Consumer DemandConsumer Demand Various quantities of a commodity Various quantities of a commodity

that an individual is willing and that an individual is willing and able to buy as the price of the able to buy as the price of the commodity varies holding all commodity varies holding all other factors constant.other factors constant.

Consumer DemandConsumer Demand Demand begins with individual Demand begins with individual

consumerconsumer Inverse relationship between Inverse relationship between

quantity and pricequantity and price• Two dimensional, Price and QuantityTwo dimensional, Price and Quantity

Downward sloping Downward sloping demanddemand

Begin with individual’s utility Begin with individual’s utility function and a budget constraintfunction and a budget constraint

Substitution effectSubstitution effect• consumers buy what’s cheaperconsumers buy what’s cheaper

Income effectIncome effect• ““income” increases if prices fallincome” increases if prices fall

Retail Poultry Deflated Price and Consumption

$0.90

$1.00

$1.10

$1.20

$1.30

$1.40

$1.50

$1.60

$1.70

$1.80

35 45 55 65 75

75

77

76

72

70

71

73

74

85

84

8382

81

80

79

78

89

88

87

86

97

96

94

95

9392

91

90

98

Per Capita Consumption in Pounds

Pork Deflated Price and Consumption, Retail

$1.00

$1.10

$1.20

$1.30

$1.40

$1.50

$1.60

$1.70

$1.80

$1.90

$2.00

48 50 52 54 56 58

96

97

86

87

82

90

91 84

83

89

85

88

00 98

93

95

92

94

99

81 80

Per Capita Consumption in Pounds

Market or Aggregate Market or Aggregate DemandDemand

Add individual demand curvesAdd individual demand curves Horizontally across consumersHorizontally across consumers http://www.aaec.vt.edu/rilp/Demandhttp://www.aaec.vt.edu/rilp/Demand

%20Changes-2000.pdf%20Changes-2000.pdf (Pages 1-10) (Pages 1-10)

Beef and Pork Demand Index, 1997 Base

0

50

100

150

200

250

1980 1985 1990 1995 2000

Beef Pork

Source: Research Institute on Livestock Pricing

Demand is a function ofDemand is a function of

Price of substitutesPrice of substitutes Price of complementsPrice of complements Consumer incomeConsumer income Taste and preferencesTaste and preferences IS NOT FUNCTION OF THE IS NOT FUNCTION OF THE

GOOD’S OWN PRICEGOOD’S OWN PRICE

Change in Demand orChange in Demand orin Quantity Demandedin Quantity Demanded

Px

Qx

D1 D2

A

B

Moving from A to B due to a price decline is a change in quantity demand.

A shift of the demand curve from D1 to D2 is a change in demand.

C

Factors effecting Factors effecting aggregate aggregate demand for a productdemand for a product

ExportsExports New product developmentNew product development AdvertisingAdvertising New informationNew information Product differentiationProduct differentiation

Income effect on food demandIncome effect on food demand

Food is normal goodFood is normal good• Income demandIncome demand

• Particularly important for meats Particularly important for meats

• Emerging economiesEmerging economies

Services are a normal goodServices are a normal good• Income servicesIncome services

Inverse Demand Inverse Demand

Price is a function of quantityPrice is a function of quantity• P = P = ff(Q)(Q)

Important in agricultureImportant in agriculture• Short run supplies are relatively fixedShort run supplies are relatively fixed

• Prices change to clear the marketPrices change to clear the market

SupplySupply

The amount of a given commodity The amount of a given commodity that will be offered for sale per that will be offered for sale per unit time as the price varies, other unit time as the price varies, other factors held constant.factors held constant.

SupplySupply Derived from cost functionDerived from cost function

• Production functionProduction function

• Input - output relationshipInput - output relationship

Assume that firms seek toAssume that firms seek to• Maximize profitsMaximize profits

• Minimize costsMinimize costs

Supply starts will individual firmSupply starts will individual firm

Production FunctionProduction Function

Total Product

Input

Output

Increasing returns to the input

Decreasing returns to the input

Opportunity costOpportunity cost The opportunity cost of commodity The opportunity cost of commodity

A is income forgone by not A is income forgone by not producing commodity B.producing commodity B.

Measures of opportunity costMeasures of opportunity cost• Market value of inputMarket value of input• Expected return over other cost of not Expected return over other cost of not

producing commodity B.producing commodity B.

Cost CurvesCost Curves Average variable cost = AVCAverage variable cost = AVC

• Total variable cost / QTotal variable cost / Q• Variable costs change with QVariable costs change with Q

Average fixed cost = AFCAverage fixed cost = AFC• Total fixed cost / QTotal fixed cost / Q• Fixed costs do not change with QFixed costs do not change with Q

Average total cost = ATC Average total cost = ATC = AVC+AFC= AVC+AFC

Cost CurvesCost Curves

Marginal cost = MCMarginal cost = MC• Change in total cost by producing 1 moreChange in total cost by producing 1 more

• TC / QTC / Q

Cost curvesCost curves

Cost

Q

MC

ATC

AVC

Supply curveSupply curve

MC curve above AVC curveMC curve above AVC curve Upward sloping curveUpward sloping curve

• Optimal output @ MC = MROptimal output @ MC = MR

• MR = Price => Optimal at MC=PriceMR = Price => Optimal at MC=Price

• The last unit of input just pays for itselfThe last unit of input just pays for itself

ProfitProfit Profit = total revenue - total costProfit = total revenue - total cost

• TR= P x QTR= P x Q

• TC = ATC x QTC = ATC x Q

Profit per unit = Profit/QProfit per unit = Profit/Q• = TR/Q - TC/Q= TR/Q - TC/Q

• = P - ATC= P - ATC

Profit maximizing QProfit maximizing Q• MC=MR=PMC=MR=P

• Profit/Q = P-ATC at optimal QProfit/Q = P-ATC at optimal Q

Optimal Q at P=MCOptimal Q at P=MC

MC

ATC

AVC

P1

P2

Cost

QQ1 Q2

Market or Aggregate Market or Aggregate Supply Supply

Combination of individual supply Combination of individual supply schedulesschedules• Add horizontally across firmsAdd horizontally across firms

Flattens with timeFlattens with time• More time to adjust supplyMore time to adjust supply

Market supply curvesMarket supply curves

Qx

PxSShort run

SLong run

Cost curves and supplyCost curves and supply

Shut down if P < AVCShut down if P < AVC• Lose on every unit producedLose on every unit produced• P>AVC make some payment to fixed costP>AVC make some payment to fixed cost

In the long run everything is variableIn the long run everything is variable• Short run defined by having fixed costShort run defined by having fixed cost

Long run supply curve for individualLong run supply curve for individual• Low point on ATC curveLow point on ATC curve

Market supply curves

Qx

Px S1 S2A

BC

Move from A to B is a change in quantity supplied due to a price decline.

Move from B to C is a shift in supply.

Supply Shifts from Supply Shifts from ChangeChange

in input pricesin input prices in returns for competing enterprisesin returns for competing enterprises in technology on yields or costsin technology on yields or costs in price of joint productsin price of joint products in yield and/or price riskin yield and/or price risk institutional constraintsinstitutional constraints

Additional referencesAdditional references

Reading roomReading roomAgricultural Product Prices, Agricultural Product Prices, Tomek & Tomek &

Robinson Chpts 2 and 4.Robinson Chpts 2 and 4.