Implications of Economic Policy for Food Security : A Training Manual

Annex 1 : A Conceptual Framework for the Analysis of Policy. Impacts on the Food Economy and on Food Security

1. Introduction

In this Annex, some basic economic concepts are presented which will help the participant to follow the analysis of the impact of macro-economic and structural adjustment policies on the food situation as discussed in Chapter 4 of the Manual and to assess the effects of policies designed to improve food security as discussed in the subsequent Chapters. Although reality is much more complex than can be expressed in simple economic models, the concepts serve to reveal important linkages between the macro and the micro spheres of the economy and to disclose the role of economic key factors which act as determinants of the levels and structure of food supply and demand. This provides the basic framework for an analysis of the food situation of a specific country and for the assessment of the likely effects of economic parameter changes on food security. Parameter changes occur continuously during the process of economic development, as the result of a changing economic environment and/or as the explicit or implicit consequence of certain policy reform measures, such as stabilisation and structural adjustment policies.

2. Model for analysing the food economy - structure of food deficits

Food security has three dimensions: availability, access, and stability. Food availability is determined by the level of food supplies, composed of subsistence production and market supplies stemming from domestic production, food stocks and food imports. Access to food is the result of the ability to express food needs (beyond subsistence production) as effective demand. Stability refers to variations and the risk of shortfalls in food production, supplies and/or demand over time.

Food security is defined as a situation where both food supply and demand are sufficient to cover food requirements on a continuous and stable basis. This general definition of food security applies, in principle, to individual household as well as to aggregate national food security. (See Chapter 1 of the Manual 1 for a detailed discussion of the concepts of food security). Food insecurity prevails if, at any time (occasionally, repeatedly, or permanently), either the volume of food supply, or food demand, or both fall short of requirements.

In order to analyse the food situation of a country and the effects of economic parameter changes on food security we use a graphic model as presented in Figures A-1 and A-2.

Figure A-1 refers to the case of a closed economy without trade links (neither food imports nor exports) to neighbouring countries or the outside world. Figure A-2 to an open economy with food imports. In reality, neither a completely closed economy (an economy without any trade relations to the outside world) nor a completely open economy (a situation without any restrictions on foreign trade, e.g. no import or export regulations, no import or export taxes, no foreign exchange restrictions) can be found. Reality is somewhere in between these two extreme cases. Depending on the relevant factors and nature of the effects to be studied, we either use the model of a closed or an open economy. A further restriction of the model consists in the fact that it deals with national aggregates of food production, supply, demand and average prices. Such restrictions are necessary to provide a basis for analysing the role and impact of relevant factors determining the food situation of a country. When applying this to a specific country case, to arrive at valid results the assumptions of the model would need to be modified and adjusted to the conditions of the country being studied. The analysis of aggregates needs would have to be complemented by a disaggregated view, taking into consideration different population groups, different geographical areas, different (groups of) food items, different market prices, etc. Such issues are discussed in Chapter 4 of the Manual.

Figure A-1: Basic model of an aggregate food situation in a closed economy

Figure A-1 (X3936E130) (3K)

Figure A-2: Basic model of an aggregate food situation in an open economy

Figure A-2 (X3936E131) (3K)

Description of the model:

The model contains five basic elements:

  • Production curve: The production curve shows the volume of aggregate food production at varying market prices of food. Food production includes subsistence production as well as food production for sale on the market. (The production curve in Figure A-1 originates at 'spr', the level of subsistence production at a market price of zero. As a market price of zero is unrealistic and little is known about the shape of the production/supply function at a market price close to zero, the lower end of the production/supply curve is shown here as a dotted line and discarded in our further model analysis. It should, however, be kept in mind that the production/supply curves (and the demand curves as well) used in the model include subsistence production which contributes to overall food supplies. See also "Note on subsistence production" in Section 4 below).

  • Supply curve: The supply curve shows total food supplies at varying market prices. It incorporates food production (see above), modified by stock changes and food imports/exports. In a closed economy (without food imports or exports) and if no stock changes are assumed, the supply curve is identical with the production curve, as shown in Figure A-1. In an open economy as presented in Figure A-2, the supply curve is identical with the production curve only up to the point where the internal market prices reach the level of world market prices (up to point C in Figure A-2, see also below). Beyond this point, the supply curve is completely elastic if, as assumed, the country is a price-taker on the world market.

  • Demand curve: The demand curve shows the volume of total food demand (effective market demand plus home consumption from subsistence production). The typical shape of the demand curve results from the real income effect of food price changes (see Section 4 below): at decreasing food prices, an increasing number of low-income households (those who depend on the market as source of food supply) are able to express their food needs as effective demand.

  • Food requirements: An approximate expression of the aggregate food requirements are the calorie or staple food requirements of a country, calculated on the basis of food balance sheets (see Chapter 2 of the Manual), including allowances for variations in distribution. (When food is unequally distributed - which is the normal case - then the volume of aggregate food requirements is higher and the requirements line is further to the right than it would be if food were equally distributed).

  • Market prices: A major factor determining the volume of food production, supply and demand are the prevailing market prices. The market price may be fixed (in a regulated economy) or the result of supply and demand (in a market economy). In a closed economy with a non-regulated competitive food market, the market price tends towards the equilibrium level po, where the volume A is produced and absorbed (Figure A-1). In an open economy without trade restrictions and interventions in the food market (Figure A-2), the internal market prices are determined by the world market prices (cif. world market price or "import parity price", i.e. the world market price plus international transport and handling costs in the case of imports, see discussion in Annexes 2A and 2B). In Figure A-2 it is assumed that the cif. world market price, hence the prevailing internal market price (pm) is below the hypothetical internal equilibrium price (po). (If the world market price were above the internal equilibrium price, there would be food exports.).
The combination of the five elements described above, as done in the Figures A-1 and A-2, leads to the emergence of different types of food deficits. Depending on the volume of the food requirements, the shape and the position of the aggregate production, supply and demand curves, and the level of prevailing market prices, the following types of food deficits can be distinguished:

  • A production deficit emerges if the food production of a country is insufficient to meet the aggregate food requirements. Referring to an average year, this situation is sometimes called a 'structural deficit' (Terminology is not always clear in this point: sometimes structural deficits are also understood as a situation where effective demand, rather than the requirements, exceeds domestic food production). A production deficit is not necessarily an indication of food insecurity, as the balance between domestic production and requirements may be imported.
In our model, a production deficit appears in all cases (at all price levels) where the production curve runs to the left of the requirements line, as shown in Figure A-3a) below. In Figure A-1, the production deficit amounts to R-A (at the price level po). In the open economy case reflected in Figure A-2, the production deficit is larger and amounts to R-C. This is due to the fact that the lower internal market price (pm) induced by the lower world market price has a depressing effect on the local food production. The significance of this effect depends on the elasticity of domestic food production (see Section 3 and Box A-1 below).

  • A supply deficit emerges if total food supplies (comprising total food production, food stocks plus imports/minus exports) are insufficient to meet the food requirements. This situation always implies a state of food insecurity and is sometimes called 'food supply insecurity' or 'national aggregate insecurity'.
In our model, a supply deficit appears at all points (at all price levels) where the supply curve runs to the left of the requirements line (see Figure A-3a) for a closed and Figure A-3b) for an open economy). In a closed economy without food stocks to draw on, production and supply curves, hence the production and supply deficits, are identical (R-A in Figure A-1). In an open economy with food imports, the supply deficit is smaller (R-B in Figure A-2), if, as assumed, the supplies from domestic production are complemented by food imports. This, however, only applies if a country has the means to pay for the food imports. If this were not the case, the supply deficit would (partly) manifest as market deficit (see below).

  • A demand deficit emerges if, due to insufficient income and purchasing power, there are people who are unable to express their food requirements as effective market demand. A demand deficit is the result of poverty and, referring to the individual household level, sometimes called 'food consumption insecurity' or 'individual food insecurity'.
In our model, a demand deficit appears in all cases (at all price levels) where the demand curve runs left from the requirements line (see Figure A-3c below). In Figure A-1 the demand deficit amounts to R-A. In the open economy case of Figure A-2, the demand deficit is smaller, amounting to R-B. The lower market price in the latter case implies a positive real income effect leading to an increased volume of aggregate food demand. (The size of this effects depends on the elasticity of the demand curve in the relevant range, see Section 4 and Box A-2 below).

Figures A-3a) - d): Types and ranges of food deficits at varying market prices

  • Apart from the types of food deficits presented above, an additional type of food deficit resulting from market imbalances (market deficits or surpluses) may occur. In our model, market imbalances emerge if the internal market prices differ from the equilibrium prices. A market (-supply) deficit emerges if, for example due to price setting below the equilibrium price (po in Figure A-1, pm in Figure A-2) or due to a lack of foreign exchange to pay for food imports, effective demand exceeds domestic market supplies in the closed economy case or the total market supplies (domestic supplies + imports/ - exports) in the open economy case. If the market price is set above the equilibrium price, the volume of market supplies exceeds effective demand and market surpluses occur. Examples of market imbalances, resulting e.g. from official price settings different from the equilibrium price, and the implications for the food situation and the structure of food deficits are illustrated in Figure A-3d) and explained below.
  • Description of cases of market imbalances:

    • If the market price is fixed below the equilibrium price (po in Figure A-1 or pm in Figure A-2), e.g. in order to make food affordable also for the poorer sections of the population, food demand would increase, hence the demand deficit would diminish. However, food supplies from domestic production as well as food imports (in the open economy case) would go down, leading to a widening of the production and supply deficits and the emergence of a market deficit: market supplies would be insufficient to cover the effective demand.
    • A market price below the equilibrium price can only be maintained if complementary measures of market intervention are applied, e.g. concessional food imports (food imports at lower than world market prices, e.g. programme food aid), stock draw-downs, producer subsidies, or food rationing. All are frequently applied policy measures which will be discussed later.

    • If the market prices is set above the equilibrium price level, marketed food production will increase and the supply deficit diminish. However, at higher prices, less people will be able to afford the food they need, effective demand will go down and the overall demand deficit widen. As a result of the increased supplies and reduced demand, market surpluses would emerge: not all food offered on the market would be absorbed by effective demand.
    • Higher than equilibrium prices can only be maintained if demand is increased by policy interventions, e.g. by building-up of food stocks and/or by consumer subsidies, or if supplies are reduced, e.g. by imposing restrictions on food import or by promoting food exports. These are, again, frequently applied policy measures. This scenario also shows that a country may well have market surpluses and even be a food exporter, yet food production, supplies and demand may be insufficient to meet total food requirements. In spite of abundant food supplies on the market, a large proportion of the population may lack the means to articulate their food needs as effective demand, and due to the lacking effective demand food production and supplies are insufficient to cover the requirements.

    The results of the analysis of food deficits are summarized in the following Table.

    Table A-1: Types of food deficits

    Table A-1 (X3936E133) (3K)

    After having discussed the constituting elements and the basic patterns of the structure of food deficits we will now turn to the question how the actual levels of food production, supply and demand are determined. Market prices play an important role as determining factor of the volume of production, supply and demand but are not the whole story. The position and shape of the production, supply and demand curves are determined by many other factors which are, furthermore, not fixed but continuously changing. Therefore, the pattern of food deficits is not given and fixed but continuously changing as well, due to variations in supply (e.g. through changes in production, stocks, imports), in demand (as result of e.g. changing incomes and income distribution), in the requirements (population growth, migration), and/or the market prices (e.g. due to changes in supply and demand, price policy, international market influences, etc.). Parameter changes occur implicitly during the process of economic development or as a result of specific policy measures. The relevance of various parameter changes and their impact on food production, supply and demand - hence on the structure and dimensions of aggregate food deficits and overall food security - will be discussed in the following sections.

    The concept of food deficits as presented above provides the basis for our further analysis. If not otherwise stated (depending on the factors to be analysed and the nature of the effects to be studied), the analysis refers to the model of a closed economy (production and supply being identical) but can easily be transferred to the open economy case.

    3. Impact of supply based factors

    The levels of food production and supply are determined by a number of natural, human and economic factors such as land, labour, weather conditions, technology, inputs available, labour and input costs, market conditions, decisions of farmers and traders, etc. The shape and the position of the production/supply curve as shown in our model are the result of the combined effects of all these factors.

    The production/supply curve originates at the level of subsistence production 'spr' in Figure A 1. Subsistence production contributes to overall food supplies. For reasons of simplicity, the volume of subsistence production is here assumed to be independent from market prices (an assumption which definitely does not hold completely true in practice). Major factors determining the level of subsistence production are the needs of the farmers' families as well as the production resources available to them (land, labour, inputs), the intensity of resource use, the technology applied, and, of course, the natural and weather conditions. In years of good harvest, the production/supply curve (including the volume of subsistence production) will shift to the right, in bad years to the left.

    The production volume beyond subsistence production (to the right of 'spr' in Figure A-1) enters the market and is determined by additional economic parameters such as the price of crops and production inputs, input and crop marketing, infrastructure, credit etc. The supply response of agriculture to price changes represents a core issue for the assessment of policy impacts on food production and supply. It centres around the question of how farmers react to changing input or output prices. Some important features of this issue are addressed in Box A-1.

    Empirical studies on agricultural supply response for different crops and regions arrive at very diversified and partly conflicting results. Estimated individual crop elasticities vary from below zero (negative response) to more than one (high response), with median values of individual short-run elasticities likely to be in the range of zero to one-third (low response) and of long-run elasticities in the range of one- to two-thirds (moderate response). Aggregate supply response tends to be significantly below the direct response for individual crops. In a poor agro-climatic subregion in India, the individual (short-run, one year) supply elasticity ranged from 0.25 to 0.77 for the main crop sorghum, while the calculated supply elasticity for all agricultural output (aggregate elasticity) was in the range of 0.05 to 0.09 (Binswanger 1989).

    Although it is almost impossible in practice to state the exact value of agricultural supply response to changing economic variables, the direction and to a certain degree, the intensity of the impact of certain parameter changes can be assessed. Such parameter changes could be the explicit objective or implicit consequence of certain policy measures. Price changes may occur due to an explicit food price policy or as a consequence of macro-economic and structural adjustment policies (e.g. currency devaluation, market and price deregulation).

    Box A-1 (X3936E134) (3K)

    The effect of price changes on supply have already been discussed above. The following examples trace the impact of other economic parameters on food production and supply. Changes in these parameters may be the subject of specific agricultural sector policy measures or the result of changing macro-economic conditions.

    Impact of changing input prices and production cost

    The prices of inputs employed in food production determine the costs of production and have a significant impact on the levels of food production and supply. This refers, for example, to the cost of agricultural labour, the prices of purchased agricultural inputs, irrigation fees, rents for land, interest rates for agricultural credits, etc. The prices of the various cost items are influenced by the nature (and possible regulations) of the factor markets, input subsidies, exchange rate, import duties, etc.

    Figure A-4: Impact of lower input costs on food production and supply

    Figure A-4 (X3936E135) (3K)

    Under normal conditions, input prices, and hence production costs, are negatively related to production: Production expands, if input prices go down, or contracts, if input prices rise. Fig. A-4 shows the likely effects of reduced production costs (e.g. lower wages, lower fertiliser price, lower interest rate for agricultural credits, etc.) on food production.

    Reduced input costs/prices lead to a downward shift of the production/supply curve. As a consequence, the (market equilibrium) price of food will go down from p to p' and the volume of production and supply will increase from vs to vs', leading to an overall reduction of the food deficits (production, supply, demand deficits from R-vs to R-vs', any market deficits will also be reduced).

    The effects, as described above, work, of course, in the opposite direction, if input costs rise, e.g. due to higher wages for agricultural labour, increases of market prices for imported inputs, removal of input subsidies, or higher interest rates.

    Impact of technological change

    Technological change means a variation of production factors (land, labour, inputs, water, etc.) by quality and/or composition, implying a more (or less) efficient use of the factors, changes in production costs and volume.

    In our graphical model, the effects of technological changes are shown in the same way as harvest variations resulting from changing weather conditions: Technological improvements lead to a right shift of the production/supply curve, while a less efficient factor combination/use would induce a shift towards the left. Fig. A-5 illustrates the case of technological improvements, caused for example by the introduction of high yielding varieties, fertiliser, expansion of irrigated agriculture, mechanisation, etc.

    Assuming competitive market structures and liberal price formation, the rightwards shift of the production/supply curve leads to a reduction in the market price from p to p' and to an increase in the volume of production and supply from vs to vs', and a corresponding reduction of the supply and demand deficits. If the price were fixed at p, food production/supply would increase even further but demand remain the same, hence market surpluses would appear.

    Figure A-5: Impact of technology improvements on food production and supply

    Figure A-5 (X3936E136) (3K)

    Major factors inducing technological improvements are research and extension. Although the impact on food production may be quite significant, it is typically of a long-run nature, as the effects need a longer time to materialise than, for example, a response to changing input prices.

    Technological changes in both directions - towards more or less efficient production - may also occur in connection with changing production systems, if there is for example a shift from smallholder food production to large scale farming (or vice versa). It depends on the country specifics of resource availability and forms of resource use whether such a shift implies technological improvement or not. There is some evidence that small-holder production can be more efficient than large scale farming.

    Impact of food imports

    Food imports increase food supplies over and above the level of domestic market production. Fig. A-6 which is based on the open economy model demonstrates the effects on domestic production and supplies, assuming that the imported food commodities are sold to the consumers on the open market. The picture would look different, if imported food commodities, stemming, say, from food aid supplies, bypassed the market and were directly distributed to needy people.

    The impacts of food imports on the structure of food deficits have already been discussed under Section 2 in relation to the open economy model (Figure A-2). The increase of market supplies and the lower price resulting from food imports induces a decline of domestic food production (from vpr to vpr'), a corresponding increase of the production deficit (from R-vpr') but a decrease of the supply deficit (from R-vpr to R-s). The possible disincentive effect of food imports on local production is of special concern in the case of concessional food aid imports when the low priced food items appear on the market and undercut prevailing market prices.

    Figure A-6: Impact of food imports on food production and supply

    Figure A-6 (X3936E137) (3K)

    If world market prices are above domestic prices, the country may become a food exporter, leading to declining domestic food supplies and a widening of existing supply and demand deficits. We may get the paradoxical but nevertheless common situation of a country being a food exporter while a substantial number of people go hungry.

    4. Impact of demand based factors

    The role of effective demand for food security is twofold:

    • the expression of the ability to gain access to food (beyond subsistence production);

    • a precondition to induce food production for the market.
    The major determinants of the level of effective demand are income and prices. Box A-2 presents relevant features of the interaction between income, prices and effective demand. Both income and prices are explicit objectives of and/or implicitly affected by a variety of macro-economic and structural adjustment policies.

    Income refers to the monetary income obtained by individual households from various sources. Individual household incomes add, in aggregate terms, to national income which may be more or less equally distributed. Low incomes and unequal income distribution are a common feature in many developing countries and a major reason for chronic or latent household food-insecurity. This issue will be addressed further below.

    Box A-2 (X3936E138) (3K)

    While income determines the amount of money that can be spent on food (and/or other commodities), prices determine how much the money can buy in real terms. Nominal or monetary income has, therefore, to be related to the prices of the good purchased, in order to arrive at what is called "real income". This can be expressed by the simple formula:

    Yr = f (Ym, p)

    Yr stands for real income, Ym for the monetary income from various sources, and p for the weighed average of the prices of all products forming part of the household budget. The latter is commonly referred to as 'cost of living price index'. The formula applies to the determination of real income of the individual household as well as to aggregate national income (real versus nominal national income).

    Any change in the price of a consumer good has a real income effect: The larger the share of a consumer good in the household budget, the stronger is the impact of price changes on real income. This is a highly important issue for food price/food security policy: As food insecure low-income households usually devote a larger share of their income to food than higher income classes (Engel's law), they are more severely affected by food price changes than higher income households. If, for example, a poor household spends 80 per cent of its income on food (a quite realistic assumption according to empirical evidence), a food price rise of 10 per cent will reduce the real income (hence the purchasing power) of the household by 8 per cent, while a high-income household spending 20 per cent of the income on food will only suffer a 2 per cent real income decline.

    In order to demonstrate the interaction between income, food prices and food demand, we complement our hitherto highly aggregated approach with a breakdown of the demand function into different income classes. This is done in Figures A-7 a) and b).

    Figure A-7 a) demonstrates what is called the Engel's law: food demand increases with increased incomes, but at an increasingly lower rate (lower elasticity). The income level 'i' indicates the minimum income which, at the given food prices, a household (fully depending on the market as source of food supply) has to achieve in order to be able to express its food needs as effective demand.

    Figure A-7 b) presents a stylistic view of household food demand (in relation to varying food prices) of different income classes. High income households are able to purchase all the food they need at higher price levels (up to p') than lower income classes, and show altogether a lower response of demand to food price changes than the other income groups (lower demand elasticity). At the price p, a household belonging to the medium income range (corresponding to the income level 'i' in figure a) would be just able to satisfy its food needs, but a low income class household would still suffer a food (demand) deficit of A-C. At the higher price level p', the food deficit of medium income class households would amount to A-B, the deficit of a low income household to A-D.

    Figures A-7 a) - b): Income, prices and food demand (a disaggregated view)

    a) Food demand at different income levels b) Food demand of different income classes

    Figure A-7 a-b (X3936E139) (3K)

    The above example shows that the concept of demand deficits, used in our model, can also be applied to determine individual household food security. In fact, the aggregate demand curve is the result of adding the individual household demand functions together as presented in Figure A-7 b). The problem of food (in-)security arises with those households whose income level is below 'i' in Figure A-7 a) and whose effective demand function runs below 'd' in Figure A-7 b). If aggregate food demand is insufficient to meet food requirements, it means the people belonging to this category of households are the ones who suffer food insecurity.

    The aggregate demand curve represents the locus of the volume of the composite effective demand of all households at varying prices and at a given level of income and income distribution (changes of income and/or income distribution would lead to a change of the position and shape of the demand curve, see below). The typical downward slope of the aggregate demand curve results from the income effect of price changes (as we treat food as one single group of commodity, the substitution effect is ruled out). At decreasing food prices, the real income increases and a growing number of poorer households are in a position to articulate their food needs as effective demand (and vice versa). The stronger income effect and demand response of low-income households to food price changes is reflected by higher elasticities of the aggregate demand curve at lower food price levels.

    Our model illustrates, in very broad terms, the interaction between food prices and demand and the way in which the volume of demand and an existing demand deficit are affected by food price changes. Price changes occur permanently, as a result of changing natural and economic conditions and the many factors determining the levels of supply and demand. The level of food prices may also be the explicit objective of price policy measures.

    Policy measures to lower consumer prices of food are aimed at enabling the poorer sections of the population to gain access to the food they need, hence to reduce what we call the demand deficit. This may be done by official food price regulations (with probable adverse effects on production and supply as discussed above), by general consumer subsidies (with substantial fiscal implications), or by specific food subsidies for selected consumer groups, e.g. poor urban households. The latter implies a lower budgetary burden but special administrative provisions in order to ensure proper targeting.

    We have already seen that household income represents, apart from the price, the other major economic parameter determining the level of demand. Income comprises the composite monetary household income from all sources, excluding subsistence production (see note on subsistence production). The income of individual households sum, in aggregate terms, to national income which may be more or less equally distributed among the members of society. The effects of changes of income and income distribution on food demand and the state of food security deserve special attention in our analysis, as the various sources of household income (e.g. profits from agricultural and other formal or informal sector activities, income from rural and urban, formal and informal, wage employment, subsidies and transfer payments, etc. )may be severely and often diversely affected by macro-economic and structural adjustment policies.

    Note on subsistence production:

    Subsistence production often constitutes a substantial part of the 'real household income' and has a significant impact on household food supply, demand, and hence overall household food entitlement and food security. In the case of subsistence production, availability of and access to food are directly linked. Therefore, households with subsistence production do not depend or depend less on the market, and their effective market demand for food will be less or, if a household produces all the food it needs (a rather rare case), zero. Transferred to the national level this means that, the larger the share of subsistence food production is in an economy, the lower is effective market demand. This does, however, not necessarily mean that there is a demand deficit - the contrary may be true.

    Figures A-8 and A-9 depict the impact of income growth/decline and income distribution on the levels of food demand and the resulting food deficits. While price changes lead, in our graphic model, to a movement along the aggregate demand curve, income and income distribution determine the position and shape of the aggregate demand curve. Varying incomes lead to a shift of the demand curve to the right or left, changes of income distribution will induce a change in shape (see also the discussion of disaggregated demand functions above). For the sake of clarity, both effects are treated separately, although, in practice, income changes are usually associated with changing patterns of income distribution, hence both effects are superimposed on each other.

    Impact of income growth/decline on aggregate food demand and supply

    Income growth (at constant income distribution) leads to a shift of the aggregate demand curve to the right, hence to an increase in the volume of demand at a given price level (from A to C) and a corresponding reduction of the demand deficit (from B-A to B-C). If the market price is fixed at p, a market deficit will appear (C-A). If the market price is allowed to move freely, the increasing demand will induce a higher market price and increased food production and supply.

    Due to the higher market price, the volume of demand increases (and the demand deficit decreases) less than in the first case (A to D instead of A to C), however the increased demand will be met by increased supplies. At the new equilibrium price, the overall demand and supply deficit will be smaller than at the outset (B-D compared to B-A) and no market deficit appears.

    Figure A-8: Impact of an overall income growth/decline on food demand and supply

    Figure A-8 (X3936E140) (3K)

    The effects of a linear income decline on food supply and demand are self-explanatory.

    Impact of income distribution on aggregate food demand and supply

    Figure A-9 illustrates, again in a stylised manner, the likely effects of a change in income distribution on aggregate food demand. Less income equity pushes the right end of the aggregate demand curve downwards (towards d'), while higher equity pushes the right end upwards (towards d''). The switch of the demand curves leads to changes in the volume of food demand as well as to different demand elasticities. Such changes have a significant impact on the level of aggregate food demand and supply, the food deficit structure of country and the overall state of food security. The effects are discussed in detail below.

    A reduction in equity

    If income tends to be less equally distributed, aggregate food demand will decrease. The small demand increases of high-income households who gain additional income (but have a low income elasticity of demand) are by far outweighed by demand shortfalls of low income households who lose, as their response of food demand to income changes is much stronger. Due to decreasing aggregate food demand, the market equilibrium price will fall. The extent of the price decline is determined by the shape (elasticity) of the supply curve.

    Less income equity, hence a switch of the demand curve from d to d', has the following effects on the volume and structure of the food deficits:

    If the market price fluctuates freely and falls to the new equilibrium price, the demand and the supply deficits will increase from B-A at the outset to B-D. If the market price were maintained at the higher level p (e.g. by official price regulations or other policy measures already mentioned), the market supplies would be not affected but demand would fall even further, and the demand deficit increase from B-A to B-C. In addition, a market surplus of A-C would appear in the latter case. Specific market interventions would be required to absorb this.

    Figure A-9: Impact of income distribution on food demand and supply

    Figure A-9 (X3936E141) (3K)

    The overall negative impact of worsening income distribution on food security is evident:

    The ability of food insecure low-income households to express their needs as effective demand is further constrained, aggregate demand is reduced, the overall demand deficit expands, domestic food production goes down as well, hence the production deficit increases. The decreasing effects on producer prices and the volume of domestic food production further accelerates the downward trend and aggravates the food security situation, as the large group of agricultural producers (representing the majority of households in many developing countries) who depend on the sale of food as a major source of income suffer further income losses.

    This last issue can also be translated from the national to the international scene, posing the question; how far have worsening terms of trade and growing international income discrepancies contributed to the widening food gaps in many developing countries.

    An increase in equity

    The effects of an opposite trend of income distribution towards higher equity (brought about, for example, by public works programmes or other income generation measures for low income groups) are easily deduced: The volume of food demand increases and the demand deficit is reduced. If the market functions and transmits the signals of increased demand to producers, food production is stimulated and the agricultural incomes rise. In summary, the demand and the supply deficits are reduced (from B-A to B-E in Fig. A-9) and overall food security improves.

    5. Impact of the food marketing system

    Food demand and supply are linked through the food marketing system. The performance of the marketing system has a significant impact on the prices the producers get and the prices the consumers have to pay. This depends on various factors:

    • market regulations (flexible versus rigid price and market regulations),

    • market structure (monopolistic versus competitive structures),

    • marketing institutions (public enterprises, private traders, transport agents, etc.), and

    • physical marketing infrastructure (roads, means of transport, warehouses, etc.).
    Structural adjustment programmes commonly aim at improvements in all these spheres. In our previous discussion, we made no distinction between producer and consumer prices. We assumed that the market prices contain already the marketing margin (difference between the consumer price 'cp' and the producer price 'pp'). The producers will, of course, only receive the producer prices. Therefore, the actual production/supply function (production/supply at pp) is, according to the marketing margin, below the production/supply curve expressed in consumer prices (production/supply at cp). This is shown in Figure A-10. Improvements of the performance of the food marketing system will reduce marketing costs, hence (in a competitive market) the marketing margins. Fig. A-11 illustrates such a situation, and the corresponding effects on food supply and demand. In our example we assume that, due to improvements of one or more of the factors mentioned above, the average marketing margin is cut by about half (from old cp - old pp to new cp - new pp). What are the consequences of the reduced marketing cost? Lower marketing costs induce an increase in producer prices and/or a decrease in consumer prices. In a competitive market and assuming normal supply and demand response, both effects are likely to happen simultaneously. The size of the relative price changes depends on the supply and demand elasticities (expressed by the shape of the supply and demand curves in the relevant price range) and, of course, on the market system (whether producer prices, consumer prices, and the marketing margins are regulated or not).

    Figure A-10: Food production in relation to consumer and producer prices

    Figure A-11: Impact of improved marketing performance on food supply and demand

    The effects of improved marketing performance on the volumes of food supply and demand and on the structure of food deficits are obvious: a result of a lower consumer price, demand increases from v to v' while, due to the higher producer price, supply increases from v to v'as well. At v' we get a the new market equilibrium, and both the supply and demand deficit are reduced from v to v', hence overall food security improves.

    The effects of the contrary case of worsening marketing performance can easily be deduced.

    6. The combined impact on the food economy and on food security

    Having analysed the structure of food deficits and the impact of economic factors determining food demand and supply we are in a position to draw some general conclusions as to the combined effects of the various factors on the food economy and the overall state of food security.

    We distinguished different types of food deficits and have seen that the effects of economic parameter changes on both food supply and demand need to be considered simultaneously, in order to be able to assess the impact on the food security situation. Changes in the volume of food supply and demand and on the structure of food deficits can be induced by changes of the market prices, by demand based factors (income and income distribution), by supply based factors (production costs, factor prices, production technology, food imports), and/or by changes in the performance of the marketing system which links both sides - the producers and consumers - of the food economy.

    As a general rule we can state that all factors inducing an increase of food demand and/or an increase of food supply are likely to contribute to a reduction in existing food deficits and to improved food security (and vice versa).

    In our graphical model, the volumes of food supply and demand increase, and the supply and demand deficits are reduced, when there is, as shown in Figure A-12,

  • a right and/or upward shift of the demand curve, and/or

  • a right and/or downward shift of the production/supply curve.
  • The new production/supply and the demand curves in Fig. A-12 cross at point C where all the food requirements are met, hence food security is achieved. If the market is not regulated and the price is allowed to move towards the new equilibrium price (p'), all types of aggregate food deficits (supply, demand and market deficits) are eliminated at this point. (It is assumed that there exist no price or market rigidities which prevent market prices from moving to new equilibrium levels. If the latter were not the case, one or both deficits, in our example the supply deficit, would not be completely eliminated, and, in addition, market imbalances would emerge, see par. 1 above).

    The analogous path of movements of the production/supply and demand curves towards decreasing production/supply and demand, and widening food gaps, can be easily deduced.

    Figure A-12: Path towards a reduction and final elimination of food deficits

    Unfortunately, reality is not as simple as indicated in our model, and there is no magic formula to induce all relevant factors to work in the same direction towards higher food security. Numerous other policy issues need to be solved, and a policy serving one purpose (e.g. consumer and/or producer subsidies to reduce existing food deficits) may be in conflict with another (e.g. fiscal measures to reduce a budget deficit).

    There are also conflicts within the food economy, as the following examples show:

    • Increasing food prices stimulate production, supply and agricultural income, but reduce the real income, effective demand, and food security of consumers who depend on the market for their food supplies (e.g. low income urban consumers).
    • Wages for agricultural labour represent, on the one hand, an important cost component of food production, on the other hand an important source of income for many households. A factor inducing a fall in the real or nominal wage reduces production costs which may stimulate food production, while, on the demand side, the income of households who depend on wage labour is reduced. Their food demand will drop and increase the demand deficit. The drop in demand is likely to affect food production in a negative sense, offsetting the positive effects resulting from lower production costs.
    • Food imports mean an expansion of food supplies which will reduce the supply deficit, in consequence also the demand deficit, but may, through a drop in demand for locally produced food, induce lower domestic food production and increase the production deficit. This applies especially to the case of low-cost concessional food imports. Even where provisions are made to target food aid to the most needy (which theoretically would not reduce effective demand for local food as those people do not have purchasing power), the leakage of food aid items on to the market, with the associated risk of disincentive effects on local production, cannot be excluded.
    • Markets do not function in the ideal manner as assumed in our model. There exist, in reality, substantial market fragmentation and market rigidities which prevent the market from passing on price and market signals and from co-ordinating effectively supply and demand. Market rigidities are often reinforced by official market and price regulations which lead to the emergence of parallel markets. Although parallel markets function, in principle, according to the 'laws' of a liberal market system, they are strongly influenced by the regulations of the official marketing system. The interaction between both marketing systems and the combined effects on the food situation deserve special attention, if a specific country case is studied.
    • Long-run versus short-run effects: While, for example, an increase in food prices leads to an immediate increase in the nominal income of producers (and/or traders) and a decrease in the real income of consumers (with corresponding effects on food demand), the incentive effect on production may take some time to materialise. Negative short-run effects may be outweighed by positive effects in the long-run, but still be a matter of concern, if they worsen the position of already food insecure households. People may be dead before the trees bear fruit. This problem is a main subject of the discussions on the 'social dimensions of adjustment' and has been expressed in the question: 'present pain, future hope?' (Woodward 1992).
    Positive effects of certain economic parameter changes on the food situation may not come through or may be blurred or outweighed by negative effects on another side. There are always gainers and losers. Even the same household may gain in one and lose in another respect. What counts is the net real impact on food supply and demand on those who are exposed to chronic, transitory, and latent food insecurity. In order to arrive at relevant conclusions, the macro-approach analysing the effects of economic parameter changes on aggregate food supply and demand needs to be broken down and complemented by micro-analyses of the effects on food security of specific population groups and at the individual household level.

    There is no easy and no general answer to the issues raised above. How food supply, demand and overall food security are affected by certain policy measures and economic parameter changes depends on the particular situation of a country, the socio-economic structure, the characteristics of prevailing food deficits, and on the specific types, dimensions, and policy package pursued and parameter changes induced. Therefore, an assessment of the effects of policy measures on the food situation can only be done on a case to case and country specific basis.

    The concepts presented above assist in such efforts, by providing the framework for an assessment of the structure and the determinants of the food situation of a country. It has become clear which factors need to be considered in analysing the food economy, and in which way changes in economic parameters affect the levels of food supply, demand, the structure of food deficits and the state of food security.