Changes in the General Level of Farm Prices

Objective: to examine the causes and economic consequences of changes in

the general level of prices.

Effects of changes in the general level of farm prices on:

1. Ability of farmers to repay debts
2. Profitability of investments
3. Competitive position
4. Relative prices

Changes in relative prices are of even greater importance from a social and
political viewpoint, since they affect the welfare of farm families and the
level and distribution of income between the farm and nonfarm sectors of
the economy.
 Farm prices, like those of other goods and services, are strongly influenced
by overall trends in the economy.
In the US, the prices of farm products have generally risen during
inflation, and have declined as much or more than the prices of
nonfarm goods and services in periods of deflation.
Prices do not move up or down precisely at the same time or at the
same rate.

Impact of Inflation on Agriculture

 Inflation may or may not benefit farmers.

 Relative price changes do not necessarily follow a uniform pattern from
one inflation to another.
 The definite beneficiaries of inflation are:
 those who purchase land earlier, since land usually appreciates
relative to other assets, and
 debtors, since they are able to pay off their obligations with
depreciated currency.
 Leads and lags in price adjustments during periods of inflation can result in
a substantial redistribution of income, even within agriculture.

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 The effects of moderate or creeping inflation (1-2% pa) are different from
rapid or hyperinflation (50-100% pa).
 Hyperinflation may lead to “flight from cash” – when money
depreciates rapidly, every individual seeks to convert cash into goods
as quickly as possible.
 Rapid inflation is accompanied by an increase in speculative activity
which, in turn, contributes to increased instability of commodity
prices.
 Inflation distorts incentives away from increasing efficiency towards
speculation.
 Inflation may result in the loss of export markets if domestic costs rice
relative to those in competing exporting nations.
 Effects may be reversed by devaluing currency.

The Effects of Currency Revaluation

 Currency revaluation can offset the effects of changes in relative prices
between countries and give the country that devalues its currency a
competitive advantage in export markets.

The Terms of Trade (TOT) of Farm Products

≈ relative price of farm produce to nonfarm produce
= index of farm prices/index of nonfarm prices
 An improvement in the term of trade of farm products leads to a gain in the
welfare of farmers, while the reverse, unless accompanied by offsetting
improvements in productivity, leads to a loss of real income.
 Agriculture has experienced widely fluctuating TOT during the 20th century.
 The greater instability of farm as compared to nonfarm prices are
attributed to the following:
1. More price-inelastic S&D curves for farm than nonfarm products.
2. Greater fluctuations in productions combined with unequal rates of
growth in supply and demand for farm products.
3. Instability in international market prices.

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 4. Differences in market organization and structure which make it
possible for many nonfarm firms to adjust production in response
to a change in demand rather than accept lower prices.

Parity Ratio – index of farm prices over index of prices paid by

farmers.

Measuring Changes in the Average Level of Prices

Index Numbers – used to measure average changes in prices at point in
time relative to a base year or period of years.
 Influenced by what is included in the index and the
weights attached to each component items.
Currently, there are seven series of price indices compiled by the Philippine
Statistical System, four of which are at the national level.
1. Consumer price index (CPI)
2. Producer price index (PPI) for agriculture and manufacturing
3. General wholesale price index (GWPI)
4. General retail price index( GRPI)
5. Wholesale price index for construction material (CMWPI)
6. Retail price index for construction material (CMRPI)

Constructing an Index Number

1. Price Relative – simplest form; ratio of current price to base period price.
𝑷𝒄𝒊
𝑹=
𝑷𝒐𝒊
R = price relative
Pci = current price of the ith commodity
Poi = base period price of the ith commodity
2. Average of price relatives
𝑷𝒄𝒊
∑𝒏
𝒊=𝟏 𝑷𝒐𝒊
𝑰=( ) 𝟏𝟎𝟎
𝒏

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 It gives each commodity item equal weight.
Others use percentage weights based on the value of each commodity in
the index relative to the total value:

𝑷𝒄𝒊
𝑰 = ∑ 𝑾𝒐𝒊
𝑷𝒐𝒊
𝒊

where
𝑽𝒐𝒊
𝒘𝒐𝒊 =
∑𝒊 𝑽𝒐𝒊

𝑽𝒐𝒊 = 𝑷𝒐𝒊 𝑸𝒐𝒊 – value of commodity i in base period.

∑𝒏𝒊=𝟏 𝑽𝒐𝒊 – total value of n commodity items in index.

3. Laspeyres index (1871) – uses quantities in the base year as weights;

biased upward.

∑𝒊 𝑷𝒄𝒊 𝑸𝒐𝒊
𝑰=
∑𝒊 𝑷𝒐𝒊 𝑸𝒐𝒊

4. Paasche index (1874) – uses quantities in the current year as weights;

biased downward.

∑𝒊 𝑷𝒄𝒊 𝑸𝒄𝒊
𝑰=
∑𝒊 𝑷𝒐𝒊 𝑸𝒄𝒊

5. Fisher’s ideal index – geometric mean of Laspeyres and Paasche

formulae; ideal in the sense that the time reversal test and the factor
reversal test are satisfied; used in the case when prices and quantities at
the base and current periods are quite different.

∑𝒊 𝑷𝒄𝒊 𝑸𝒐𝒊 ∑𝒊 𝑷𝒄𝒊 𝑸𝒄𝒊

𝑰=√ ∗
∑𝒊 𝑷𝒐𝒊 𝑸𝒐𝒊 ∑𝒊 𝑷𝒐𝒊 𝑸𝒄𝒊

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 Problems in Constructing Indices
1. Selecting components of index
should be based on a sample of all possible retail prices.
 Cost of collecting data generally prohibits exhaustive coverage.
 Sampling is complicated by numerous outlets selling various
items, by possibility that posted or listed prices are not the
actual sales prices, by price specials not coinciding with the day
or days price information is collected.
 Need to preserve uniformity of quality through time: as new
products become available or items change in quality and other
become obsolete, the index must be modified to reflect these
changes.
2. Choosing the base period
should be time of “normal” prices
The common practice is to use an average of prices for several
years as the base price.
 Because of changing product mix and product quality, the base
period should not be too far removed from the current period.
3. Choosing the weights
need not come from the same time period as the base price
 e.g. index of price received by farmers: the index is the
commodity’s proportion of total income. What if the
quantities marketed differ from total quantities produced?

Steps in Computing the CPI in the Philippines

1. Identification of the base year
Base year - usually a year in which the index number is set
to 100.
The year 2000 was chosen as base year for two reasons:
a. It was perceived to be more politically, economically,
and socially stable
b. It was the year when the Family Income and
Expenditure Survey (FIES) which is the basis of the
weight was conducted.

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 2. Determination of the market basket
Market basket – consists of goods and services that are
commonly purchased and bought by an average Filipino
household; determined through interview of key informants
in various outlets as to the availability and saleability of the
different items.
3. Determination of the household consumption pattern
(weights) – uses FIES; weight is proportional to household
expenditure for each item.
4. Monitoring of prices in the basket
5. Computation of the CPI
𝑷𝒄𝒊
∑𝒊
𝑷𝒐𝒊 𝒘𝒊
𝑪𝑷𝑰 =
∑𝒊 𝒘𝒊
where Wi = PoiQoi

Economic Indicators Derived from CPI

1. Inflation Rate – the annual rate of change in CPI.
𝑪𝑷𝑰𝟐 − 𝑪𝑷𝑰𝟏
𝑰𝒏𝒇𝒍𝒂𝒕𝒊𝒐𝒏 𝑹𝒂𝒕𝒆 = ∗ 𝟏𝟎𝟎
𝑪𝑷𝑰𝟏
2. Purchasing Power of Peso (PPP)

𝟏
𝑷𝑷𝑷 = ∗ 𝟏𝟎𝟎
𝑪𝑷𝑰
3. Deflated prices and income

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 Note: Index numbers provide a reasonably accurate measure of
changes in relative prices over a period of years, but they are not
good indicator of well-being or relative income changes.

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