Discuss using elasticity concepts, why agricultural markets are subject to huge price fluctuations

Demand is price inelastic because it is a necessity good, with little amount of substitutes and it forms a small proportion of income. Hence, due to supply changes, price fluctuations tend to be significant.

From the diagram, given inelastic demand, when the supply of agricultural goods drops from S1 to S (due to weather condition or supply shocks), the prices go up significantly from P2 to P1 as opposed to an elastic demand D, where prices only go up to P0. The rationale being since the demand is price inelastic, there are not many substitutes available. So even if the price goes up, people buy the goods regardless of price, hence suppliers will pass on price increments to consumers if there is a drop in supply due to poor weather conditions

Price Quantity curve

Price Quantity curve

Supply is price inelastic because production or gestation period is long, low availability of spare capacity (for example there is not much spare resources that the farmers could use to generate more supply, even when the price of agricultural goods go up, this is likely due to them using all the land and resources for production in the first place), goods are perishables so they cannot be stored easily. Factors of productions are also immobile (they cannot be easily transferred from one geographical location to another, such as spare land). Similarly, for a given change in demand along an inelastic supply, prices go up significantly.

Rental vs quantity of apartment

Rental vs quantity of apartment

From the diagram, given inelastic supply S1, when demand increases from D1 to D2, the prices go up significantly to from R0 to R1, as opposed to R2 for elastic supply. The rationale being since the supply is price inelastic, it is not responsive to price changes, given that demand increases, supply does not respond fast enough in the short run (because farmers cannot increase production suddenly over a short period of time due to limited capacity and immobile factors of production) and prices go up significantly.

By |2015-10-20T01:09:38+00:00October 20th, 2015|Economics resources, Micro: Demand & Supply|0 Comments

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