AEP; Economics of Agribusiness
Chapter 1; Position of agriculture and agribusiness within economy
Some definitions:
Agriculture and horticulture are the sum of industries producing agricultural and horticultural
products. What belongs to agriculture and horticulture is rather arbitrary.
Industries are firms or part of firms that produce similar products using a similar technology.
There are several definitions of agribusiness or agri-complex. Most often used:
- ‘agribusiness based on domestically produced raw products’
→ Including agriculture/horticulture, direct/indirect agricultural input delivering
industries and processing industries in the first stage of processing.
→ It includes all the production that disappears if there is no agriculture/horticulture
within a country.
- ‘agribusiness based on domestically produced and imported raw products’
→ The production that disappears if there is no agriculture/horticulture and no imports
of agriculture/horticulture products in a country.
Agricultural production chain/column refers to all production stages of an agricultural of food
product from resources to consumers (including retailers).
Agriculture demands inputs that originate from domestic input delivering firms or imports. Products
produced by agriculture are exported, consumed directly (by households) of processed. Exports and
domestic household consumption as a whole are called final demand.
Indicators to determine the importance of agriculture and agribusiness:
1) Value added; measure of income, measure of production, measure of economic growth
a. Net value added (NVA): the sum of rewards of the production factors or factor
inputs (labour, capital and land used in production).
Revenue - variable input (non-factor inputs/capital depreciation).
b. Gross value added (GVA): if capital depreciation is added to NVA.
c. Net domestic product (NDP): sum of all NVA of all industries in economy.
d. Gross domestic product (GDP): adding capital depreciation to NDP.
e. Net national income (NNI): if the net primary incomes earned abroad is added to
NDP. Net primary incomes is the balance of rewards of factor inputs employed
abroad and rewards of foreign factor inputs employed domestically.
− External effects of production (non-priced by-products, either negative or positive)
− Non-valued production (household work, volunteer) is not included in GDP
− Not a measure for welfare (the income is measured, not the utility of people)
− GDP does not tell anything about the distribution of income
− GDP fluctuates because of relatively unstable prices in agriculture
f. The share of agriculture in GDP is as follows: GVAagriculture / GDP
𝐺𝑉𝐴 𝑎𝑔𝑟𝑖 𝐺𝑉𝐴 𝑎𝑔𝑟𝑖 𝑌𝑎𝑔𝑟𝑖 𝑌𝑓𝑜𝑜𝑑 𝐶𝑓𝑜𝑜𝑑 𝐶𝑡𝑜𝑡𝑎𝑙
g. Development over time: = × 𝑌𝑓𝑜𝑜𝑑 × 𝐶𝑓𝑜𝑜𝑑 × 𝐶𝑡𝑜𝑡𝑎𝑙 ×
𝐺𝐷𝑃 𝑌𝑎𝑔𝑟𝑖 𝐺𝐷𝑃
i. Agricultural GVA is relatively decreasing compared to production (Y), due to:
~ Differentiation (dividing the production process vertically)
ᶥ Opposite: integration
ᶥ Specialisation is dividing the production process horizontally
ᶥ Opposite: diversification
ᶥ Driving forces behind differentiation/specialisation are reduction
of production costs and scale advantages.
~ Relatively high productivity; higher level of production with same
quantity of inputs, or a certain production level with less inputs.
, ~ Specific factors; price changes of individual inputs, the products
produced, policies and/or negative revenues of by-products.
ii. Ratio between agricultural and food production decreases
~ Changing consumption patterns; more demand for processed products,
pre-prepared meals, restaurants.
~ Shifting of food production to other sectors; increasingly processed
products contain less agriculture and more other goods/services.
iii. Food production divided by food consumption(C) (incl. imports) = Self-sufficiency
~ Depends on country’s possibility to produce food, relative productivity of
food sector and of governmental policies.
iv. The share of food in total consumption decreases.
~ Engel’s law: an increase in income (consumer expenditure/consumption)
result in less than proportional increase in food consumption per capita.
~ Decrease is less for rich countries than for poorer countries as more
processed products are demanded.
v. The share of consumer expenditure in GDP; depends on its relative size
compared to other final demand categories.
~ GDP is spent on ‘final demand’, consisting of consumer expenditure C,
public expenditure G, investment I and export E.
~ GDP equals 𝐶 + 𝐺 + 𝐼 + 𝐸 + 𝑀 (M is import)
2) Employment; important for suppliers of labour (source of income) and for governments
(source of collecting taxes).
a. Agriculture: mainly family members and temporary workers.
b. Horticulture under glass: mainly hired low skilled labour
c. The share of agriculture in total employment (E) equals: Eagri / Etotal = 2,58% (2012)
Eagri 𝐿𝑡𝑜𝑡 𝑌𝑎𝑔𝑟𝑖 ×𝑃𝑎𝑔𝑟𝑖 𝑃𝑡𝑜𝑡
d. Development over time: = 𝐿𝑎𝑔𝑟𝑖 × ( ) × 𝑃𝑎𝑔𝑟𝑖
Etot 𝑌𝑡𝑜𝑡 ×𝑃𝑡𝑜𝑡
i. Contribution of agriculture to total employment is decreasing, because labour
productivity (L = Y/E) in agriculture is increasing more than in the total economy.
ii. The high price of labour results in labour saving technological change (e.g.
robots) and substitution of labour by other inputs.
iii. Contribution of agriculture to total employment is decreasing, because share of
agriculture in total value of production (Y) is decreasing.
iv. Contribution of agriculture to total employment is increasing, because of the
relative strong price (P) reduction of agricultural products (due to relative strong
increase in productivity and relative reduction of consumption of agricultural
products and immobile production factors in agriculture).
− Employment should not be values positive automatically (utility matters more)
− Maintaining employment with subsidies is unfavourable to economic welfare
3) Balance of payments; export balance = value of exports - imports
a. Exports are important, because (as part of final demand) they make it possible to
create gross value added (GVA) and they are a way of earning foreign currencies.
b. A positive export balance indicates that a country produces more products than it
consumes and more foreign currencies are received than paid.
c. The sum of net export balances of all goods and services equals the surplus or deficit
on the so-called ‘goods and services account’ of the ‘balance of payments’.
d. The Netherlands is both a large exporter and importer of agricultural/food products.
e. Imports and exports of the same products occur, because they do not take place at
the same time or imports are exported again (transit trade or re-exports).
− Maximising exports makes no sense; the income earned with exports is important
, − To export, agriculture and the processing industries need imports (feed/machinery)
4) Land use and landscape; agriculture/horticulture are the largest land users in Ned.
a. Reduction of agricultural area in developed countries results from population
increase and increase wealth level (more roads, houses, recreation).
b. Higher incomes lead to an increased demand of recreation and nature.
c. Landscape can be seen as an external effect of agricultural production.
5) Emissions of pollutants; important negative external effect of agricultural production.
a. Greenhouse effect; global warming
i. Negative: extra costs (irrigation, dikes etc.)
ii. Positive; extra CO2 plant growth
b. Acidification due to SO2 and NH3 is a threat to wildlife in natural areas
c. Eutrophication due to N and P minerals damages the quality of surface water.
d. Residues of pesticides, herbicides and fungicides can be harmful to public health.
e. Agriculture is main producer of minerals in the Netherlands; mineral production of
dairy farming is decreasing due to milk quota (fixed production), increase in milk
production per cow and environmental policy measures (incl. supply quotas).
f. Agriculture/horticulture had a share of 18% in Dutch emission of greenhouse gasses.
g. The contribution of agriculture in the emission of two other greenhouse gasses is
large; N2O (nitrous oxide/laughing gas) and CH4 (methane; produced by dairy cattle)
h. Reduction in use of fertiliser due to manure policies explains the reduction in nitrous
oxide emission.
i. Since 1995, emissions of greenhouse gasses by agriculture has decreased, because of
reduction of livestock numbers (milk quota), use of residual health (coming from
electricity plants) by horticulture under glass, energy savings and mature policies.
Chapter 2; Production and technological change
Some definitions:
A firm can be defined as an organisation that converts inputs (labour, capital, raw materials) into
outputs (goods/services that have value and are sold; manufactured commodities, transportation,
storing). The process of using and combining inputs to create outputs is called production.
Inputs (factors of production) are the resources that are used in the production process (like labour,
capital goods, energy and materials). In economic analyses, these inputs are usually aggregated into
main categories of inputs, because it is more interesting to analyse that instead of one single input.
Variable inputs are inputs which use can be varied in the short run. Besides, there are quasi-fixed
inputs that cannot be adjusted in the short run; in the long run these can also be varied.
There are a number of reasons why firms exist:
1) Economies of scale
a. Indivisibilities (working together, using equipment together, sharing machinery)
b. Division of labour or specialisation (master all skills involved in particular area)
2) Reduction of transaction costs between many parties.
3) Firms with a certain scale may be able to create an identifiable brand name
4) Avoidance of government policies like taxes, quotas and price controls.
Firms size is limited since the benefits of economies of scale reduce/disappear with the scale of
operation increasing and costs of organisation, monitoring, administration and decreased motivation
(due to limited tasks in large firms’ employees may be less motivated and therefore less productive)
increase more than proportionally with firm size and may exceed the benefits.
,Specific characteristics of agriculture and the agricultural production process:
Atomistic market form; a large number of firms produce the same commodity and compete
for the use of inputs. Main market form; perfect competition (form the perception of
farmers). Individual producers are price takers in input and output markets.
Farms are too small to do research; supplied by other agencies/companies.
The technical production period; the technically determined length of time between the
decision to produce and the moment when output becomes available (supply lag). Moreover,
a lot of capital is used in several production cycles. Besides restrictions of physical capital
there are restrictions of human capital; knowledge about the production process.
Seasonality. For perishable products this create a strong discontinuity in price. For non-
perishable products it is important to make a choice about moment of ordering and storage.
Uncertainty about the level of output, due to weather and the risk of disease; large
difference between planned (based on expectations) and actual output.
Joint production. May happen because of natural features of agricultural production process,
requirements of crop rotation, waste that is used in another industry and positive and
negative externalities.
The production set are all possible combinations of inputs and outputs that are technological
feasible. The relation between a single output and inputs can be shown by a production function:
the upper boundary of the production set, describing the relation between inputs 𝑥𝑖 and output 𝑦
and showing the maximal amount of output 𝑦 that can be produced with each combination of inputs.
Single output case: 𝑦 = 𝑓(𝑥1 , 𝑥2 , 𝑥3 , … )
Multiple outputs 𝑦𝑗 (transformation function): 𝐹(𝑦1 , 𝑦2 , … , 𝑥1 , 𝑥2 , 𝑥3 , … ) = 0
Inputs can be variable or quasi-fixed. Often only physical outputs (only products) are included, while
joint outputs (nature, environment, etc.), the external effects or externalities, are ‘ignored’.
So the production function shows the relationship between inputs and output at the boundary of the
single-output production set.
Neo-classical assumption of the production function
General Cobb-Douglas
y = f(x1 , x2 , x3 , x4 ) y = Ax1a1 Ax2a2 … Axnan
Continuous (‘smooth’)
Increasing (non-decreasing) ∂y when ai ≥ 0
≥0
in inputs ∂xi
Concave in inputs ∂2 y when ai ≤ 1
≤0
∂xi 2
Other characteristics of the production function
General Cobb-Douglas
Production elasticity 𝑦 ∂y xi 𝑎𝑖 (constant)
𝐸xi = ∙
∂xi 𝑦 for all 𝑖
𝑛
Returns to scale (scale % 𝑐ℎ𝑎𝑛𝑔𝑒 𝑜𝑢𝑡𝑝𝑢𝑡 𝑦
𝑢= = ∑ 𝐸xi 𝑢 = ∑ 𝑎𝑖
parameter 𝒖) % 𝑐ℎ𝑎𝑛𝑔𝑒 𝑎𝑙𝑙 𝑖𝑛𝑝𝑢𝑡𝑠
𝑖=1
Substitution elasticity %∆ 𝑥𝑗 /𝑥𝑖 𝜎𝑖𝑗 = 1
𝜎𝑖𝑗 =
%∆ 𝑀𝑅𝑇𝑆𝑖𝑗 For all 𝑖, 𝑗
Concave mean hollow to the origin, increasing with a decreasing extent.
∂y
∂xi
indicates the marginal production of input xi , which is the extra output of one additional unit of
input. The marginal product of each input is non-negative and these cannot increase as more of the
input is used, holding the level of other inputs constant. This means that adding a unit of input, we
, can produce the same quantity of output as before and mostly even more, but the additional output
decreases by adding more and more inputs.
The production electricity of input 𝑖 shows the percentage change in output when the input
increases with 1%, and is defined as the % change in output 𝑦 divided by the % change in input xi .
Returns to scale show the percentage increase of the output if all inputs increase 1%:
- Decreasing returns to scale: 𝑢 < 1
- Constant returns to scale: 𝑢 = 1
- Increasing returns to scale: 𝑢 > 1
The substitution elasticity (between zero and infinite) shows to what extent two inputs can
substitute each other when producing an output. It is the rate at which one input can be substituted
for another The higher the substitution elasticity, the better substitution is possible and the flatter is
the isoquant. An isoquant shows all the possible combinations of two inputs resulting in the same
output (holding other inputs fixed). An isoquant is convex to the origin. The slope of the isoquant is
∂y
𝑑𝑥 ⁄∂x 𝒇
minus the ration of the marginal products of the two inputs: 𝑑𝑥2 (𝑦 𝑐𝑜𝑛𝑠𝑡𝑎𝑛𝑡) = − ∂y 1
= − 𝒇𝟏
1 ⁄∂x 𝟐
2
Without the minus sign, this slope is the marginal rate of technical substitution MRTS12 between x1
𝑓
and x2: 𝑓1 = 𝑀𝑅𝑇𝑆12
2
The MRTS depends on the units of measurement of the inputs; the degree of substitution is
therefore best shown by an elasticity. The extent of convexity is an indication of the ease to
substitute one input for another in the production process (when quantity of production is constant).
Inputs are complementary if 𝜎𝑖𝑗 is equal to zero; inputs are used in a constant ratio. The elasticity is
infinite if inputs are perfect substitutes.
According to the neo-classical theory, the production function is increasing in inputs and has
decreasing marginal products. These are conditions imposed to a functional form, which is an explicit
specification of a production function. Examples are Cobb-Douglas, quadratic, CED and translog.
Simple forms are better than more complex forms, as long as they comply with the neo-classical
criteria and perform well with real production data. Cobb-Douglas is simple and therefore popular.
However, the simplicity of Cobb-Douglas is also its main limitation. A functional form is flexible if a
priori values are not imposed to the different parameters of this functional form but have to be
estimated. If the use of a certain input increases, the production and substitution elasticities may
change too.
Depending on the functional form, production functions are characterised by different production
elasticities, returns to scale and substitution elasticities.
Technological change is an application of new technical knowledge which leads to more output
when using a constant amount of inputs or it leads to a constant amount of output when using less
inputs. Technological change causes the production function to shift upwards, while the isoquants
shift towards the origin. Technological change is part of the process of technical innovation:
1. Creation of new technological knowledge
2. Its application to develop new production techniques
3. The diffusion of these new techniques amongst producers
Technological change should be distinguished from:
- An increase in production due to an increase in an input
- Changes in the relative proportions of inputs using existing technology (a shift along the
isoquant)
- Scale-effects (increases in output achieved by producing in larger units but using existing
technology)
- Improvement of efficiency in the use of inputs
New technical know-how means:
