setting, look there's no point in you er, reducing agricultural product prices, cos all that's going to do is increase supply. One of the main problems of the European Community is over-supply, alright, so they try and use it as an argument, this perverse supply response, as an argument to maintain prices at their current level. Alright, now, whether there is a perverse supply response is, is an empirical question erm, and it's generally observed that perverse supply response is about as common as a that we looked at in demand analysis. Attracts a great deal of attention, erm, from theorists, but in er, in reality, it's not as common as some lobby groups might suggest that it is. But nevertheless, we don't necessarily always need to observe a positive erm, a positive relationship between own price and er, quantity supplied. Right, if we broaden the number of commodities, and recognize that er, farming is a multi-product enterprise, alright, farmers just don't produce one produce, alright, they tend to produce a whole range of products, and therefore we've got to accommodate these inter-relationships between prices of barley, prices of wheat, prices of oil seed rape,s and er, and so on and so forth, and there can be a nu a number of fairly complex inter-relationships er, there. Alright, if products are competing, alright, say like wheat and barley, they, they could be, termed competing products in supply, so if the price of barley went up, erm, that may have implications on the amount of output of wheat produced. Alright, simply because farmers switch production, alright, away from wheat, into the more prosperous barley. Alright, now not all products are going to be, you know, you can't switch with the same amount of ease across all products, there are only, you know, if you are erm, a wheat farmer in the south east of England, alright, you're not likely to switch into milk production just bec just because milk prices have risen. Right, you don't have er, the climatic conditions, or possibly even the expertise erm, to, to, to sort of, to switch. Alright, so, although there may be some switching possible, it's, that's, the degree of switching won't be the same for, for all er, for all commodities. Alright, not only do we have competing products on the farm, but we have joint products on the farm, in that if you rear sheep, sheep are not only used for the meat that they produce, but also the wheat [LAUGHTER] [] the er, the wool that's on, that's on their backs. Alright, so increases in er, say the subsidy on sheep will have impacts on the wool market.... Okay, but if, as a general statement, if products erm, are joint products in supply, it's likely that there'll be a positive relationship right, between the price of er, the joint product and the quantity supplied of the, of the product in question. Right. So we need to know, on what, on what farms are products er, competing or erm, or, or are they produced jointly. Okay. Something else that's very important there, T, denoting the effect of technology. God, this is really, hello can you still hear me? Oh well, right, so technology is very important. The effect of technology is twofold. The first effect of technology is that it increases the productivity of farms, right. Most cereal yiel yields, potato yields have risen between two and three percent per year er, in the U K. Right, and that increase in production has come about through the use of technology, whether it be agro-chemicals, better seed varieties, more mechanization, technology has increased production per unit of land, alright, per unit of labour. The technology also has the effect of increasing the variety of production methods... farmers can either er, rear livestock extensively, or intensively, where the technology for intensive production exists, and if you're not familiar with the technology of intensive say, milk production erm, or, or it doesn't exist, then clearly you won't be able to, to use those intensive tech techniques.... You know, you can grow bananas in Scotland if you want, the reason why you can do that is that we have the technological know-how in order to do that. Okay, we can't really say anything about agricultural supply unless we acknowledge the institutional setting in which farmers er, actually produce food. Now, in most countries in the developed world the institutional setting is by far the most important factor, alright, simply because food subsidies and protectionism, er, is er, second to none in agriculture.... Alright, and policy measures designed to protect agriculture, can have either a direct effect on production or an indirect effect. For a direct effect, well, think about milk quotas, supply and control of potatoes in the potato market, potato quotas, clearly
[speaker002:] [cough]
[Chris:] clearly the government is saying you are only allowed to plant a certain acreage, but that will clearly affect erm, farmers, farmers' response. Indirect effect is, is through, through prices, in that most erm, intervention in agricultural markets is through er, price manipulation. Alright, higher prices mean that in order to increase income, the farmers need to produce more output, right, there, so erm, there's a coupling of support to, to output. Right, so the more that you produce, the more in the higher income you'll get, because prices are higher. Right. So how do farmers produce more in that situation, well they apply lots of technology. Right, they apply agro-chemicals er, and so on, use machinery, etcetera. Alright, so although the institutional setting can have a direct effect alright, it's much more likely that the effect will be indirect, right, through, through high prices, and in order for, farmers to er, reap the benefits of support, they need to maximize their yields, and that's what farmers have done in this country. That's why yields have grown so much because there's been a certainty of relatively high and growing prices, and therefore, in, in order to, to maximize their income, farmers are, er, maximizing yields. Alright, yield maximization is not a necessary condition for profit maximization, alright, in er, in a free, free market. Alright, however, when prices are fixed, it cer certainly is. Right that's, we've already mentioned or alluded to the fact erm, that time is very important in agricultural supply. Right, and in virtually any agricultural supply response model, we'll need to include time. Most agricultural response models er, are dynamic, in that they do incorporate time. Why, why is that the case? Why do we need a dynamic specification?... Well, we ought to recognize that if prices are increased there won't be an instantaneous er, change in supply which in inferred from our static models.... Essentially because there is a erm, a production lag, or a growing season that we, farmers will have to base their production decisions alright, on previous prices. Alright, when the supply comes on to the market, you know, it may be nine months down the road if it's an annual crop, if you're looking at something like erm, production of cocoa, right now, a cocoa tree takes about nine years to mature, therefore alright, you're not going to know what prices are going to be nine years down the road, you're going to have to base your production decisions and therefore your output decisions on what prices are nearly a decade, nearly a decade ago. Okay, so because there is this production time lag, there is a growing season, right, we need to incorporate time into our models. So that's one reason why we need a dynamic specification. Another reason is that farmers are often reluctant, right, to change their output, erm, or adjust their, their output instantaneously, and either un unable, or basically unwilling, and there is psychological resistance to changing the technique of production. Alright, if an innovation comes onto the market that enables a farmer to increase his output, alright, if that er, innovations that lies, lies outside of erm, sort of orthodox or traditional methods there may be a psychological resistance to actually adopting it simply because we're a newfangled thing ooh, I, I don't know how it's going to, how it's going to work. They say it's going to increase production, but it may involve other costs. It may, although production on average may rise using this innovation may increase the, the variability of output, and farmers don't like variations in output. It may off it may also take time for farmers to acquire the skills necessary in order to increase, or to use, to adopt this technology. Alright, and will give, give rise to a delayed response, so even though prices may rise, farmers' output response won't be immediate, right, not only because of the growing season that's involved, but due, but due to psychological resistance, erm, to the adoption of that technology, and also it may take time to acquire the necessary skills to implement that technology.... Right, [clears throat] er, okay. Other things that might, er, impinge upon the supply response over time, might be things like erm, er, rotations. Now rotations are frequently used in agriculture, and if you're locked into a rotation, it doesn't really matter what happens to current price, you're not going to be able to af to change your output, right, because you've got to er, keep into this, in this rotation. You've got to leave land fallow, or erm, you know, you, you can't indulge in mono-culture continuously, or if you do, you've got to be, you've got to manage the soil condition very, very carefully indeed, you can just er, produce a desert if you're not, if you're not careful. Alright, so where farmers are locked into a specific rotation, and rotations are quite generally used, alright, they may not be able to erm, change their output erm, until they can change the rotation. Alright, a, another reason erm, we could term asset fixity, it's in general erm, fixed, fixed factors, right, erm, or fac factors of production in agriculture are dominated by fixed factors, right. Essentially land and expensive capital machinery. Okay. So, in the short run, by definition, you can only change output, the response or by changing variable factors in production. Changing the level of, [clears throat] agro-chemical intensity, right, possibly er, labour input. Alright, but you won't be able to change, the d the, the underlying constraining factor erm, of production, which is the amount of land you have. Alright. Alright, so, short run supply response is generally much more inelastic than, than long run supply response, due to this asset fixity argument.... Also, farmers are going to be, because most of the assets on a farm are fixed assets, right, farmers are going to be very reluctant, alright, to cease production just because prices are low for a couple of years. Right, economic theory tells us that production will continue in, in the short run providing average variable costs are covered. Alright.
[speaker002:] [cough]
[Chris:] Now, if most of the erm, factors of production used on the farm are fixed factors, farmers may well continue for years and years erm, because although they're not cove covering total costs, or, or total average costs, they are covering average variable costs, alright. The costs of the seed, the cost of chemicals, the cost of casual labour. Alright. So even when prices do fall very low for quite long periods of time, alright, farmers will still maintain production, even they're making losses. I mean, you can make losses in the short run, it's rational to do so, alright, where, where a large proportion of your costs are, are fixed costs essentially. I mean if you, in the agricultural depression of the nineteen thirties, that's a depression that lasted erm, the best part of a decade, you know, but farmers didn't go out of production you know, for about five, six, seven years down the line, because virtually all of their assets were tied up in fixed assets. Right, they're able to cover their variable costs, alright, but not their, not their fixed costs. And so it took a great deal of time erm, in the nineteen thirties, for farmers to cease production. It did occur because the depression was so er, was so long erm, but by and large, farmers don't go out of, don't cease erm, production just because of a couple of years of er, poor harvests or low, low prices. Right, I mean the exceptions to, to the sort of, that general sort of rule of thumb are enterprises where variable costs account for a large proportion of total costs, things like egg production, pig production, they tend to be very short run supply elasticities tend to be very high in those type of enterprises, primarily because most of the costs, alright, are tied up in, in variable costs. Alright, you don't need expensive machinery, large amount of land, right, to produce or, or pigs. I've got a number down here, er, seventy percent of total costs of egg production are var are variable costs, and essentially that's the feed, the chicken feed. Right again, horticulture is another enterprise where fixed costs only represent a quite small proportion of total costs. Alright, in something like horti horticulture, right, the main, the main cost is going to be harvesting costs, the labour, the labour costs, right, and this is why if you go into the er, into somewhere like Somerset when there's been a bumper harvest, and just see the fruit rotting on the trees. Farmers won't even bother to harvest it, right, simply because, the bulk of it, the total production costs, will be labour, will be the labour costs of harvesting, and if they can't cover those labour costs of harvesting by selling their produce, which they won't be able to if there's been a bumper harvest because prices are very low, they'll just leave the things rotting on the trees and er, that is, that is what, what happens quite regularly in horticultural markets which tend not to be markets that are supported through the Common Agricultural Policy. Right, [clears throat] erm... So compounding this effect of asset fixity may be erm, the case where a number of similar products, or competing products er, their, their prices fall simultaneously, so if you're, you know, if you're wheat, if you're a cereals farmer in the south east of England, alright, and the prices of wheat, barley, and virtually all, sort of, oil seed rape, anything else that you can use the land for, if they all fall, you know, there's no point in switching production, alright, so you may continue to, to produce, even though the price of the product has fallen, alright, because the prices of all other competing products has fallen. Right, and you simply may not be able to switch into milk production or horticulture, because you don't have the technological know-how, or the soil may be inappropriate, the climate may be inappropriate, right, so that's another factor, influencing, well making er, supply quite rigid, quite inflexible in, in the short run.... Erm, clearly in an in any agricultural supply function, you may want to incorporate the fact that weather plays a vitally im important, important role. How do we incorporate that? I don't really know, it's, it's quite difficult. Alright, because the weather, although clearly er, important, is a multi-faceted concept, in that it involves rainfall, sunshine hours, and not only the amount of rain, the amount of sun, but when those things actually occur. Alright, I mean, erm, I don't know if you'll be able to see this... right... [LAUGHTER], erm, let's just do it like that, I haven't got the overhead with me today. What I've got here is a time series of potato yields over time. Right now, potato yields are quite variable, right and erm, not only are they variable, but on this time series of yields you can, you can see the effects of technology. Right potato yields are just er, are rising quite dramatically, particularly since this point here is the end of the Second World War, and over the last part of this graph you can see yields have risen dramatically. But notice here in seventy er, seventy three and four, is that right, seventy three and four, alright, yields fell, alright, by about a third, well, well over a third in two, in the two years. That was the effect of weather, right. In the first year, right, there was not enough rain, right, in order to swell the tubers, right, presumably the same thing happened in the second year, but no, the reason why er, yields were very low in nineteen seventy four, was because there was too much rain. Alright. Okay. The weather's pretty complicated to model and er, although it is vitally important in er, agricultural supply, it's very difficult to incorporate into, into models. If it is incorporated, there's usually an index of er, of rainfall that's used. Right [clears throat] another thing that we want to er, want to incorporate is risk or un or uncertainty. Agricultural production is inherently uncertain. In a free market that uncertainty comes from both erm, production uncertainty, good, good yields, bad yields due to poor weather, or good weather, but also comes from price uncertainty. Alright, now farmers are notoriously risk-averse, right, in the face of uncertainty. Right, so given a choice between erm, an average, a guaranteed income of say fifty pounds per hectare... right if they're given a cer a certain, if that fifty pounds is certain every year, alright, they will choose that every time in a, er, well just yes. A cert certainty equivalent of fifty pounds per year would be erm, would be desired, or chosen virtually all the time, in preference over erm, incomes of sort of zero and a hundred in alternate years. I mean, in the long run their both, they both give the same outcome, alright, but farmers want to try and avoid that variability of income, alright, so they'll much prefer to, instead of having, you know, they probably prefer erm, a certain income of forty pounds rather than erm, an equal chance of getting one hundred pounds or zero. Right, clearly that's not erm, profit maximizing. Right, however, variability is something that isn't taken into account, right, in our normal models of profit, profit maximizing behaviour. Right cos they're static models, alright, there's no uncertainty there. When we include uncertainty, er, we ought to acknowledge that farmers may behave not as profit, profit maximizers erm, but as profit satisfiers, and that's reflected in their, in their risk-aversion. Right, now if they're acting rationally, right simply because you have a zero income of say two years on the trot, you may just well be driven out of business, if you're er, a farmer in the developed, developing world you may er, possibly thrown off the land, or you may even starve. Alright, so farmers like to er, reduce erm, variability of their, of their income. Right. We'll come onto this later, later on, but er, it can be shown quite easily, why farm, how farm, why farmers er, behave what you may, from what economic theory would tell you is, is an irrational manner, alright, and it's simply because they're trying to minimize their, their risks. Alright, risk and uncertainty is something that's excluded from most economic models. Okay, so they'll always choose options, farmers will always choose options that are, are less risky. And the best way to do that on a farm is to diversify, and this is why most farms in the U K are mixed farms. Alright. They grow, they grow a proportion of, of er, some of their land is devoted to crops, some of their land is devoted to, to livestock.... So they're all, they're trading off their gains from economies of scale, right, with erm, variability of, of income that may result from sort of, putting all their eggs in one basket, so diversification is the main way in which farmers cope er, with an uncertain environment. Okay. Erm, right.... So we can just, if we have look now at the effect of time... on output to supply diagram, okay, in the short run supply will be very ine inelastic. Alright, but as you move through time, the supply response becomes increasingly more elastic. Right, now let's just say, P one... P two, right, prices change from P one to P two in the short run, the change in quantities can be very small. But, due to the factors that we've mentioned, alright, the supply will ex will expand progressively over time, right, so our long run supply curve... alright, will become a lot more elastic than the short run supply curve, right, so if you think of our elasticity formula, I over changing quantity over changing price, times price over quantity, right, as we go through time... our original, our original prices and quantities are going to stay the same, right, P one, Q one, that's not going to change through time, right. If this price change is maintained, and delta P is going to stay the same, right, the only that thing that changes is the level of output, right, which is in the numerator. And as a result, long run elasticities alright, are always greater than short run supply elasticities. The only thing that's changing is, er, farmers' response to a, to a price change. Right,... erm... I think in actual fact, we'll er, we'll leave things, we'll leave things there. I won't bother starting, starting this. Right. Sorry.... Oh, er, that was probably something, hang on, er, probably structure of industry or something erm... oh, N, that gives N, number of, number of firms supplying the market, you know, perfect competition in the
[speaker002:] Have you got that one? Yes, what, I'm sorry, have you got some time on tomorrow? Is there by any chance, any tea or coffee?