The Case Study

The main purpose of thecase studies is to supplement OER materials prepared for Agricultural Economics MSc program by elaborating key practical issues reflecting the problem and context of agricultural marketing system of Ethiopia.The study was financed by Bill-Melinda Gates Foundation (BMGF) through AgShare pilot project. The project is implemented by School of Agricultural Economics and Agribusiness ofHaramaya University in collaboration with OER Africa/SAIDE, Michigan State University (MSU), four faculties of members of Collaborative Masters in Applied and Agricultural Economics (CMAAE) network. The findings, interpretations, and conclusions expressed in this case studyare entirely those of the authors. They do not necessarily represent the view of the above mentioned institutions. The case studies and other OER materials will be available online soon.

Acknowledgements

The author is grateful to the AgShare Pilot Project for financing this study. Thanks also go to AgShare project team of AgShare pilot project of the School of Agricultural Economics and Agribusiness, Particularly Mr. Fekadu Gelawfor his useful discussion and valuable comments provided. Last but not least I want to express my gratefulness to the office of Ministry of Trade and Industry who provided me the necessary information in this case study.

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Table of Contents

CHAPTER ONE: INTRODUCTION

1.1Background of the Study

1.2Problem Statement

1.3Objectives of the study

1.4Scope of the study

CHAPTER TWO: RELATED LITERATURE REVIEW

2.1Concepts of Market, Market Demand and Price

2.2Economics of Market Failure

2.2.1 Imperfect Information

2.2.2 Price Instabilities and market

2.2.3 Policies and Institutional Infrastructures

2.2.4 Feasibility of Price Intervention from Time Perspective

2.2.5 Interventions Resulting Undesirable Markets

2.3What are the functions of Price in Market?

2.4Why Governments intervene in price/Controls price

3.1Description of the Study Area

3.2Research strategy

3.3Sampling method

3.4Method of analysis

CHAPTER four: ANALYSIS OF PRICE MEASURE EFFECT ON MARKET

4.1Rationale for Government Intervention

4.1.1 Failure of competition

4.1.2 Information Asymmetry

4.1.3 Promoting Equity and Ensuring fair distribution

4.1.4 Results of interview discussion

According to the Ministry of Trade, the price ceilings have had the following objectives:

4.2Assessment and Analysis of Reaction of the Market Participants

4.3.1 Consumers Respond/Reaction

4.3.2 Suppliers (Retailers, wholesaler, and shop owners) response.

4.3Governments approach and follow-up during the price ceiling measure

4.4Why did the government lifted up the price control

CHAPTER FOUR: SUMMARY AND RECOMMENDATION

5.1Summary

5.2Recommendations

REFERENCES

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CHAPTER ONE: INTRODUCTION

1.1Background ofthe Study

For decades, global agricultural markets have been characterized by steady production and productivity growth, slowing demand and as a result, falling real prices for agricultural produce. For instance, from 1973 to 2000, food prices fell by about 60% and agricultural prices by about 55% in real terms (World Bank report, 2004). This decline in prices has been majorly attributed to the supply side; rapid technological progress in agriculture means lower unit costs of production and, with competition in product markets, lower profit margins per unit of output and lower commodity prices. Together with declining product prices, the pressure on farmers to adopt the new technologies rose and competition in product markets effectively squeezed farmers’ profits. They accrued largely to buyers of food and agricultural products, with a consequent decrease in real costs of food and fiber products to consumers (Gardner 2002).

It is also believed that better production methods, i.e. higher applications of fertilizer, pesticides, and an expansion of irrigation results in a massive increase not only in productivity but also in total output.As a result, many countries have involved in setting of price floor in different form in order to protect their farmers and producers from lower price in agricultural products. For instance in U.S.A during the periods of 1920’s, 1930’s and 1933 great economic depression severalattempts were made to limit lower price from voluntary participation in crop reduction and the organization of agricultural product cooperative marketing agreements tothe federal government intervention to stabilize price and the Agricultural Adjustment Act declaration of 1933 (Bowers et al, 1984).

The issues of increased production in agricultural output/surplus production, decline in price of agricultural output and government support to stabilize low price for agricultural products were also a recent market phenomenon for Ethiopian producers /farmer particularly in maize, wheat, sorghum and vegetables such as tomato, potato and onion during the mid 2004/5 when the Ethiopian Government tried to adopt a development approach, called Agricultural-Development-Led-Industrialization (ADLI) that aims to enhance bottom-up broad-based economic growth. Agricultural-Development-Led-Industrialization (ADLI) has indeed increased national food production as a result of the promotion and dissemination of nationwide agricultural extension packages. Although an increase in food production has not been linked with the development of markets. Hence, the existing market with its insufficient information system and underdeveloped warehouse, storage and trading system proved unable to absorb and cope with increased cereal production, particularly since 2004/2005 when national surplus grain was first offered in markets in Ethiopia(Relief Web report, 2011).

As a result government has intervened with its corporation named as Ethiopian Grain Trading Enterprise (EGTE) to play a price stabilization role in the Ethiopian grain markets through purchasing of grains at a price higher than the price set. Since 2004/05 grain production has increased substantially every year and hence also the availability of grain, especially maize, sorghum and wheat, for local purchase. Furthermore, to support local production and to stabilize grain market prices, the Ethiopian Government arranged with donors to purchase a certain amount of food aid from domestic markets/farmers, producers were also provided advice to shift from producing staple cereals to cash crops, etc. However, since 2004 the objective to stabilize grain market prices through local purchases failed because of the lack of capacity and financing on the donor and government side and price for some agricultural cereals remained low up until 2006 (Relief Web report, 2011).

On the contrary, the period succeeding the 2008/9 global financial crisis has come up with a different context in the rise of food price, agricultural commodities, inflation and fluctuation in oil price augmented by various natural and man- made disasters here and there attributing to worldwide food price rice. Particularly the rise in food price has become worse in Sub-Sahara Africa including Ethiopia, according to seminar reportmade in Mozambique byCOMESA (2010) that “There exists high price , however, considerable variation across countries and commodities. For example, food price increases were relatively small (25-39%) in South Africa, Ghana, and Cameroon. On the other hand, food prices increases were quite large (over 150%) in Ethiopia and Malawi. Since the price increases in these latter two countries actually exceed the price increase in the world markets for the same commodities, this suggests that domestic factors (such as general inflation, crop failure, or manipulation of the exchange rate) must have played an important role in the price hike”.

Further it concludes that it appears that the rising food prices in Ethiopia has been the outcome of monetary policy misalignment, the balance of payment problems resulting from sharp increases in fuel prices, as well as a supply shortfall that was disguised by overestimated cereal production.Nevertheless it does not mean that in no way the international price crisis has no effect on the domestic price rise in staple food in these countries.Conversely although the sources of price rise have been relatively different in each country, the policy reactions have been similar—increased intervention in cereal markets. As anticipated, the rise in price of staple food, in turn, has enforced different governments to take different measures across the globe including Ethiopian government price ceiling measurement.

Incidentally it was on the eve of 2011 Christmas that Ethiopian government has announced its strategy of price ceiling to contain “price escalation” though an instrument not yet proven whether it is appropriate mechanism or not . Following the week before National Bank of Ethiopia’s announcement for raising interest rate on deposits and loans in view of slowing down the ever increasing inflation rates,the Ministry of Trade announced the price control/ price limit in January 2011 with the intention to stem food price inflation (Capital, 2011).

However in the theory of economics, demand and supply function, price caps / limits force producers to sell the products under unacceptable and, in general, below equilibrium prices.

Of which the acceptable prices would be the one that include both real (differences between cost and revenue) and imagined ones, such as the price of uncertainty existing within the system.

And some even argue that price ceilings discourage proper functioning of the market and such setting price below the equilibrium pricewill result excess demand and causes shortage in the marketas it may not reflect the true cost of producing them. The extent at which such price ceiling will have adverse effect on supply of commodities will depend on the magnitude at which this new price was set far below the price that would have prevailed in the absence of such government interventions the equilibrium price.

Having this in mind, therefore in this project, it is intended to investigate the effect of price ceiling measure on the demand and supply of some selected products in Addis Ababa.

1.2Problem Statement

In a free market economic system, scarce resources are allocated through the price mechanism where the preferences and spending decisions of consumers and the supply decisions of businesses come together to determine equilibrium prices. The free market works through pricesignals. When demand is high, the potential profit from supplying to a market rises, leading to an expansion in supply (output) to meet rising demand from consumers. Day to day, the free market mechanism remains a tremendously powerful device for determining how resources are allocated among competing ends. However this is not always the case thesedays, and it appears in many situations the assumption of free market, supply and demand are no longer working and as a result measures are taken governments including ours to influence prices. Price ceiling measure is one of them taken by government in the hope correcting the outcome of market imperfections, market failure, to prevent consumers from unnecessary price charge, to achieve a more equitable distribution of income and wealth and to improve the performance of the economy.

On the contrary, many claim that market interventions like price ceiling measure are wrong because even though imposing price ceilings on certain goods may seem to be attractive to consumers, such measures, in general, will end up harming the consumers these interventions were intended to help.

Stating further that price ceilings force producers to sell the products under unacceptable and, in general, below equilibrium prices, motivate producers switch to other goods that they think are more profitable and that are outside government’s radar for price controls, discourage business activities/ market activities. In the end, less and less of the highly valued goods will beavailable to the consumers, which hurt consumer welfare. Pricecontrols, moreover, force producers to supply mostly low quality products into the market, which may lead the economy to be filled with lower quality products than would be otherwise. The process will eventually create dissatisfaction on the part of the consumers. Economic history has shown that such consumer dissatisfaction, would force consumers to shift their attention to imported goods, which could only be obtained in the black market at times and other illegal practice in market.

Therefore, the main focus in this project is to assess the effects of the aforementioned price ceiling onsupply and demand of commodities. Specifically, it attempts toanswer the following questions.

  • Has the price ceiling measure reallyachieved its purpose of protecting buyers from high price?
  • How did the different markets actors reacted to the price ceiling?
  • What were the effects of the price ceiling on the demand of commodities?
  • What were the bases for selecting those specific commodities listed in the price ceiling measure?
  • Was there the necessary institutional setup to effectively implement the policy measure?
  • What complementary measures had to be taken along with it? and,
  • Was the measure timely?

1.3Objectives of the study

The general objective of the study is to assess the effect of the price ceiling on the supply and demand of some selected consumableitems.

The specific objectives of the study are:-

To assess the effect ofprice ceiling measurement in achieving price stabilization on those items.

To explain howdid government take the price ceiling measurement in the way that it did?

To identify the bases of setting price measurement.

To assess theresponse ofthe various market actors such as suppliers, business people, customers and officials to the price ceilings.

To investigate the overall effects of price ceiling on the supply and demand of the selected commodities in market.

To review the effects of government price intervention measures.

1.4Scope of the study

Though dealing on the overall effect of the policy is useful for having good understanding about price ceiling effect, this time the project will only consider some products like wheat and wheat floor, sugar and edible oil as main focus of study because these items are the ones which the government is still applying price ceiling even for the second round out of 18 items listed in the primary announcement. Besides to the delimiting the variety of commodities the study also confines itself in the capital of the country, Addis Ababa,as a study area because of relative uniform implementation of price ceiling and availability of focus group of study.

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CHAPTER TWO: RELATED LITERATURE REVIEW

This part of the paper addresses the theoretical overview of market demand and price, government intervention in market, result of intervention in market system, market reaction and results associated from theoretical perspective.

2.1Concepts of Market, Market Demand and Price

Literally market, for most people is believed to be as place where goods are being sold. But market in economic system is more than just a place, where individual consumers and producers/suppliers through their interaction function called exchange determine the answer to the basic economic problems of demand and supply. Incidentally the term market has got a variety of meanings, for example, Abbott and Makeham (1979), defined marketas an area in which exchange can take place. Thus, a market actually brings buyers and sellers for exchange. It acts as intermediary between buyers who demand goods and services, and the sellers who produce or supply goods and services. It also means the people living there who havethe means and the desire to buy a product. In this process market equilibrium position- a point where quantity demanded in the market is just proportional to quantity supplied with agreed up on price would be established in according to the theory of free market economy concept. Mendoza (1995) alternatively, defined market as a system because market usually comprises several interrelated structures along the production, distribution channels and consumption units underpinning the economic process. Modern economies rely heavily on markets and prices to allocate resources between competing uses. The interplay of demand (the behavior of buyers) and supply(the behavior of sellers) determines the quantity of the good produced and the price at which it is bought and sold in a free market /competitive market. Technically speaking competitive market is one in which the number of buyers and sellers are very large, allengaged in buying and selling a homogeneous product without any artificial restriction andpossessing perfect knowledge of market at a time. In doing so demand and supply of commodities are governed by market set price. Demand depends on thepriceof the commodity, the prices of related commodities, and consumers' incomes and tastes whereas supply depends not only on the price obtainable for the commodity but also on the prices of similar products, the techniques of production, and the availability and costs of inputs. Thus, in a competitive market economy the price of goods or commodities will reach in a point relatively stable called market equilibrium price as result of demand and supply function. Ideally these functions result in free competition by which the market economy can operate through the invisible interactions of demand and supply.When competition exists, resource allocation through unimpeded markets is expected toproduce higher economic welfare than resource allocation through state planning. For example, in theory, it can even be demonstrated that, under certain circumstances, the allocation of resources by means of the market mechanism is optimal (Arrow, 1985). Each participant in this economy act independently from each other,seeking their own interest, and taking as given the fact that other agents will also seektheir best so that market equilibrium reached, meaningthat in each market aggregate demand equals aggregate supply, so the correspondingequilibrium price clears the market. However, in practice, the entire economy is not left out entirely on demand and supply in determining price of goods and services. Because the aforementioned facts in competitive conditions do frequently not apply in practice, the allocation of resources is not optimal from a theoretical perspective and a quest for methods of improving the resource allocation arises (Bator, 1958). This situation is described as a market failure- is a situation where scarceresources are not put to their highest valued uses.