AAMP Training Materials Nicholas Minot (IFPRI) email@example.com Module 2.2: Modeling Smallholder Commercialization
Contents • Agricultural commercialization conceptual framework • Agricultural household models before and after 1985 • Separable vs Non-Separable household models • Household modeling exercises • Conclusions • Resources
Agricultural CommercializationConceptual Framework Marketed surplus = Food and cash crop production Food demand -
Agricultural CommercializationConceptual Framework Labor, mgt Weather Preferences Population Income Land Inputs Food and cash crop production Food demand Marketed surplus - = Food prices Infrastructure and market efficiency International markets & trade
Agricultural household models – Before 1985 • “Separable household models” • Maximize household income • Allocate income among consumption goods to maximize utility • “Separable” in that production decisions are not affected by consumption decisions • Marketed surplus is difference between optimal quantity of production and optimal quantity of consumption • They could only be equal by coincidence so this should only occur rarely
Agricultural household models – Before 1985 Model doesn’t explain several important patterns
Agricultural household models – Before 1985 • Attempts to explain differences between model and actual farmer behavior • Food first: Farmers first produce enough food for consumption needs and only if they have extra land do they produce for the market • Problem: Overly simplified view since many farmers do produce cash crops even though they have not produces all their food requirements. • 40-60% of smallholders in many countries are net buyers of staple food crops • Risk aversion: Farmers maximize income and minimize risk • Problem: Better explanation, but still doesn’t explain the fact that farmers do not participate in markets (neither buyer nor seller) for many commodities
Agricultural household models – After 1985 • Non-separable household models • Singh, Squire, & Strauss (1986) Agricultural Household Models • Models incorporating transaction costs, ie cost of buying or selling a commodity • Creates a gap between a) price household can buy at and b) price it can sell at • Example: • Suppose market price of maize is 300, but it costs 50 to transport it to the market or to transport from market to household • Farmer can pay 350 to purchase maize or he can earn 250 from selling maize • If maize is worth 290 to household, it is not worth buying or selling maize, so household does not participate in market
Agricultural household models – After 1985 • Why do transaction costs make models non-separable? • Cannot calculate profit-maximizing production without knowing consumption preferences • Consumption preferences whether household is buyer or seller price of commodity for household profit maximization • Thus, consumption preferences and profit maximizing income must be solve simultaneously • Spatial arbitrage between household & market • Shadow price (Ph) for household • Ph = Pm +t if household is buying commodity • Ph = Pm – t if household is selling commodity • Pm+t > Ph > Pm-t if household neither sells nor buys • The larger is t, the more likely household neither sells nor buys
Agricultural household models – After 1985 Implications of non-separable agricultural household models
Agricultural household models – After 1985 Implications of non-separable agricultural household models Price Price Demand Supply Price range over which household does not react to price changes Demand Supply Quantity Quantity One household Several households
Agricultural household models – After 1985 Implications of non-separable agricultural household models Price Price Price range where most households are sellers & respond Price range over which many households are self-sufficient & do not respond Price range over which most households are buyers & respond Quantity Several households Quantity Many households aggregated
Agricultural household models – After 1985 • Estimating non-separable household models • Need data on production technology, market prices, transaction costs, and consumption preferences • Use simultaneous equations for supply and demand • Econometric software such as Stata • Simulation based on existing parameters • Need info on current production and consumption patterns, prices and transaction costs, and elasticities of supply and demand • Use mixed complementarity programming (MCP), which allows inequalities (Ph<= Pm + t) • Modeling software such as GAMS • Very similar to modeling spatial equilibrium between markets
Agricultural household model in Excel • Characteristics of Excel worksheet [Exercise – Ag HH Model] • Two commodities: maize and coffee • Area of maize & coffee depend on prices of both commodities • Yield of maize & coffee depend on fertilizer price • Maize demand depends on exogenous income • Can change: productivity (yield), world prices, exchange rate, income, and distance (marketing costs) • How to use the Excel model • BLUE represents cells you can change to calibrate model • YELLOW represents cells you can change to simulate a shock • GREEN shows the output cells, which should not be changed • Table shows “before” and “after” simulated shock • Solid lines represent “before”, dashed lines “after”
Agricultural household model – Exercises • Increase household income by 20% (Cell E23) • What happens to maize consumption? • Does the household start to buy maize? Why? • Why does coffee production decline? • What happens to marketed surplus? • Increase household income by 40% • What happens to maize consumption? • Does the household start to buy maize? • Explain why the household does or doesn’t start to buy maize
Agricultural household model – Exercises • Increase exchange rate by 20% (Cell E14) • Increase the exchange rate from 85 KSh/US$ to 102 KSh/US$ (this implies a devaluation of the shilling devaluation) • Why does maize production decline? • Why does the fertilizer price increase? • What happens to coffee yield? And coffee area? • Explain the contradictory effects on coffee. • Increase exchange rate by 40% (Cell E14 = 119) • What happens to maize purchases? • Why does devaluation cause farmers to shift from maize to coffee production? • Increase world fertilizer price by 20% (Cell E25 = 20%) • How is the effect different than 20% devaluation?
Agricultural household model – Exercises • Increase the marketing costs for fertilizer, maize, & coffee by 30% • This simulates a household that lives farther from roads and markets • What happens to the cost of fertilizer? • What happens to the buying and selling price of maize? • What are the two factors causing coffee production to decline? • What happens to the marketed surplus percentage? • Increase the base maize consumption (Cell C7) from 1000 to 1400, then increase maize market cost by 50% • This represents a net maize buyer and raises cost of purchasing maize • What happens to coffee production and sales? • Why do higher maize marketing costs reduce cash crop marketing
Agricultural household model – Exercises • Increase maize productivity by 30% (Cell C28) • This simulates a 30% increase in maize productivity due to, for example, an improved maize variety • What happens to maize yields? • What happens to maize area? Explain this change. • Why does coffee area and production increase? • What is the effect on the value of sales and the marketed surplus? • Increase coffee productivity by 30% (Cell D28) • What happens to coffee yield and production? • What is the effect on the value of sales and the marketed surplus? • Why does an increase in maize productivity have almost the same effect on marketed surplus as an increase in coffee productivity?
Agricultural household model – Exercises • Increase maize market price by 30% (Cell C11 = 36.4) • This simulates a 30% increase in maize prices in the market due to, for example, a bad harvest in another part of the country • What happens to maize area and yields? • What happens to coffee production? • Decrease maize market price by 10% • What is the effect on maize and coffee production? • Why do these price changes have so little effect on the agricultural household? • Increase world coffee price by 20% • What happens to coffee yield and production? Why? • What is the effect on the value of sales and the marketed surplus?
Conclusions • Rising income dampens commercialization if household is self-sufficient • Devaluation (or depreciation) increases commercialization by shifting incentives toward export crops • Distance to market and high marketing costs reduce commercialization by reducing fertilizer use & yields and lowering farm gate price of commercial crops • More…
Conclusions • If household is net buyer of food, high marketing costs reduce commercialization by diverting land from commercial crops to food crops • Higher productivity in staple food crop contributes to commercialization by making land available • Higher maize prices have no effect on self-sufficient households, which explains inelasticity of supply of staple foods
Resources • Singh, I., L. Squire, & J. Strauss. 1986. Agricultural household models: Extension, application and policy. Baltimore: Johns Hopkins University Press. • de Janvry, A., M. Fafchamps ,and E. Sadoulet. 1991. Peasant household behavior with missing markets: some paradoxes explained. Economic Journal 101 (409): 1400-17, November. • Taylor, J. 2003. Agricultural Household Models: Genesis, Evolution, and Extensions . Review of Economics of the Household, Vol. 1, No. 1. http://www.reap.ucdavis.edu/research/Agricultural.pdf • Renkow, M. Agricultural household models. Lecture notes. http://www.ag-econ.ncsu.edu/faculty/renkow/ECG_540/05_household.pdf