Qn. Explain why prices of agricultural goods tend to be subject to huge price fluctuations
Agricultural goods are normal goods with price inelastic supply and demand.
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 for the same drop in supply. The rationale being since the demand is price inelastic, people buy the goods regardless of price, hence suppliers will pass on price increments to consumers.
Supply is price inelastic because production or gestation period is long, low availability of spare capacity, goods are perishables so they cannot be stored easily. Similarly, for a given change in demand along an inelastic supply, prices go up significantly.
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 and prices go up significantly.
join our economics resources and tuition!