3. Supply and demand

THE IMPACT OF SUPPLY AND DEMAND

Introduction

The quantity of produce that consumers want to purchase is affected by many factors, the most important being:

• price of the goods;

• tastes and preferences of the consumers;

• number of consumers;

• incomes of consumers;

• prices of competing produce;

• range of products available to consumers.

The quantity that producers supply is also affected by a number of factors, the most important being:

• price of the goods/products on the market;

• price of inputs/costs of production;

• technological factors;

• climate;

• storage possibilities.

The price of a product is mainly determined by supply and demand. Basically, a balance is achieved between what people are prepared to supply at a price and what people are willing to pay for the product. As the price rises the quantity that will be supplied also rises and the quantity demanded falls, and vice versa. It is important to note that:

Supply is what producers are prepared to sell at a certain price

Demand is how much consumers are prepared to buy at the market price

While supply is influenced by production it is not always the same as production (e.g. farmers may sometimes grow perishable crops and not harvest them because the price is too low). For less perishable crops, farmers or traders may decide to store them in the hope that prices will rise, rather than sell them immediately. When prices do rise they may take the products out of store to sell. At this time supply is equal to production harvested for immediate sale plus products taken out of store.

However, it should be stressed that demand is not how much people would like to buy, nor what they should buy for a healthy lifestyle. It is what they are prepared to buy at the prevailing price.

Short-term price fluctuations

Unlike the prices of staple foods such as maize or rice, horticultural product prices fluctuate enormously. They can fluctuate from day to day and during the day, depending on supply and demand.

The main causes of short-term price changes of fresh produce are:

1. The amount of produce on sale in the market on a particular day and the quantities sold in the previous few days.

2. Short-term demand changes (e.g. holidays and festivals).

3. The effect on demand of prices of competing products.

To take advantage of opportunities when prices are high a supplier needs to be in close communication with the markets and able to transport produce rapidly. In many countries farmers are increasingly able to deliver products, such as leafy vegetables, to markets when prices are high, using mobile telephones to contact buyers.

Seasonal price changes

In countries with pronounced seasons, supplies are low at the start of the harvest season, so prices are high. Prices are at their lowest when the crop reaches maturity in the main production areas. At the end of the season prices normally increase again as supply diminishes. Prices are generally highest during the off-season, when only a small percentage of farmers are able to grow the crop. These considerations are illustrated in Figure 4.

Figure 4
Supply and price changes over a season

Farmers who are located in areas where early or late-season crop production is possible (for example, hill or mountain areas) or who can use production methods, such as plastic tunnels or greenhouses, that bring forward the harvesting date, are best placed to take advantage of high early or late-season prices.

Similarly, production under irrigation can supply crops in the off-season when prices are normally the highest.

Harvesting vegetables grown in greenhouses

Irrigation of a potato field

M. Marzort

Long-term price changes

Figure 5 shows how production and prices can fluctuate from year to year. The graph shows how a season of high prices and low supply is often followed by a season of low prices and high volumes. This is because many farmers individually make the same decision to expand production in response to high prices in one year. Wiser farmers often deliberately decide to do the opposite to what their neighbours are doing.

Figure 5
Fluctuations in price and production over several years

Figure 6
Long-term relationship between prices and demand

Long-term balance between supply and demand

Figure 6 shows that the lower the price, the greater will be the demand. However, as the price goes down less will eventually be supplied (because farmers will produce less). Conversely, the higher the price, the more will be supplied. The relationship between what people are prepared to buy and what farmers are prepared to grow at different prices should eventually lead to a balance between supply and demand.

The theoretical point at which supply and demand are in balance is referred to by economists as "equilibrium". At this price there is enough incentive for farmers to produce the quantity that consumers will buy at that price. In practice, although the marketing chain tries to achieve this balance it is rarely done because there are so many factors affecting both supply and demand and because farmers lack adequate information about demand.

A BETTER UNDERSTANDING OF MARKETS

The way horticultural markets operate is complex. Markets are not very rational. Very often they appear to panic or overreact. If traders believe that there is a shortage of a product, prices will rise. Often, the increase is out of all proportion to any shortfall in supply. The converse is also true. If the market expects even a small oversupply, then prices fall rapidly.

The effect on supply of changes in price

High prices have a large effect on farmers' profits (as shown in Table 1). In the short term a farmer's response to high prices will be to try to increase the quantity of produce marketed. For example, tomato farmers may harvest green, unripe tomatoes. In the longer term the farmer will consider expanding the crop area and look for ways to increase production. In response to high prices farmers usually increase their production in the next season. As many of them make the same decision, there is a large increase in supply and oversupply occurs. Prices fall and farmers reduce production in the following season. This was illustrated in Figure 5.

The effect on demand of changes in price

When prices fall consumers increase their purchases. They buy less when prices rise. However, the response to price changes depends on the type of product. For example, increases in the price of staple foods eaten daily, such as maize, rice, roots and tubers or green bananas, have a relatively small effect on volumes of sales, as people still need to eat. Similarly, falls in price will not lead to major consumption increases. This is not the case with luxury or non-essential food items such as oranges and apples. Small falls in price can cause a disproportionately large increase in sales, while small price increases can lead to a big fall in sales.

Condiments, spices and other products that are used in small quantities are relatively insensitive to changes in price. Low prices do little to increase sales as people do not change their recipes to use more spices when prices are low. This means that when products like garlic are in over-supply, prices fall dramatically, as consumers do not respond to price changes by buying more.

The effect on price of changes in demand

Consumer demand and tastes change constantly. Short-term changes can be caused by the weather. In northwest Europe, sunny days increase the demand for salad crops (tomatoes, lettuce, cucumbers) but when the weather becomes cooler vegetables for cooking are in stronger demand. This leads to short-term fluctuations in the prices of these commodities.

Longer-term changes in demand are caused by changes in taste, attitude and society. For example, perceived health benefits have led to long-term growth in the sales of broccoli (considered to be an anti-oxidant which is believed to reduce the risk of heart disease) and garlic (also considered to be good for the heart).

In Europe there has been a fall in the sale of fresh vegetables that need to be peeled and cooked (carrots, potatoes, etc.) and an increase in demand for semi-processed, cleaned, easier-to-prepare products such as frozen peas and carrots and frozen potato chips. This is because people are now reluctant to spend as much time cooking as they used to. Richer European consumers are often described as "cash rich-time poor".

While prices of oranges have fallen, those of easy-peeling types of citrus have increased because consumers prefer the convenience of mandarins and clementines.

The effect of increasing income on sales

Food consumption patterns change as the amount of money that consumers have to spend increases.

1. Consumption of cereals barely increases as incomes improve.

2. Sales of milk products and beverages increase rapidly as incomes increase and, at higher income levels, these become the first and third most important expenditure categories.

3. Fruit sales increase most rapidly with increased income.

Information such as this helps to indicate the relative importance of specific products and identifies which products are likely to increase in sales as economies develop. Farmers in countries with growing economies need to be aware of these opportunities and extension workers need to have the knowledge to help them take advantage of the changes that are taking place.

RAPID CHANGES IN FOOD MARKETING ARRANGEMENTS...

The way that food is marketed is changing rapidly.

In general, the changes reflect changes in society and lifestyle.

Among the most important trends are...

· A rapid growth in populations in towns and cities which, in turn, means longer and more sophisticated marketing channels;

· People have less time to prepare food (e.g. because both parents work) but more cash to spend on prepared foods;

· There has been a decline in families eating together at home and an increase in taking snacks and eating out, particularly at fast-food restaurants;

· There has been an increased use of refrigerators and deep freezers, enabling food to be stored for longer and allowing fewer but larger shopping trips, and an increased use of cars which enables large quantities to be carried.

The changes in food marketing in developing countries tend to follow the pattern of change that has already been seen in developed countries. The speed of change is often much faster, particularly among the wealthier consumers. For example, between 1989 and 1997, richer Chinese consumers cut their consumption of grains by 15 percent, increased their meat consumption by nearly a half, doubled their egg consumption and tripled consumption of chicken and of vegetable oils. These changes took a century to happen in the West, but about a decade in P. R. China.

The overall trend in agricultural marketing has been the development of larger agribusinesses, the emergence of supermarket chains and the growth of trucking companies that can maintain cool chains. These companies are more sophisticated, demanding, professional and generally more powerful than traditional traders.

New ways of operating have to be developed by farmers if they are going to supply these new buyers. Traditionally, foodstuffs have been sold through wholesale markets where prices are determined on the day of sale. The growth in processing, agribusiness, supermarkets and international trade is leading to an expansion in long-term supply arrangements and a movement away from 'spot markets'. Processors and supermarkets need to ensure that they will receive guaranteed supplies of produce in the volume and quality they require and at the time they require them. This involves production planning and forward contracts. To work with such buyers it is normally necessary for small farmers to form themselves into official or unofficial groups and be prepared to supply on the basis of contracts. NGOs, in particular, are playing an increasingly important role in linking farmers to markets in this way.

Supermarkets offer a pleasant, convenient and hygienic environment in which to shop.

To supply them, farmers will need to re-organize their production and marketing practices.