Basic Price Concepts

Agricultural prices can be viewed from many perspectives: at the farmgate, at the rural and urban wholesale levels, and at the consumer level; at harvest time and in the season of relative scarcity; at the border in the case of imports and exports, or at inland locations; by quality of the product, and so forth. Some classes of policies are aimed at reducing the difference between producer and consumer prices, through improvements in the efficiency of the marketing chain. Others try to reduce the seasonal fluctuations in prices, through better access to storage facilities and improved mechanisms for timely arrival of imports when needed. Yet others try to induce farmers and rural traders to improve the quality of the delivered product, thus obtaining a better average price.

These kinds of policies have an important place in the pantheon of sectoral policies, but there are policies that can influence the entire constellation of agricultural prices, moving them all upward or downward together. For this purpose, agricultural prices are best viewed from another perspective, that of relative, or real, prices. As mentioned earlier in this volume, real agricultural prices are calculated by dividing the nominal, or raw, agricultural prices by other prices, i.e. by those of other sectors, or by those of the economy as a whole. Real agricultural prices can be calculated for any level in the marketing chain, but for analyzing producer incentives, they usually are calculated on the basis of farmgate prices.

Which other prices should be used as the denominator in the calculations? Indexes are required here, since the concepts refer to weighted averages of many prices. The most commonly used price index is the consumer price index. Thus, the real price of rice may be expressed as the price of rice divided by the consumer price index.

1. Simon Schama, Citizens: A Chronicle of the French Revolution, Knopf, New York, 1989, pp. 306-308.

2. Jo Swinnen and Frans A. van der Zee, 'The political economy of agricultural policies: a survey', European Review of Agricultural Economics, 20(3), 1993, pp. 261-262.

This concept measures the purchasing power of a unit of rice harvest, in terms of all goods and services in the economy. Since it is a ratio and an index, its value at any moment in time is not meaningful, but its year-to-year changes show changes in the purchasing power of farmers.

For policy analysis and decision-making, it is useful to construct sector-wide and sub-sectoral indexes of agricultural prices, for both nominal and real prices, rather than leaving the analysis at the level of prices of individual products. In this way, measures of the movements in prices at the level of the entire sector can be created and monitored. An index of all real agricultural prices can be calculated as the index of nominal agricultural prices divided by the consumer price index. This concept shows what is happening to producer incentives in regard to their purchasing power. The data necessary for calculating a real agricultural price index are available in every country (average farmgate prices and total quantities produced for each product). Often, they are issued in published form, but in a surprising number of cases such an index is not calculated or maintained up to date. In order to keep decision makers informed about the most fundamental trends in the sector, it should be calculated annually.

In these calculations, the consumer price index may be replaced with other indexes: a producer price index, a GDP deflator, an index of agricultural input prices, an index of non-food consumer prices, and so forth. Each definition of real agricultural prices measures a somewhat different concept, but all of them constitute numerical expressions of trends in the purchasing power of agricultural output.3 Deflating an agricultural price index by an index of prices of agricultural inputs would give a real index which indicates trends in profitability of the sector's production, abstracting from productivity changes. On the other hand, deflating it by the consumer price index yields an index of the purchasing power of farm households as consumers.

Under any of the alternative definitions, these indexes provide an empirical dimension to the discussion of the effects of policies on agricultural incentives, and a basis for monitoring the sector's performance over time in the price dimension.

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