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S6 Economics

Price Fluctuations

Price  fluctuations  refer  to  the  state  of  upward  and  downward  movement  of  prices  especially  of agricultural products. There is greater oscillation in prices of these goods as compared to prices of manufactured goods. 

 

THE CAUSES OF AGRICULTURAL PRICE FLUCTUATIONS:  

  1. The long gestation period. The agricultural commodities have long gestation period and their supply cannot be increased in the short run which forces prices to rise. However in the long run after harvesting the supply increases which forces the prices to fall due excess supply on the market. 
  2. Bulkiness of agricultural products hence difficult to transport.  Most of the agricultural products are bulky and cannot easily be transported from areas of plenty to areas of scarcity. In areas of plenty prices reduce due to the excess supply and in areas of scarcity prices increase due to shortage. 
  3. Natural factors which affect the level of output.  Unfavourable natural such as poor soils, prolonged  drought  reduce the supply  of  agricultural  products  which  forces  the  prices  to rise. On the other hand favourable natural factors such reliable rainfall, fertile soils leads to   increase in supply of agricultural products which forces the prices to fall due to excess supply. 
  4. Perishability  and  thus  difficulty  of  storage  of  agricultural  products. Agricultural products  are  highly  perishable and  they  cannot  be  stored  for  a  long  time  and  therefore producers are  forced to  sell them quickly because they cannot be stored for a long time which leads to a fall in their prices However after most of the produce is sold, the supply reduces which forces the prices to rise due to scarcity. 
  5. Many  producers  hence  planning  is  difficult/poor  planning  by  the  farmers. When farmers fetch high prices in one season, they plan to produce more in the following season which increases supply and thus forces the prices to fall, on the other hand if the prices are low in one season farmers plan to produce less and thus force the prices to rise because of the shortage.
  6. Weak bargaining position of LDCs on the world market/ External determination of prices of agricultural products. The major buyers of agricultural products from LDCs like Uganda dictate the prices of agricultural products, when they dictate low prices in the market;  the  local  farmers  are  paid  reduced  prices  for  their  produce.  On  the  other hand when the buyers dictate the high price, the local farmers are also paid increased price for  their products. 
  7. Price inelastic demand for agricultural products. Farmers easily change price whenever output  changes  for  example  a reduction  in  output  leads  to  an  increase  in  price  and  an increase  in  output  leads  to  a  reduction  in  price  since the farmers  expect  minimal  or  no change in demand.
  8. Income inelastic demand for agricultural products/low income elasticity of demand for agricultural products .There is a tendency for farmers to increase output in order to benefit from the increased incomes of the buyers, however the buyers do not demand for more which causes a surplus of agricultural output hence a fall price to clear the surplus. After sometime there is acute shortage on the market which forces the farmers to increase the price since the buyers continue demanding the same quantity.
  9. Poor  surplus  disposal  system/  poor  infrastructure. The  poor  infrastructure  in developing countries limits accessibility to markets. In areas of plenty the prices fall due to excess supply of agricultural products. On the other hand in areas of scarcity prices rise since it is hard to acquire those products due to poor infrastructure.
  10. Divergence  between  planned  and  actual  output. When  actual  output  is  greater  than planned output, the prices of agricultural products fall because of flooded market and when the actual output is less than the planned output the prices rise because of the decrease in the output on the market. 

 

THE COBWEB THOERREM/ MODEL: 

The cobweb theorem is an economic model used to explain how small economic shocks can become amplified (strengthened) by the behaviour of producers. The amplification is, essentially the result of information failure, where producers base their current output on the average price they obtain in the market during the previous year/season. 

This  is to  some  extent,  a  non  rational  decision, given  that  a  supply side shock  between planting and harvesting can lead to an unexpectedly lower or higher price, this results in either higher output or a lower output in subsequent years/seasons and moves them into a long-term disequilibrium position.   

 

ASSUMPTIONS OF THE COBWEB THEOREM/MODEL: 

  • It assumes that there is no quick adjustment of supply in the market therefore there is time lag within which supply changes.
  • It  assumes  that  there  are  two  different  parties  i.e.  suppliers  and  consumers  and  their plans differ. 
  • It  assumes  that  the  producers  never  learn  from  past  mistakes  and  cannot  anticipate price movement/price changes. 
  • It assumes that producers never keep old stock in a period of low prices to be sold in a period of higher prices. 
  • It assumes that there is no chance of hitting equilibrium with first unplanned supply.  

 

TYPES OF COBWEB: 

1.  CONVERGENT/DAMPED/STABLE COBWEB: 

This where the supply curve is steeper(more inelastic) than the demand curve implying  that  a  small  price  fluctuation  leads  to  attainment  of  equilibrium,  in other wards price fluctuation can be seen to steadily approach the equilibrium point. 

2.  DIVERGENT/EXPLOSIVE/UNSTABLE COBWEB

This is where price fluctuations tend to deviate far away from equilibrium over time. Demand is relatively more inelastic than supply.       

3. REGULAR/PERFECT COBWEB:

This is when the slopes of both demand and supply curves are the same. In other wards the slope of supply and demand curves are identical. The price elasticity of  demand  and  price  elasticity  of  supply  are  equal.  Price  fluctuations  will neither converge nor diverge.  

An illustration of a convergent/damped/stable cobweb, divergent/explosive/unstable cobweb, regular/ perfect cobweb: 

 

THE EFFECTS OF AGRICULTURAL PRICES FLUCTUATIONS: 

  1. It leads to fluctuation/ unstable export earnings. In some seasons when export prices increase, earnings from exports increase and in seasons when export prices decrease, export earnings also fall.
  2. It makes projected planning based on export earnings from agricultural commodities difficult. This is because it is hard determine how much revenue the country will get from her exports because of the rising and falling prices of agricultural products. 
  3. It  leads  to  fluctuation/instabilities  in  the  balance  of  payment  position. Rising agricultural export prices leads to increased foreign exchange earnings which results into improvements  in  the  balance  of  payment  position  On the other  hand  falling  prices  of agricultural  exports  leads  to  a  fall  in  foreign  exchange  earnings  which  results into the worsening balance of payment position.
  4. It  leads  to    fluctuation/unstable  incomes  of  the  farmers/producers. Rising  prices  of agricultural products leads an increase in the farmer’s income .On the other hand falling prices of agricultural products leads a fall in the farmer’s incomes.
  5. Leads to fluctuation/unstable terms of trade. Rising prices of agricultural products on the  international  market  leads to improvement  the  terms  of  trade  of  the  country.  On  the other hand falling prices of agricultural products lead to worsening terms of trade. 
  6. It worsens the problem of income inequalities/disparity .Falling prices of agricultural products leads to a fall in the incomes of the farmers  compared to the incomes of those in the  industrial  sector  which  are  relatively  stable,  This worsen  income  inequality  in  the country.
  7. Investment  in  agriculture  becomes  uncertain  and  this  causes  speculation  and irrational use of land. Since farmers’ earnings are unstable they lose interest in farming and some abandon agricultural production and this reduces agricultural output.
  8. It leads to fluctuation in employment levels. Rising prices of agricultural products leads to  increased  investment in the  agricultural  sector  hence  increased  employment opportunities.  On  the  other  hand  falling  prices  of agricultural  products  discourages investment in the sector hence reduced employment opportunities.
  9. It leads to rural urban migration with its associated evils/ negative consequences. This happens when farmers in rural areas become frustrated in agriculture and decides to move to urban areas with hope of getting better jobs, however majority of such people fail to get those jobs, resulting into open urban unemployment, development of slums, prostitution, robbery etc.
  10. Leads  to  fluctuation/unstable  government  revenue.  Rising  prices  of  agricultural products leads increased earnings of the farmers which widens the tax base. On the other hand falling prices of agricultural products leads to reduced earnings of the farmers, which leads reduced tax base and thus reduced government revenue.
  11. Leads  to  fluctuation/unstable  exchange  rates.  Rising  export  prices  leads  to  increased foreign exchange inflow which results to a fall   in the exchange rate thus a rise in the value of the local currency. On the other hand falling  export prices  leads to reduction in foreign exchange inflow which leads to a rise in the exchange rate hence a fall in the value of the local currency. 

 

STEPS/WAYS TO STABILISE PRICES OF AGRICULTURAL PRODUCTS:

  1. By  use/  Operation  of  buffer  stock.  This  is  where  the  surplus  output  is  bought  by  the marketing boards during bumper/rich harvest and sold during periods of scarcity. In this case the government builds stock during the time of plenty by buying from the farmer the surplus output to avoid price falling so low and sells or releases the stock to the market in time of shortage or scarcity to avoid prices rising so high.
  2. Use  of  stabilisation  fund  policy:  This  is  the  deliberate  attempt  by  the  government  of paying producers less than the market price when prices and incomes are high, putting the realised difference into a fund and later using that fund to pay the producers high price than the  market  price  when  prices  and  incomes  are  low  to  avoid fluctuations  in  prices  and incomes as would be dictated by market forces.
  3. Undertake agricultural diversification: the farmers should be encouraged to undertake several economic activities within the agricultural sector in order to avoid depending on a single activity whose price may fall or rise so as to stabilise their incomes.
  4. Improve on the infrastructure/improve the transport facilities/ the disposal system. This will enable  the  easy transportation  of  agricultural  products  from  areas  of  plenty  to areas where prices are low to areas of scarcity where prices are high in order to keep prices stable in all the areas.
  5. Promote industrialisation within the agricultural sector. The established industries buy the excess supply of agricultural products to use them as raw materials which would have caused a fall in their prices, thus helping to stabilise the prices of agricultural products. In addition agro-processing helps to   add value to them and therefore enabling agricultural exports to fetch more earnings.
  6. Strengthen/Join  international  commodity  agreements. This will help  to  improve  the bargaining  power  of  the exporting  countries  of  a  given  commodity,  through  such agreements the exporting countries are in position to bargain for high and fair prices for their commodities.
  7. Modernise agriculture in order to reduce dependence on nature: This is done through the use of irrigation farming, commercialisation/mechanisation of agriculture in order to ensure  that  agricultural  production  takes  place throughout  the  year  to  reduce  price fluctuations when the agricultural output rises or falls.
  8. Undertake market expansion through diversification. This is done through expanding the  existing  markets  and finding  new  ones  for  the  agricultural  products.  This  helps  to overcome  flooding  of  the  market.  When  the producers  supply  to  different  markets,  the consumers compete for the products and this helps to stabilise the prices of the agricultural products.
  9. The  government  may  set  minimum  price.  This  helps  to  protect  producers/  farmers against exploitation by the buyers because the agricultural commodities are sold at the price fixed by the government controlling price fluctuations.
  10. Adopt a strict quota system. This is done by regulating the amount to be supplied on the international market of the agricultural products which may help to control excess supply and subsequent price fluctuations.
  11. Use contract farming/ Future market arrangement;   the farmers should be encouraged to sign contracts with the consumers before production takes place e.g. a poultry farmer can  sign  a  contract  with  a  hotel  manager  to supply chicken  and  eggs  at  an  agreed  price before production takes place.
  12. Encourage  producer  cooperatives  to  regulate  supply. Cooperative  helps  to  bring producers of a given commodity together. This enables them to regulate the supply of their product, look for the market jointly and all these help to stabilise prices.
  13. Improve on the Storage system. This helps to stabilise supply of agricultural products on the market, through storing the excess supply during bumper harvest to avoid over flooding the market thus stabilising prices.
  14. Encourage proper planning of production: This is done through sensitising the farmers about  the  importance  of regulating  supply  so  as  to  avoid  over  flooding  the  market,  thus help to stabilise prices. 

THE INTERNATIONAL COMMODITY AGREEMENTS:

The international commodity agreements are arrangements between the producing and Consuming countries to stabilise markets and raise the average prices. Such markets include markets for coffee, Tea, Sugar, Cocoa, Cotton etc.  

 

Examples of international commodity agreements include; 

  • Internal coffee organisation (I.C.O)
  • International cocoa organisation ( I.C.C.O)
  • International Cotton  Advisory organisation( I.C.A.O)
  • International Sugar Origination (I.S.O) •  International Tea organisation (I.T.O)  

 

OBJECTIVES OF INTERNATIONAL COMMODITY AGREEMENTS: 

  • To facilitate inter-governmental consultations and coordination regarding commodity prices and priorities 
  • To encourage sustainability in the production and supply of a particular commodity by initiating development projects aimed at adding value to the commodity. 
  • To improve the marketing by increasing the consumption of the commodity through innovative market development activities.
  • To improve the quality of the commodity by working closely with the producing and consuming countries.
  • To develop innovative and capacity building among the producing country .
  • To ensure transparency in the commodity market through providing comprehensive information by means of statistics and market studies.

 

THE ROLE OF INTERNATIONAL COMMODITY AGREEMENTS: 

  • Promoting the consumption and production of the commodity on the world market.
  • Stabilising the price the commodity on the world market.
  • Ensuring production of better quality products by the producing/exporting countries.
  • Improving the marketing of the product through innovative market development activities e.g. advertising in the world business journals, on different business websites.
  • Facilitating inter-governmental consultations and coordination regarding commodity policies and priorities. 

Discussion

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