Economics of Agriculture (Lecture modified Notes 2018-19) PDF

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ADDIS ABABA UNIVERSITY SCHOOL OF COMMERCE DEPARTMENT OF ECONOMICS

LECTURE NOTES

ECONOMICS OF AGRICULTURE (Econ 3111)

BY: Gemeda O.

Academic Year: 2018/19 Addis Ababa

CHAPTER 1: INTRODUCTION 1.1.

Definition and scope of economics of agriculture

1.1.1. Basic concepts The "agriculture” comes from two Greek words, “agros” = field and “cultura” = cultivation. According to that, agriculture is a sort of economic activity connected with land, with soil cultivation. Agriculture in the form of animal husbandry and plant cultivation goes through the human history almost from its very beginning. One of the very first stories in the Bible is the story of the brothers Cain and Abel, land cultivating farmer and shepherd. All the definitions that follow the word “agriculture” should not be considered as a mere production of crops or farming. In addition to this, now a day, agricultural activity includes animal husbandry and forestry. Specifically, the agriculture sector has the following main areas: Crops production, Fruits production (Pomiculture), Forestry (Silviculture), Livestock, Poultry farming, Beekeeping (Apiculture) and Fisheries (Aquaculture). Again it goes beyond business on farms and includes such business activities as marketing, processing and distribution of agricultural products and other off farm activities like supply of inputs (seeds, fertilizers, credits, etc).  Agricultural production has several general characteristics that distinguish it from other forms of production. These are:  The existence of many small production units (despite differences among countries, agriculture employs by far the largest share of the world population).  The plurality of products from one producing unit (individual producing unit or farm typically engage in production of several different types of commodities).  The biological nature of the production process (production processes are geared to the life cycle of the particular plant or animal that is involved requiring considerable quantities of heat, moisture, and soil nutrients).  The nature of location decision (decision is how best to use the land).  The existence of considerable degree of production for self-sufficiency (majority of farmers in the world plan their activities in terms of production for home consumption rather than for the market. In other words, it does not enter commercial channels).  Its sensitivity to natural forces such as rainfall intensity, climate, drought, temperature and the like.

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Because of the fact that agriculture is special (almost unique) in a number of ways, a specialized branch of economics called Agricultural Economics has developed to address the problems associated with it. And agricultural economists make extensive use of microeconomics or price theory in which propositions on the functioning of markets in terms of production, consumption, and exchange are developed from hypothesis about the behavior of individual producers and consumers. In contrast, macroeconomics utilizes highly aggregated concepts such as total consumption, national output, investment, etc, which are closely linked with agriculture. Recently some studies (e.g. Trimmer et al, 1985) have noted that macroeconomic policies and adjustments can have a major impact on the agricultural sector.

The central theme in studying agricultural economics is that resources - land, labor, capital, time, etc - are limited or too few to satisfy all human wants and that as a consequence of this scarcity, choice must be made. The problems with which we will study are ones of "constrained choice" (socio-economic influences - land tenure, farm size, market system, infrastructure, government actions, cultural influence); that is how limited quantities of inputs are allocated between alternative production uses of agricultural as well as non-agricultural activities, and of how limited income are allocated between the many products that consumers may buy.

1.1.2. Definition Different agricultural Economists have defined Economics of agriculture in different manner, but with the same content. 1. DR TAYLOR: “Agricultural Economics deals with principles which underlie the farmer’s problems of what to produce, how to produce and what to sell and how to sell it in order to secure the largest net profit which is consistent with the best interest of the society as a whole.”

2. BLACK: “Economic principles imply economizing. Hence, the object of the science of Economics in agriculture as anywhere else is to provide the basis for economizing resources.”

3. GOODWIN: “Agricultural Economics is a social science connected with human behavior during the process of production, distribution and consumption of products on the farm and ranches.”

4. JOUZIER: “Agricultural Economics is that branch of Agricultural science which treats the manner of regulating the relation of the different elements comprising the resources of the farmer whether it is to be the relations to each other or with other human beings in order to secure the greatest degree of prosperity to the enterprise.”

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5. ASHBY: “Agricultural Economics is an applied science; i.e., it is a methodological pursuit of knowledge of economic process and organization in agriculture and their results. For the purpose of stabilizing, adopting or modifying them, and if and when necessary changing of their results.”

6. HIBBARD: “Agricultural Economics is a study of relationships arising from the wealth getting and wealth using activities of man in agriculture.” 1.1.3. Scope of Agricultural Economics We may dare to say that Agricultural Economics is as wide as the discipline of Economics because we can apply all economic principles in agriculture. We may again use different concepts of general Economics in Agricultural Economics like production, consumption, distribution, marketing, financing, planning, etc. It can also be studied at micro or macro level.

Role at Microeconomic Level Agricultural economists at the micro level are concerned with issues related to resource use in the production, processing, distribution and consumption of products in the food and fiber system. Production economists examine resource demand by businesses and their supply response. Market economists focus on the flow of food and fiber through market channels to its final destination and the determination of prices at each stage. Financial economists are concerned with issues related to the financing of businesses and the supply of capital to these firms . Resource economists focus on the use and preservation of the nation’s natural resources. Other economists are interested in the formation of government programmes for specific commodities that will support the incomes of farmers and provide food and fiber products to low income consumers. Role at Macroeconomic Level Agricultural economists involved at the macro level are interested in how agriculture and agribusiness affect domestic and world economies and how the events taking place in other sectors affect these firms and vice versa. For example, agricultural economists employed by the Ministry of Ethiopian Agriculture will evaluate how changes in monetary policy affect the price of food. Macroeconomists with a research interest may use computer-based models to analyze the direct and indirect effects that specific monetary or fiscal policy proposals would have on the farm business sector. Macroeconomists employed by multinational food companies examine foreign trade relationships for food and fiber products. Others address issues in the area of international development.

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1.1.4. Nature of Agricultural Economics 1) Agricultural Economics makes use of the principles of general economics with some

modification. Economic principles are applied to solve certain problems in agriculture. 2) Agricultural economics is a specialized form of pure science instead of being an applied

science because it does not directly apply all the principles of Economics. 3) Agricultural Economics is a normative science as well as an art like General Economics. As a science, it explains cause and effect relationships between various economic variables operating in agriculture. As an art, uses those relationships to solve various problems in agriculture.

1.2.

Historical development of agricultural Economics

The application of economic theory to agricultural problems has gone through a process of slow acceptance. The origin of the field, now known as Agricultural Economics reach back in many directions and over a long period of time. The filed came from two separate sources: one from physical sciences, and later, from economic theorists. Since agriculture and its production systems are influenced by physical (topography, climate), social (tradition, culture) and economic (market, infrastructure) factors, a comprehensive body of science, which includes physical science, social science, and economic theory, is fundamental. The severity and length of the agricultural depression beginning in the 1880s caused increasing attention to be devoted to its causes and possible solutions. Primarily agronomists and horticulturalists made the most notable early efforts. They recognized that the ability to grow plants and animals was not sufficient to make farmers succeed. Agricultural Economics is an important study area because it is concerned with society's basic needs. Getting food and other agricultural products to all people in the world in the right form at the right time is an extremely complex process. 1.3. Agriculture and Economic Development 1.3.1. Role of Agriculture in Undeveloped Economy An economy can be broadly divided into three sectors namely: 1. The primary sector which consist of agriculture, mining, fishing, etc. 2. The secondary sector includes all types of industries. 3. The tertiary sector which represents the service sector includes banking, insurance, transport, trade and other services.

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Position of agriculture in the developing economies:  it represents the main economic activity  it employs the prevailing share of economically active population  it forms the main source of export The transformation of agriculture from its traditional subsistence roots, induced by technical change, to a modernizing and eventually industrialized agriculture sector is a phenomenon observed across the developing world. In the 1950s, although agriculture was ignored by scholars as a non-contributor sector to the development of the economy, it was observed that the success story of East Asia began their drive towards industrialization by first developing their agricultural sector. This brought a clear consensus that the strategy of industrialization in the 1960s and 1970s could only be successful because of agricultural productivity, and farm income was significantly increased in the initial phase of industrialization. The following are the economic benefits that come in the way of industry from a growing and productive agriculture, coupled with the immediate concern of alleviating poverty as the initial force that pulls the wheels of economic growth and development. 1. Product Contribution Expansion of non-agricultural sector is strongly reliant on agricultural sector, not only for a sustained increase in the supply of food, but also for raw materials used in manufacturing products and export earnings that pay for imported capital equipment and intermediate inputs. The domestic farm sector is the principal source of food for consumption by growing number of non-food producers employed in industry. a) Food for the non-agricultural workforce For both macro and microeconomic reasons, a given country cannot achieve sustainable rapid economic growth without first solving the problem of food security. At the micro level, inadequate and irregular access to food limits labor productivity and then income per capita and further reduces investment in human capital. Instability in the food sector can have three macro-level effects. First, it can affect the quantity of investment through an increase in precautionary savings or a decrease caused by greater uncertainty. Consumers save to protect themselves against the effect of possible increase in food prices and farmers save to insure themselves against a sudden drop in crop prices. Here

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we have to note that these are precautionary savings and are kept in liquid form, not for investment and may not contribute to economic growth. Secondly, instability in the food sector can reduce the quality or efficiency of investment (rate of return), because unstable food price give little information of the kind that is relevant for long-run investment, as they cause instability in all other prices in the economy. Finally, price instability can induce a bias towards speculative rather than productive investment activities and thereby slowdown economic growth. Moreover, in poor countries, food price instability causes price instability in other sectors of the economy, since the food sector dominates the economy. An important reason for investing in a country’s agricultural sector, therefore, is above all to realize the potential to stabilize the domestic food supply and enhance food security. If the food sector is ignored and the industrial sector is focused upon, the consequence is that employment in the industrial sector increases with increased income, the largest portion of which is spent on food. This will cause the price of food rise, squeezing the real income of laborers downwards, close to the previous level, and reducing the incentive to work. This in turn places upward pressure on wages, and ends up reducing employment and/or industrial profit. Therefore, the capacity of the industrial sector to produce a growing volume of manufacturers could be restricted unless agricultural production is growing simultaneously. This is also the reason why the industrial and agrarian revolutions always should go together, and why an economy in which agriculture is stagnant do not show industrial development (Lewis, 1978). Above all, increased food security of the poor can contribute substantially to long run economic growth. It also has a short-run economic dimension in that attaining stabilized food prices seasonally and yearly. Securing food encourages farmers to invest more in innovation and technologies that increase farm productivity. b) Raw materials for domestic agro-processing industries Once food supply is secured, the agricultural market surplus is available as input for domestic agro-processing industries, which is used for consumption or production of intermediate goods. A domestic supply of raw materials stabilizes fluctuations in the availability and prices of imported inputs. Moreover, it saves foreign exchange. Thus, it promotes self-sustained development of the industrial sector, particularly in the early stages. c) Foreign exchange earnings through exports of agricultural products Agricultural products are needed to earn foreign exchange through exports. Sufficient growth in agricultural products helps in composition in a world’s product market to earn foreign

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currency that developing countries need to run their economy. As long as a country is not industrialized, export earnings largely come from primary products generated by agricultural sector. This income, combined with domestic farm sales income, is the important part of the net capital outflow from agriculture that can be transferred or used to finance imports of industrial equipment and other investment outside agriculture, such as investment in infrastructure development. 2. Market Contribution a) Expand market for the products of the other sector The second important role that agriculture can play is providing effective demand for products of the industrial sector. This includes rural agriculture-based households’ demand for consumption goods and farm inputs produced by the industrial sector. The expenditure pattern from the net additions to income arising from accelerated growth of agriculture creates demand for a wide range of goods and services with a high employment content, much of the production of which must be broadly diffused in rural areas. In fact this can occur only through accelerated growth in employment (more precisely, increased demand for labor), which is facilitated by the indirect effects of agricultural growth itself. Thus, agriculture offers a potential for rapid growth in domestic demand for labor-intensive goods and services. It is believed that a productive agriculture implies higher level of income to the large rural population, which then generates a large demand for manufactured goods that enables manufacturers to produce at scale that allows them to exploit efficiency gains from scale economies. This includes rural agriculture-based households’ demand for consumption goods and farm inputs produced by the industrial sector. Hence, the farm sector is the major market for domestic industrial products. Farmer’s expenditures on industrial products -both consumer goods and producer goods- represent one aspect of agricultural sector’s market contribution to general economic development through sectoral diversification. b) Flow of agricultural products to other sectors of the economy As agriculture develops and its production becomes more market oriented, many other institutions, generally non-agricultural in character, come into existence. These institutions include those providing marketing, processing, packing, and distribution services. c) Development of international trade

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Surplus products from the agricultural sector, as a result of its development, can move to the international market. This, in turn, can result in the flow of necessary capital as well as consumer goods from outside. 3. Factor Contribution Development of agriculture releases some resources for being transferred to the other sectors. As these resources are productive in nature, we call transfer of these resources to the nonagricultural sectors as ‘factor contribution’ of agriculture. Factor contribution can be in the following forms. a) Provision of capital The non-agricultural sectors require funds for acquiring material capital. In the initial stages of their development, these funds will be generated in the agricultural sector and then transferred to other sectors. In a closed economy in the initial stages, it is the agricultural sector, which commands most of the income, capital and also labor. Even when an underdeveloped economy is an open economy, the outside source of capital like foreign aid and foreign commercial investment can make only a limited contribution to the economic development. Further, foreign political influence is likely to accompany such capital and this may not be acceptable to the present day underdeveloped economies. The transfer of capital to non-agricultural sectors can be voluntary or compulsory. It is voluntary when the agriculturalists themselves invest their savings in the industrial projects. The agriculturalists of England and the land owners of Japan present an important example of this type of voluntary flow of capital to the non-agricultural sectors. The compulsory form of flow of funds is generally brought about by the government of the day through taxation on the agricultural sector-its net proceeds being spent for the development of the non-agricultural sectors. Forced extraction of surplus from agriculture by taxation, confiscation, imposition of levies or arbitrarily kept low prices of agricultural products, can be the other measures taken by the government to transfer funds from the agricultural sector to the non-agricultural sectors. However, this form of compulsion is not always necessary for the transfer of funds. Agricultural development itself may bring down the prices of agricultural produce, reduce the cost of production in manufacturing and other sectors, increase their profits and thus indirectly help in the generation of capital in these sectors. b)...