Economics of Food Economics of Food DemandDemand

Dr. George NortonAgricultural and Applied

Economics,College of Agriculture

& Life Sciences,Virginia Tech

International Agricultural Development and Trade

AAEC 3204

Objectives TodayObjectives Today

Identify determinants of food demand

Begin discussion of income elasticities and price elasticities of demand

Effective demand for food

Food NeedFood Need

Determinants of Food DemandDeterminants of Food Demand

Income

Price (own)

Price (substitutes + complements)

Population

Habits, customs, preferences

Figure 1: Demand CurvesFigure 1: Demand Curves

0 500 1000 1500 2000 2500

200

150

100

50

B

A

Price, $ per ton

Quantity, million tons per year

Demand curve at higher income (D’)

Demand curveat low income (D)

B’

A’

Engel’s Law & Bennett’s LawEngel’s Law & Bennett’s Law

Engel’s Law -- As income increases, people spend a smaller proportion of their total income on food.

Bennett’s Law -- The richer one becomes, the less he or she spends on starchy staples

Measure of Income Growth on Measure of Income Growth on DemandDemand

Income elasticity of demand:

21

2

3.01

3.0

%

%

Q

I

I

Q

I

Q

How do we measure the effect of income growth on the demand for a commodity?

Size of income elasticitiesSize of income elasticities

Normal Goods?Normal Goods?• Zero to oneZero to one

Superior Goods?Superior Goods?• Greater than oneGreater than one

Inferior Goods?Inferior Goods?• NegativeNegative

Income elasticities of demand Income elasticities of demand for agricultural commodities in for agricultural commodities in

Sub-Saharan AfricaSub-Saharan AfricaWheat .92

Rice .93

Maize .46

Millet .15

Roots & tubers -.04

Pulses -.14

Income elasticities Income elasticities differ by countrydiffer by country

CerealsCereals BeefBeef MilkMilk

BrazilBrazil .15.15 .58.58 .45.45

NigeriaNigeria .17.17 1.201.20 1.201.20

Own Price Elasticity of DemandOwn Price Elasticity of Demand

Q

P

P

Q

P

QEp

%

%

Ep > |-1| Elastic

= -1 Unitary elasticity

< |-1| Inelastic

Price

Quantity

inelastic

elastic

Income EffectIncome Effect

If the price of a commodity increases, the real purchasing power of a given

amount of income is reduced, causing demand to change because of an

“income effect”.

Cross Price Elasticity of DemandCross Price Elasticity of Demand

2

1

1

2

1

2

%

%2,1 Q

P

P

Q

P

QEp

+ Substitutes

0 unrelated

- complements

How are elasticity How are elasticity estimates obtained?estimates obtained?

ePOPdIcPbPaQ wrr Pr

Qr

Q

Pb

P

Q

Q

P

r

r

Q

P

P

Q

bP

Q

ln

ln(if in logs)

Homogeneity ConditionHomogeneity Condition

02,11 pp EE

own price elasticity

income elasticity

Cross price

elasticities

Example of using Example of using homogeneity conditionhomogeneity condition

Commodity Cross-price elasticity

Rice & beans -.35

Rice & wheat .60

Rice & chicken .10

Rice & milk -.05

Rice & other goods 0

Income elasticity of demand for rice

.4

How much would the rice price have to decrease in order to increase rice consumption by 7%?

What happens to aggregate food What happens to aggregate food demand as income grows?demand as income grows?

D = P + ngD = rate of growth of demandP = rate of population growthn = income elasticity of demandg = rate of growth of per capita

income

D = P + ng

Example:

D = 3.0 + .9(-3) = .3

D = 2.5 + .7(3) = 4.6

Change in Aggregate Food Change in Aggregate Food DemandDemand

Level of income

Rate of population growth

Rate of per capita income growth

Income elasticity of demand

Rate of growth in demand

Very low 2.5 0.5 1.0 3.0

Low 3.0 1.0 0.9 3.9

Medium 2.5 4.0 0.7 5.3

High 2.0 4.0 0.5 4.0

Very high

1.0 3.0 0.2 1.6

D = P + ng

Commodity Trends and Commodity Trends and ProjectionsProjections

Cereal demand (food, feed) Meat demand Grain production in LDCs Grain imports in LDCs U.S. grain exports Food prices Per capita food availability in LDCs Child malnutrition

Cereal Imports by RegionCereal Imports by Region

Net Trade by RegionNet Trade by Region

Growth in Cereal Production

Cereal Yields by RegionCereal Yields by Region

Factors Affecting Real PriceFactors Affecting Real Price

Supply factors?Supply factors?

Demand factors? factors?

What are some of the factors that will What are some of the factors that will affect the real price of food over the affect the real price of food over the

next 10 – 20 years?next 10 – 20 years?

Factors affecting location of Factors affecting location of the supply curvethe supply curve

Technology Number of sellers Substitutes in

production Input cost

Price

Quantity

S1S2

Using Supply & Demand CurvesUsing Supply & Demand Curves

1. For a commodity?

2. For groups of commodities?

How can one use supply and demand curves to predict future price

changes?

Price

Quantity

P1

Q1

Supply

Demand

Rate of Growth of Agricultural PricesRate of Growth of Agricultural Prices

% change P = % change F - % change Qprice elasticity of demand

P = price

F = production

Q = quantity demanded

How do agricultural prices How do agricultural prices affect the pooraffect the poor

Farmers?

Consumers?

Indirect effects? if

ConclusionsConclusions1. Income increases for the poor can have a

large effect on nutrition because poor spend a high proportion of their budget on food.

2. Need to increase supply for commodities with high income elasticity of demand (n). Otherwise, prices will rise

3. If n is low, but country wants to increase consumption of a good, need education or a subsidy.

4. At world level: shift to feed grains as income rises.