CHAPTER 1

INTRODUCTION

1.1 Definition and Scope of Agricultural Economics

Before we attempt to define the term agricultural economics, let us begin with splitting the two
words of the term ‗Agriculture’ and ‗Economics’ and then attach specific definition for each. In
here, the term agriculture means different things to different people. Some think solely of
economic activities of farmers and ranchers while others include agri-business firms and still
others include government sector in their definitions implying agricultural sector encompasses
broad linkage of sectors more than farms, ranches and agribusinesses. Agriculture includes
group of interrelated activities that encompasses planting, growing, and subsequent care and final
disposition of a wide range of crops and livestock. Accordingly, agriculture is the purposeful
tending of crops and livestock. Alternatively, it can also be defined as the production,
processing, storing, marketing, and distribution of crop and livestock products. On the
other hand, Economics is the study of resource allocation under scarcity. Resources are scarce
because they exist in finite numbers or volume. Thus, economics is a particular social science
that analyzes the use of limited resources in a way to achieve or satisfy the desired wants and
needs of human beings at optimal.

Now by bringing the meaning of both terms into one, we can define Agricultural Economics as a
discipline that adopts the principle of economics to the problems of agricultural sector. It is an
applied economics that surveys agriculture in its many facets and forms. It is an empirical branch
of general economics that applies economic theories, principles and research methods to crop
production and livestock management. Given this, sometimes, agricultural economics is referred
to as agronomics that uses economic methods to optimize actions by farmers and ranchers. In
general, Agricultural Economics is an applied social science that deals with how human beings
choose to use scarce productive resources and technical knowledge to produce agricultural
output and how to distribute them for consumption to various members of society and/or
industries over time. This can well be understood from the following broad viewed definitions.

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  ―Agricultural Economics is an applied social science that deals with how producers,
consumers, and societies use scarce resources in the production, distribution, processing,
marketing, and consumption of food and fiber products‖ Penson, Oral and Rosson
(2002).

 ―Agricultural Economics is an applied social science dealing with how human being
chooses to use technical knowledge and scarce productive resources to produce food and
fiber, and to distribute it for consumption at various members of society over time‖
(Cramer and Johnson, 1979).

1.2. Historical Development of Agriculture

Early man depended on hunting, fishing and food gathering. To this day, some groups still
pursue this simple way of life and others have continued as roving herdsmen. However, as
various groups of men undertook deliberate cultivation of wild plants and domestication of wild
animals, agriculture came into being. Cultivation of crops, notably grains such as wheat, rice,
barley and millets encouraged settlement of stable farm communities, some of which grew into a
town or city in various parts of the world. Early agricultural implements like digging stick, hoe,
scythe and plough developed slowly over the centuries and each innovation caused profound
changes in human life. From early times too, men created indigenous systems of irrigation
especially in semi-arid areas and regions of periodic rainfall.
Farming was intimately associated with landholding and therefore with political organization.
Growth of large estates involved the use of slaves and bound or semi-free labor. At about the end
of the Middle Ages, increasing communications, the commercial revolution and the steady rise
of cities in Western Europe tended to turn agriculture away from subsistence farming towards the
growing of crops for sale outside the community, i.e., commercial agriculture. In the 16th and the
17th centuries, horticulture was greatly developed and contributed to the so-called agriculture
revolution. Exploration and intercontinental trade as well as scientific investigation led to the
development of horticulture knowledge of various crops. The exchange of mechanical devices
such as the sugar mill and the cotton gin helped to support the system of large plantations based
on a single crop.
The industrial revolution, after the late 18th century, swelled the population of towns and cities
and increasingly forced agriculture into greater integration with general economic and financial

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patterns. The era of mechanized agriculture began with the invention os such farm machines as
the reaper, cultivator, thresher, combine harvester, and tractor which continued to appear over
the years leading to a new type of large-scale agriculture. Modern science has also revolutionized
food processing. Breeding techniques have developed highly specialized animal, plant and
poultry varieties thus increasing production efficiency greatly. The attempt to increase
agricultural output by disseminating knowledge of improved agricultural practices through the
release of plant and animal types and by continuous intensive research into basic and applied
scientific principles relating to agricultural production and economics has continued until this
date and will also prevail in the generations to come.
1.3. Specific feature of agricultural production

Agricultural production is a specialized sector of the economy. The conditions under which it
operates and the nature of its products differ from all other non-agricultural sectors of the
economy. Reddy et al. (2009) identified some of these features to include the following:

1. Perishability of the product: Unlike industrial products, some agricultural

commodities are perishable within a period of one week if they are not consumed. Most fruits
and vegetables belong to this category. The perishability of these products coupled with the
influence of weather results in price variation of these commodities. Most industrial products
are durable and are not subjected to frequent price changes. Most farm products are
perishable in nature; but the period of their perishability varies from a few hours to a few
months. Their perishability makes it almost impossible for producers to fix the reserve price
for their farm grown products. The more perishable products require speedy handling and
often-special refrigeration, which raises the cost of marketing.
2. Agriculture is a fundamentally different production activity than
manufacture (what we call also industrial production). What makes it different is the
unavoidable dependence on the natural environment for production. Production in agriculture
is mainly the result of biological phenomena, whose evolution is mainly out of the direct
human control. Crop production, for example, takes time and there is very little men can do
to change it, given that the vegetative cycle of many crops is defined by the natural cycle of
daylight and temperature. Also, animal production requires the growing cycle of livestock,
which is pretty much defined by nature. This timing of production and its dependence on

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natural phenomena has consequences on the economic outcome of the production that
deserve to be underlined. Agricultural production is sensibly more uncertain than that in any
other sector of the economy. Input in the production process need to be committed well in
advance, and there is little or no power for farmers to reverse the decisions on the inputs
when they discover that output production may be either less than expected or valued less of
what it was supposed to be.
1. Seasonality of production: Farm products are produced in a particular season of the
year. They cannot be produced throughout the year. It leads to intra-year seasonality in
the prices. In the harvest season, prices of farm products fall. But the supply of
manufactured products can be adjusted or made uniform throughout the year.
2. Bulkiness of products: The characteristics of bulkiness of most farm products makes
their transportation and storage difficult and expensive. This fact also restricts the
location of production to somewhere near the place of consumption or processing. The
price spread in bulky products is higher because of the higher costs of transportation,
handling and storage. In contrast, industrial products are neatly packaged and pose no
problem of storage and transportation. Industrial products can easily be made available in
any part of the country.
3. Variation in quality of products: There is a large variation in the quality of agricultural
products, which makes their grading and standardization somewhat difficult. There is no
such problem in manufactured goods because they can be produced of uniform quality.
4. Irregular supply of agricultural products. The supply of agricultural products is
uncertain and irregular because of the dependence of agricultural production on natural
conditions. With the varying supply, the demand remaining almost constant, the prices of
agricultural products fluctuate substantially more than that of manufactured products.
5. Small size of holding and scattered production Farm products is produced throughout
the length and breadth of the country and most of the producers are of small size. This
makes the estimation of supply difficult and also creates problem in marketing.
6. Price Fluctuation. Agricultural commodities are subjected to price fluctuations due to
time lag in their productions. Weather and other factors impose limitations between the
period of decision to produce and actual realization of the output. Due to uncertainties
surrounding agricultural production, this time lag in the production may upset the plans

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 of the farmer. Farmers have no control over the weather and marked situations. Between
the period of planting and harvesting, price of the product can fall. The price fluctuations
of agricultural commodities cause variations in farm incomes. This type of situation does
not occur in industrial sectors.
7. Processing: Most of the farm products need some kind of processing before consumption
by the ultimate consumers. The processing function, though adds value, increases the
price spread of agricultural commodities. Processing firms enjoy the advantages of
monopsony, oligopsony or duopsony in the market.
1.4. CHARACTERISTICS OF TRADITIONAL AGRICULTURE

Traditional Agriculture can be defined as a primitive style of farming that involves the
intensive use of indigenous knowledge, traditional tools, natural resources, organic fertilizer and
cultural beliefs of the farmers. It is noteworthy that it is still used by about 50% of the world
population.

The term traditional agriculture conveys part of its own meaning. The word ―traditional‖ means
―to do things the way they have usually been done.‖ Because natural resources, culture, history,
and other factors vary from place to place, the way things have usually been done also differs
greatly from one location to another. And, because conditions change, no type of farming
system, no matter how traditional, is ever completely stable. In fact, one of the major challenges
to agricultural development is to stimulate improvements in production practices and introduce
higher value products to raise incomes over time. To do so, we need to understand the common
characteristics found in traditional agriculture.

A) Livelihoods and the Intermixing of Farm and Family Decisions

Traditional agriculture takes several forms, but small farms predominate in most developing
countries. Farm families have access to many types of assets including human labor, land,
physical capital such as equipment, financial capital, natural assets, and social and political
assets. Farmers make decisions about how to use their assets in production, labor supply,
consumption, and other activities, and these decisions reflect their ―livelihood strategies‖.
Production and consumption decisions are generally intermixed on traditional farms.

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 B) Labor and Land Use
Traditional farms generally are very small, usually only 1 to 3 hectares (about 2.5 to 7.5 acres).
Labor applied per hectare planted, however, tends to be high. In many areas, land is a limiting
factor and is becoming more limiting over time as populations continue to grow. Labor is
often underemployed at certain times of the year, while capital assets are fully exploited. Much
sharing of work and income occurs on traditional farms so there is little open unemployment
during slack times. This sharing means that the individual‘s wage may be determined by
the average rather than the marginal productivity of labor. As a part of a diversified livelihood
strategies, family members often work off the farm part time, sometimes on neighboring
farms, sometimes in other areas as they seasonally migrate, and sometimes outside agriculture.
Petty trading, often carried out by women, is a common off-farm livelihood strategy in many
countries.

C) Seasonality

Labor use in traditional agriculture varies seasonally along with agricultural cycles. During slack
seasons, those immediately following planting or preceding harvest, labor may be abundant.
However, during peak seasons, especially during weeding and harvest, labor can be in short
supply. Wages often exhibit similar seasonal fluctuations. The seasonal nature of agricultural
production causes variations in consumption and nutritional status, particularly in African settings.
Because storage facilities may be lacking and mechanisms for saving and borrowing
incomplete, consumption patterns can follow agricultural cycles.
D) Productivity and Efficiency
Traditional farms are characterized by low use of purchased inputs other than labor. Yield per
hectare, production per person, and other measures of productivity tend to be low. These factors
do not mean, however, that traditional farms are inefficient. As T. W. Schultz points out,
traditional farms tend to be poor but efficient. Why? The crop varieties, power sources, methods
for altering soil fertility, and certain other factors available to traditional farms constrain
productivity growth, and hence reduce returns to labor and traditional types of capital.
Efficiency, as measured by equating marginal returns to resources in alternative uses, is often

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high. In other words, given the technologies available to traditional farmers, they tend to do a
good job
of allocating labor, land, and other resources. The implication is that just reallocating the
resources they currently have will not have a major impact on output. It makes sense that with
static levels of technology, physical conditions, and factor costs, farmers would gradually
become very efficient at what they do. A situation with low use of certain inputs, low
productivity, but high economic efficiency under static conditions has important implications if
productivity is to be increased. First, new technologies can help to change the production
possibilities available to farmers. Second, investments to improve the quantity and quality of
productive assets such as land can stimulate income growth. Third, education may be needed to
help farmers learn to adjust resource use to changing conditions so as to maintain their high
levels of efficiency.

E) Rationality and Risk

Traditional farmers are economically rational. They are motivated to raise their standard of living
while, of necessity, they are cautious. Traditional farmers are not adverse to change, but
proposed changes must fit into their farming systems without altering too abruptly the methods
they have developed over time to reduce risk and spread out labor use. Traditional farmers face
many risks, including weather-related uncertainty, agricultural pests and diseases, price and
market-related
risks, and human health risks. Decisions often reflect attempts to manage this risk. Because
formal risk management mechanisms such as insurance are often not available, traditional
households turn to informal mechanisms in response to a risky environment. One mechanism by
which traditional farmers spread risk is by exchanging labor and other resources through joint
and extended families. By joint and extended families, we mean relatives (and sometimes
friends) beyond parents and their children. In many countries, a substantial degree of sharing
labor and goods occurs among friends and neighbors, which not only adds to social status but
spreads risk.

F) Off-farm Employment
Because agriculture is so visible in developing countries, it is easy to assume that rural dwellers
are only farmers. In reality, in most countries, off-farm income is an important source of

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earnings, especially for the rural poor. Many landless and near-landless families provide labor to
other farmers. Others work in non-agricultural enterprises; some are self-employed, producing
goods and services for sale. Non-farm employment involves small-scale rural manufacturing,
transport, services, and petty trading. Income from these enterprises helps offset fluctuations in
earnings from agriculture, representing a risk-management strategy. It can smooth intra-year
variations in on-farm labor demands. Rural non-farm employment accounts for about 35–30
percent of income across the developing world. Non-farm income is particularly important for
women who can combine their household obligations, including child care, with work. The
percentage of rural workers in the non-farm sectors varies from country to country, but generally
is in the range of 20–50 percent.

G) THE ROLES OF LIVESTOCK

Livestock play many vitally important roles in traditional farming systems, roles that are
sometimes misunderstood by outsiders. Since about 60 percent of the poor in sub-Saharan Africa
and Asia are dependent on livestock for some part of their livelihoods, there is need to improve
animal productivity in developing countries. Livestock systems can place pressure on the
environment, while environmental stress and change has important implications for small-scale
producers. There is little doubt that when crops and livestock directly compete for the same
resources, it is usually more efficient for humans to consume grain than it is to feed the grain to
livestock and consume meat. However, in most traditional farming systems, livestock consume
little grain.

H) Sources of Fertilizer, Fuel, Hides, and Hair

Animal manure is vitally important as a source of fertilizer and fuel in many countries. Animal
manure increases soil fertility and adds organic matter. In countries where wood is scarce, animal
dung is dried and burned for fuel. Often, these two uses of animal manure compete. Dung that is
burned cannot be used to increase soil fertility. Clothing and blankets are made from animal
hides and hair of not only cattle and sheep, but buffalo, goats, and other livestock.

I) Providers of Power and Transport

In many countries, livestock are the principal source of power. They plow the fields, transport
products to market, and are used in processing tasks like grinding sugarcane. Tractors are still
relatively rare in many developing countries. The large investments needed to purchase tractors

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make them prohibitively expensive for traditional farmers. And, on the steep slopes and rough
terrain in parts of some developing countries, it will be many years, if ever, before mechanical
power replaces animal power.

J) Social and Cultural Symbols

Livestock, particularly cattle and goats, are highly valued in some societies for social and
cultural reasons. A family‘s social status may be measured by the number of animals it owns.8
Cattle are given as gifts during ceremonial occasions. While livestock serve major economic
functions, they serve these other social and cultural functions as well.

K) Changes in Livestock Systems

Rapid urbanization and growing incomes in many developing countries have been associated
with increased demands for animal proteins as a food source, a phenomenon that has been named
the livestock revolution. Growing demand has raised meat prices and put pressure on global
livestock systems.10 While much of this demand will be met by industrial producers, traditional
farmers can play a role. This role is probably strongest in the dairy sector as cheese can be
produced on a small scale. Traditional farmers, particularly those with access to grazing land,
can also benefit from increased prices of cattle and other ruminants. Although impacts of climate
change will vary by location, it is likely that substantial

1.4 The Role of Agriculture in Economic Development

Traditionally, economists have analyzed agricultural development in terms of its contribution to
the growth of the overall economy. Accordingly, over the past two centuries there have been
major changes in the roles attributed to agriculture in economic development. To the early
Physiocrats agriculture was viewed as an engine of economic growth. They argued that
agriculture is the only activity that is capable to generate large enough surplus to stimulate
growth in other sectors of the economy. On the other hand, the classical economists of the 19th
century believed that diminishing marginal returns to agricultural land would eventually lead to
overall economic stagnation. For example, as of Malthus and Ricardo - agriculture was viewed
as a major impediment to economic progress because the combination of a limited supply of land
and diminishing returns to the application of labor and capital to land were deemed to limit the
improvement of welfare. To them these were the conditions prevailed in a developed country
like England.

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After the emergence of development economics within the discipline of economics (after the 2nd
world war) there have also been major changes on the views about the role of agriculture in the
economic development. After long debates, in recent times, there has been realization that
accepts ―agriculture is central to economic growth in poor countries‖ (Block, S. and P. Timmer.
1994). The discussion in recent decades has been shaped by Johnston and Mellor's (1961) classic
article "The Role of Agriculture in Economic Development‖, in which they identify five types of
inter-sectorial linkages (forward and backward linkages operating through both production and
consumption) that highlight agriculture's role in economic growth. These include providing food
for domestic consumption, releasing labour for industrial employment, enlarging the market for
domestic industrial output, increasing the supply of domestic savings, and earning foreign
exchange. In least developing countries, therefore, agricultural sector accounts significant
proportion of the national accounts including foreign exchange earnings. It also contributes a lot
to economic growth and development of these countries by providing food, market, raw
materials and other inputs for growing economy, and the required foreign exchange reserves.
Accordingly, the contributions that agriculture adds to economic growth and development can be
categorized into five broad elements:

A. Product contribution;
B. Market contribution;
C. Factor or input contribution;
D. Foreign exchange contribution; and
E. Welfare contribution

1.5. Agricultural system

An agricultural system, or agro-ecosystem, is a collection of components that has as its overall

purpose the production of crops and raising livestock to produce food, fiber, and energy from the
Earth's natural resources.

1.5.1. Low external input sustainable agriculture

Low-External-Input and Sustainable Agriculture (LEISA) is agriculture which makes

optimal use of locally available natural and human resources (Such as soil, water, local plants

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and animals, vegetation, human labor, skill and knowledge) and which is economically feasible,
culturally adapted, ecologically sound and socially justice. (Reijntjes, Haverkort and Waters-
Bayer, Farming for the Future, 1992).

Low external-input sustainable agriculture (LEISA) is a term that refers to farming practices that
are conducted with three key goals; environmental conservation, economic profitability and
social equality. It can simply be described terms referred to as responsible farming. It entails
farming with the goal of obtaining better yields while also making sure that the environment is
well protected to support farming even in several years to come (Himanshu Tiwar.et.al, 2022).

Basic concepts of low external-input sustainable agriculture (LIESA):

LEISA aims for long-term stability and adequate production level. LEISA practices must be
developed within each ecological and socio-economic systems. LEISA incorporates that best
component of indigenous farmers knowledge and practices, ecologically -sound agricultural
practices. Optimize the best possible use of locally available resources.

Need of low external-input sustainable agriculture (LIESA):

Low external input sustainable agriculture systems are designed to use existing soil
nutrient and water cycles, naturally occurring energy flows for food production. As well as
such systems aim to produce nutritious and quality food. Such systems have tended to
avoid the use of synthetically compounded fertilizers, pesticides, livestock feed additives,
growth regulators, instead relying upon crop rotations, animal manures, crop residues,
legumes, off-farm organic wastes, green manures, appropriate mechanical cultivation,
and mineral bearing rocks to maintain soil fertility and productivity.

Basic principles of low external-input sustainable agriculture (LIESA):

1. Water conservation

2. Soil conservation techniques

3. Enhance soil microbial activity

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 4. Maintain animal-plant relationship

5. Use solar energy

6. Use of locally available resources

Benefits of low external-input sustainable agriculture (LIESA):

 It does not advocate for the use of chemicals and commercial fertilizers.
 This reduces certain harmful effects on the environment that can pollute it.
 This preserves the natural environment, resulting healthy produce.
 It promotes the culture of animal husbandry through feeding on natural
feeds.
 There is better protection of animal species, creating a natural balance in
the ecosystem.

Limitations of low external-input sustainable agriculture (LIESA):

 It also hinders the full exploitation of land, labor and capital because it advocates for the
use of productive resources sparingly.
 It limits the proper land usage.
 Income that is generated from farming is also very limited due to sparingly
use of land.

1.5.2. High external-input sustainable agriculture (HEISA)

High external input Agriculture (HEIA) are technologies that utilize high external inputs such as
inorganic or chemical fertilizers to increase nutrient depletion from the soil, pesticides to control
pests and diseases, herbicides to control weeds and irrigation facilities for water management in
the farms. These technologies are often beyond the financial reach of the small - holder farmers.

The basic aspect of conventional agriculture was to maintain subsistence level production by
using locally available resources. All resources had been naturally recycled and reused

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without wasting. But due to pressure of increasing population in developing countries steps
were taken to expedite food production deviating from the traditional pattern.

The pressure of world population explosion exerted more on the people of developing countries.
In order to confront the pressure of world population explosion the farmers as well
as the researchers and extensionists were compelled to join the Seed – Manure‖ revolution
born with the label Green Revolution. The aim of this Revolution was to provide food for
the increasing population by enhancing the harvest per unit and the intensification of the
number of cultivation seasons. In response to the green revolution practices, introduced in
late 1960s our agricultural production increases significantly.

High yielding hybrid seeds which were introduced by green revolution were new to our
environment. The growers had to practice new techniques to get higher production. Due to
the fact that hybrid seeds were more sensitive to nutrients the growers were encouraged to
use chemical fertilizer in large quantities as external inputs. As the new crops were foreign to
the environment they were susceptible to pests and diseases. Consequently, the necessity
arose to apply chemicals, which became an additional burden to growers. Application of
chemical fertilizers and pesticides increased the cost of production.

The hybrid varieties were dwarf in nature and could not compete with weeds. Application of
weedicides or manual weeding was essential to mitigate the competition between hybrid
varieties and weeds. From land preparations to harvesting all agricultural practices, related to
hybrid varieties were more labor intensive. Mechanization was an integral component of green
revolution. To increase the working efficiency of the production system machinery like tractors
have been introduced. These machines require fuel. The water consumption of new crops was
also higher. Therefore, it was necessary to improve irrigation facilities. The external resources
were used extensively in this agricultural system many of the resources used in higher external
input agriculture were not recycled. This system failed to add anything to enrich the soil.

Advantages of high external input agriculture (HEIA)

 Agricultural Production could be rapidly increased to meet the demand for food for the
increasing population.

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  As a result of availability of adequate food stuffs many problems related to diseases
caused
by mal-nutrition and deficiency were prevented or reduced.
 New improved varieties gave yields within a short period of time.
 Mechanization solves the problem of labor shortage.
 Income and profit margins of the products were increased.
 Productivity of land increased.
 Increased market facilities for production.

Disadvantages high external input agriculture (HEIA)

 Increase in soil erosion due to constant furrowing by machinery.

 Dependence on imported machinery, chemical fertilizer, pesticides, hybrid seeds and
other
inputs.
 Extensive use of pesticides disturbed the natural mechanism of controlling pest and
diseases as the artificial pesticides kill both pests and their natural enemies.
 Use of artificial agro-chemicals adversely affected the soil pH, caption exchange
capacity,
soil structure, soil texture and soil organisms. Consequently, the microbial activities of
the
soil tend to reduce forming dead soil.
 Although the need for high capital investment, large scale farmers benefited while small
scale farmers who were short of capital ran into debit.
 Neglecting environment friendly traditional varieties of seeds and their genetic resources
faced extinction due to introduction of hybrid varieties. Conventional agricultural
knowledge and techniques were neglected and extinguished.

At present many advantages gained from High external input agriculture are progressively
diminishing and the yield per unit is decreasing. Therefore, the farmer, researchers and
extensionists are compelled to move towards a sustainable agriculture system free of high
external inputs.

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Review question on chapter one
1. Explain the role (contributions) of agriculture in economic development. What
contribution does agriculture contribute to the economy of Ethiopia.
2. Explain the basic concept of agricultural economics and its focus area (scope)
3. Differentiate the nature of agricultural production with other sector of the economy
4. Examine the characteristics of traditional agriculture in less developing countries. Which
of those characteristics do exhibit in Ethiopian agricultural system.
5. Analysis the very much importance of low external input sustainable agriculture and high
external input sustainable agriculture from the perspective of less developing countries in
general and Ethiopia in particular.

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 CHAPTER 2

2. ECONOMICS OF AGRICULTURAL DEVELOPMENT

It should have to be recalled that, the problem of agricultural development is not that of
transforming a static agricultural sector in to a modern dynamic sector, but of accelerating the
rate of growth of agricultural output and productivity, consistent with the growth of other sector
of a modernizing economy. In line with these economists have made strong investigation of the
very causes for agricultural stagnation and underdevelopment in developing countries and they
have also developed different models (theories) of agricultural development to influence decision
makers. This chapter will go through review of some of these models and look their implication
to Ethiopian economy, and critically evaluate the internal strengths and weakness of each model.

2.1. Changing views/perspectives of the role of agriculture since 1950

Historical perspective of the views regarding the role of agriculture in economic development
since 1950s can be divided roughly into three periods namely the economic growth and
modernization era (1950-1960s), the economic growth-with-equity period (1970s), and the
economic growth and policy reform period (1980s).

The Economic Growth and Modernization Era (1950s – 1960s)

During the 1940‘s and 1950‘s there was a renaissance of interest in analyzing the determinants of
economic growth. During this period, the economics profession turned its attention to the study
of economic development to better understand the anatomy and physiology of the growth
process and to formulate prescriptions for appropriate development policies and strategies
(Weber, 1968). It was widely believed during this period that industrialization was the key to
development and that the industrial sector, as the advanced sector, would pull the backward
sector, agricultural sector. More specifically, as the view of this period, industry is viewed as the
leading sector which would be considered as a source of alternative employment opportunities to
the rural population, would provide a growing demand for foodstuffs and agricultural raw
materials, would process goods and services for domestic consumption or export, and would
begin to supply industrial inputs (e.g. fertilizer) to agriculture. As a result, it was widely believed
during this period that industrialization was the unique key to development.

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During this era of economic growth and modernization it was also became fashionable to use as
an analytical and planning framework of one-sector models of the Harrod-Domar types. This is
mainly because of their aggregative nature and use of simple production functions with only
investment as a key element. In the process, however, economists had developed simple two-
sector dualistic development models to analyze the role of agriculture in relation to industry.
Finally, dualistic development remained the dominant economic view which affected
development economic thinking throughout 1950s and 1960s. The dualistic development models
continued to assign essentially passive role to subsistence agriculture in the development of the
rest of the economy. Therefore, the dual sector development models of 1950 and 1960s attach a
negative or static role of agriculture to the overall economic growth and transformation of
economies in the developing countries.

To the dualistic development models, agriculture‘s primary contribution to economic growth and
development was to provide only a costless supply of labour to support the growth of industry
and the development of cities. As a result, most of the western development economists of the
1950s and 1960s did not view agriculture as an important contributor to economic growth.
Accordingly, the rapid transfer of resources (especially surplus labour) from agriculture to
industry was deemed as an appropriate short-run economic development strategy. The
intellectual support to this conclusion lies on the assumption stating ‗the value of the marginal
product of labour in agriculture was zero over a wide range of employment’ (Lewis, 1954).
These implications were translated into policy frameworks that were disastrous in the role
assigned to agriculture in the growth and transformation of economies in developing countries
and which adversely affected the welfare of farm people in most developing countries, and,
consequently, had adverse effects upon the overall economic growth in the agrarian economies.

Even though two-sector models did provide important insights into the interaction between the
agricultural (backward) and industrial (advanced) sectors, there were at least three fundamental
points that the dual-economy models did not address explicitly. These include foreign trade
sector, the determinants of agricultural output, and the two way links between agriculture and
industry. The foreign trade sector was eliminated because of the fact that a closed economy being
selected as the frame of reference rather than the open economy. The dual- economic sector
models of 1950s and 1960s suffered from further shortcomings including inadequate attention to

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the need for technical change in agriculture; lack of attention to the biological and location-
specific nature of agricultural production process; and lack of a solid micro foundation based on
empirical research at the farm level.

The Growth-with-Equity Period (since 1970s)

The growth with equity view of economics was emerged by the recognition of some of the
shortcomings of the economic thinking of the Economic Growth and Modernization Era. A
better understanding of the determinants of agricultural output both in microeconomic and
macroeconomic terms is essential if agriculture is to play an active role as a supplier of
resources. Moreover, it is true that growth could result only if agriculture and industry made
active and simultaneous interdependence. Recognition of this active interdependent was a large
step forward from the naive industrialization-first prescription before 1970s. As a result, growth
with equity view of the 1970s economics thinking gave greater attention to growth with
employment opportunities and the distribution of real income. This shift spills over from three
reasons:

a) The goal of economic growth for third world countries was seriously questioned and the
need to redefine the goal of development more broadly was required.
b) From the 1960s onwards it became apparent that rapid economic growth in some
countries (Pakistan, Nigeria and Iran) had harmful effects and in some cases had
disastrous results ranged from civil war to the establishment of murderous authoritarian
regimes.
c) Though in some countries where rapid economic growth had not contributed to social
turmoil, the benefits of economic growth were not trickling down to the poor and the
income gap between rich and poor was widening.

Thus growth-with-equity concerns stimulated a number of important theoretical and policy

debates. The first concerned the interactions between income distribution and rates of economic
growth. The analysis focused on changes not only in the size of distribution of income during the
course of development but also on its functional distribution (economic impact of growth on
small farmers, on women, etc.) as well. The second centered on employment generation and the

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possible existence of employment-output trade-offs in industry and agriculture (for example
population growth, rural-urban migration and its impact on agricultural production and output;
urban industry and its capacity to employ new entrants to the labour force, etc. have got
attention). Taking these and other issues, new concern was raised about creating rural jobs in
agriculture and industry, and in the relative output and employment generation capacities of large
and small enterprises. In agriculture these two debates centered on how much emphasis should
be given to improving small farms as opposed to creating large and more capital-intensive farms
and plantations. The debate centered its idea within the following points.

 The majority of the poor in most developing countries live in rural areas and because
food prices are a major determinant of the real income of both for rural and urban poor,
the low productivity of agriculture was seen as a major cause of poverty.

 Urban industry had generally provided few jobs for the rapidly growing labor force;
development planners increasingly concentrated on ways to create productive
employment in rural areas, if only as a holding action until the rate of population growth
declined and urban industry could create more jobs
In the process, the debate has changed the idea towards a more important role of agriculture in
development. As a result, there was a rapid expansion of micro-level research on agricultural
production and marketing, farmer decision-making, the performance of rural factor markets, and
rural non-farm employment in 1960s and 1970s. In industry, the small-versus-large debate led to
empirical studies of rural micro and small-scale enterprises.

The Economic Growth and Policy Reform Period (1980s)

This period witnessed a major shift in development economics towards economic growth, policy
reform and market liberalization. The shift from microeconomic analysis of agricultural projects
to macroeconomic policies was considered as a cutting edge of development in food policy
analysis, and it was the dominant development theme of the 1980s. In the economic growth and
policy reform era, therefore a major analytical advance in the way that economists viewed policy
was the development of the food policy analysis approach. The approach synthesized work in a
number of areas, outlining how to trace the effects of macroeconomic adjustments as well as
sectorial level policies on food production, income generation, and consumption patterns of the

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poor. In Africa, the policy reform was strongly advocated in the World Bank's report, and
structural adjustment programs were launched or in underway in the mid of 1980s. In Asia,
agricultural development proceeded more rapidly than expected and can be considered as major
success story of the 1980s. For example, India achieved food self-sufficiency in grain production
in the mid-1980s.

The food policy analysis approach has set two distinguishing schools: the production incentives
school and the basic needs school. The production incentives school emphasizes the need to get
prices high, i.e. raising agricultural price in order to increase farmers‘ incentive to produce. The
basic needs school stressed the need to keep price low in order to ensure that the poor could
afford an adequate diet. The approach recognized that both of the production concerns of the
production incentive school and the consumption concerns of the basic needs school were
legitimate and it showed how they will be linked through food prices. Food policy analysis hence
forms a bridge between the two approaches.

In addition food policy analysis approach recognized in a more explicit manner that policy
formation takes place in an open economy where the financial and commodity markets are
increasingly integrated and thus calls for the integration of food and agricultural policy with
macro policies such as the exchange rate and interest rates, in a world economy framework. As a
result, in the mid-1980s, policy makers in many countries become interestingly concerned about
food security. Many works were also stressed that food security should involve assuring both an
adequate supply of food (through own production and trade) and access by the population to that
supply (through improved distribution facilities). This is because with the achievement of
national food self-sufficiency in major Asian countries, it was apparent that a large percentage of
people neither had the access to resources (land, credit, etc.) nor the purchasing power (income)
to secure their food needs.

In general, as economists‘ have been involved in the analysis of development problems in

nations characterized by static agricultural technology and rapid growth in demand for
agricultural products, attention has shifted increasingly to a concern with the conditions under
which an agricultural surplus can occur and be sustained. Mainly, there has been a shift of view
away from an earlier "industrial fundamentalism" to an emphasis on the significance of growth
in agricultural production and productivity for the overall development process of a given

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country. In other words, there have been changes in the views regarding the role of agriculture in
the process of economic development. Accordingly, ‗agriculture is not a static sector rather it
is a productive sector which produces different commodities’.

Sustainable development is development which meets the needs of the present generation
without compromising the ability of future generations to meet their own needs.

An economically sustainable system must be able to produce goods and services on a continuing
basis, to maintain manageable levels of government and external debt, and to avoid extreme
sectoral imbalances which damage agricultural or industrial production.

An environmentally sustainable system must maintain a stable resource base, avoiding over-
exploitation of renewable resource systems or environmental sink functions, and depleting non-
renewable resources only to the extent that investment is made in adequate substitutes. This
includes maintenance of biodiversity, atmospheric stability, and other ecosystem functions not
ordinarily classed as economic resources.

A socially sustainable system must achieve fairness in distribution and opportunity, adequate
provision of social services including health and education, gender equity, and political
accountability and participation.

These three elements of sustainability introduce many potential complications to the original,
simple definition of economic development. The goals expressed or implied are
multidimensional, raising the issue of how to balance objectives and how to judge success or
failure. For example, what if provision of adequate food and water supplies appears to require
changes in land use that will decrease biodiversity? What if non-polluting energy sources are
more expensive, thus increasing the burden on the poor, for whom they represent a larger
proportion of daily expenditure? Which goal will take precedence?

2.2. The Need for Economic Growth and Development in Agriculture

In recent years, guarantying employment to all nations is recognized as the economic

equivalent of the right to vote in political democracy and seen as a fundamental human right. A

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progressive expansion of human needs that generate additional employment opportunities
coupled with accelerated growth in the productivity of material and non-material resources
provide the essential foundation for full employment. A theoretical understanding of
employment generation as one dimension of the social development process also challenges
common misconceptions and supports the view that full employment is an achievable goal for
the international community.

A solution to the current problem of unemployment can be arrived at by viewing employment as

a natural function of social development. The faster and further a society develops, the greater
its capacity to generate employment opportunities for its members. This can only be possible
through sustained economic growth and development. Development also occurs when society
possesses unutilized resources that are harnessed to fulfill unmet social needs such as expansion
of employment opportunities. Development of agriculture coupled with generation of new
technology within the system is critically important for ensuring food and nutritional security
for the hundreds of millions of people that still live below the poverty line, for raising rural
incomes and generating employment opportunities, and for stimulating industrialization and
overall economic development of the country.

Agricultural growth was also the precursor to the industrial revolutions that spread across the
temperate world, from England in the mid-18th century to Japan in the late 19th century. More
recently, rapid agricultural growth in China, India, and Vietnam was the precursor to the rise of
industry. Higher agricultural productivity generating an agricultural surplus (which was partially
taxed to finance industrial development) and enabling lower food prices underpinned these
success stories of the structural transformation. The paradox in this transformation is that higher
agricultural growth was necessary to stimulate overall economic growth, resulting in an eventual
decline in the share of the agricultural sector in gross domestic product (GDP) and national
employment.

In general, in today‘s globalizing world, Agriculture can be taken as the lead sector for overall
growth in agriculture-based countries for four basic reasons.

i. Agriculture is a large sector. In low-income countries, at an early stage of economic

transformation agriculture accounts the large share in GDP and national employment.

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 This suggests that strong growth in agriculture is necessary for overall economic growth.
As the largest sector, agriculture has an important role in providing resources for the
development of the overall economy. That is, countries which successfully invested in
agriculture can tax part of the surplus generated to finance industrial development.
However, the heavy exploitation of agriculture through tax before meaningful investment
in agricultural development can prove lethal, as has often been the case in Sub-Saharan
Africa.

In Sub-Saharan Africa, the growth rate of agricultural GDP per capita was close to
zero during the early 1970s and negative through the 1980s and early 1990s but which is
positive in the 2000s. In the 1980s, developing countries taxed agriculture relative to
other sectors at a level of about 30 percent on average and 45 percent in Sub-Saharan
Africa, with overvalued exchange rates, high tariff protection in industry, and taxes on
agricultural exports all contributing to the bias. The positive growth rates in the past 10
years suggest that the stagnation in Sub-Saharan African agriculture may be over and that
agriculture could be the engine of faster growth and poverty reduction in the region. It
has been estimated that a 10 percentage point reduction in total taxation to the sector
would increase overall annual growth by 0.4 percentage points.

ii. Growth in agricultural output reduces food prices. In low-income countries,

agricultural productivity determines the price of food, which in turn determines wage
costs and global competitiveness. Productivity of food staple and its price stability are
thus the keys to growth and development of any economy.
iii. Comparative advantage in their economy lies in agriculture. Because of natural
resource endowments that favor agriculture (a lack of skilled labour, and a difficult
investment climate that reduces competitiveness of manufactured goods) for many years,
comparative advantage in low-income countries still lies in primary activities and agro
processing industries.
iv. Agricultural growth has strong growth linkages to other economic sectors. When
agricultural incomes are spent on domestically produced non-tradable goods and services,
it stimulates demand for domestic industry and services. Production linkages foster

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 growth in agro processing industries and food marketing and demand for intermediate
inputs and services.

Thus, a comprehensive policy approach to stimulate agricultural growth should be implemented.

Such a policy approaches includes four key elements: improving producer incentives, providing
core public goods and a better climate for private investment, building effective institutions, and
ensuring sustainable use of natural resources. Investments in core public goods such as science,
infrastructure, and human capital combined with better policies and institutions are major drivers
of agricultural productivity growth. In addition, much of the needed investments will have to
come from rural savings and the private sector, with the rural investment climate an important
determining factor. Investment in public goods such as infrastructure is part of a good investment
climate for the private sector, but well-functioning institutions and regulations are equally
important. Therefore, so as to achieve growth and transformation in agriculture, countries have to
make endeavors to create surplus production in the sector and hence pave the way suitable for
new investment opportunities.

2.4. Sources of Economic Growth and Economic Transformation

Economic growth or an increase in national income (either in GDP or GNP) is a prerequisite for
economic transformation. According to structural transformation theorists (mainly Fischer and
Clark), economic transformation refers to the steady shift of employment and investment from
the essential primary economic activities to secondary activities such as industries and still to
greater extent into tertiary production sectors such as service-oriented industries.

Economic growth by itself is not an automatic upshot rather it depends to a significant extent on
the availability of productive services rendered by resources and the capacity of institutions to
create scientific knowledge and to develop productive technologies. Research and technology
development is the foundation of productivity gain in the agriculture. Agricultural technology
unlocks the constraints imposed by resource endowments by providing new processes, practices,
and methods of production. Agricultural research is the source of new technologies and the
emergence of new productive technologies and its adoption also benefit the environment.
Basically, according to Y Hayami and W Ruttan, in agriculture, there are two kinds of
technologies

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 i. Mechanical technologies (agricultural machineries) are designed to facilitate the
substitution of power and machinery for labour. Typically, this involves the substitution
of land for labour, because higher output per worker through mechanization usually
requires a larger land area cultivated per worker. Thus, mechanical technology is labour
saving technology.

ii. Biological and chemical technology (improved seed and improved method of farming)
are designed to facilitate the substitution of labour and/or industrial inputs for land. This
may occur through increased recycling of soil fertility by more labour-intensive
conservation systems; through use of chemical fertilizers; and through husbandry
practices which permit an optimum yield response.

Development of technology should be guided by the constraints of that locality (or country). For
example, land is abundant in America but relatively agricultural labour scarce country. So, here,
labour scarcity is the constraint in agriculture business. As a result, USA more focused on
developing agricultural machineries to increase the labour productivity. The new innovation is
tractor and other machineries that unlock this constraint in the farming business. In contrary,
Japan is land scarce country. Japan has developed technology like hybrid seed and other
biological technology that improves the land productivity and nullifies the constraints imposed
by scarce land resource.

In summary, some of the sources of growth include:

i. Quantitative and qualitative availability of productive resources including natural,

skilled manpower and capital resources - economic growth depends to a significant
extent on the quantitative and qualitative availability of productive resources that a
country has. The better the quality and quantity of the resources the more the potential
that the country has to grow. For example, availability of more capital generally means
more production, and more production means more economic growth.

ii. Economy’s capacity (or rate) of making saving and hence investment – the current
saving provides funds for investment needs. Thus, to have more for tomorrow you often
have to have less for today by making more saving today. This should in turn mean more
growth in the future. Thus, to get more capital from agriculture countries have to make

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 revolution on the saving and hence investment culture. So, the level of investment may be
a big determinant of future growth.

iii. Improve in factor productivity - in order to achieve growth in agriculture, either

aggregate input use or productivity of inputs (output per unit of input) should increase.
Despite growth in inputs use is typically identified as the driving force of economic
growth, in agriculture, the driving force has been productivity growth or an increase in
output per unit of input.

iv. Proportion of resources allocated to research and development activities and its
capacity to generate productive technologies. Economy‘s extent to advance scientific
knowledge and technological progress is perhaps the most widely accepted (and easiest to
understand) source of economic growth. The ability to increase production using the
same or fewer aggregate inputs (factor productivity) could not occur without the
development of new agricultural technologies such as higher yielding varieties of crops,
improved livestock breeds, and innovative tillage and irrigation equipment.

Thus productive technologies make things possible to produce more from the same
quantity of resources (or factors inputs). This in turn boosts the potential level of output
of the economy. Therefore, countries should give due attention to technological
progresses. The pace of technological change will in turn depend on the amount of GDP
devoted to research and development activities, extent of the economy to advance
scientific skills, and the quantity and quality of education system.

In general, an economic growth, which is closely associated with the advance of science and
technology can be achieved by increases in output per factor input (i.e., increase in factor
productivity) and improve in the production technology. An increase in the factor productivity
facilitates the transfer of labour and capital from sectors with low output per worker to sectors
with higher output per worker and improves in the production technology augments productivity
of factors inputs. Hence the two basic sources of economic growth in any country are an increase
in the factor productivity and improve in the production technology.

2.5. Evolutionary Stages of Agricultural Transformation

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Agricultural transformation occurs when a substantial number of rural households have incomes
exceeding the poverty level; operate farms commercially; i.e., selling a substantial portion of
their farm output; specialize in production at the farm level and adopt new technologies on
regular basis; invest more heavily on the farm; and purchase commercial inputs including hired
labour significantly (or at large quantities).

From both historical and contemporary cross-section perspectives this transformation in

agriculture seems to endure through at least four phases that are roughly definable according to C
P Timmer.

1. Stagnant agriculture gets moving - This stage starts when agricultural productivity per
worker rises. This increased productivity creates surplus. As a result, one farmer can feed
more people and then the surplus would tend to be absorbed in other sectors in the
economy. The main concern of this stage is thus ―getting agriculture moving‖. Hence,
policy intervention to do so should focus on institutional change; introduction of new
technology; change in the structure of markets and providing incentives; make farmers
safe by subsidies; and significant investment in rural infra-structure and research and
development activities.

2. Existence of dual economy - Surplus created in the first stage causes an existence of
dual economies. In this stage the surplus created can be tapped directly through taxation
and factor flows and indirectly through government intervention into rural urban terms of
trade. Therefore, in this stage, there is extraction of rural economy to the urban sector.
Hence, agriculture now is the key contributor to the growth of the rest of the economy. It
contributes surplus resources in terms of labour, capital, output, etc. Thus, the agricultural
policy interventions should focus on establishing market links with industry; continue
provision of technologies and incentives to create a healthy agricultural sector; improve
factor markets to mobilize rural resources; and extracting surplus resources from rural
sector to urban areas. In general, at this stage, the main emphasis of policy intervention is
to link agriculture to other sectors.

3. Progressive integration of the agricultural sector into the macro economy via
improved infrastructure and market equilibrium linkages. In this stage, the share of
food expenditure in urban budgets declines and the net-work between agriculture to other

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 sectors increases. The aim of policy makers at this stage of agricultural transformation
process is also to integrate agriculture into the macro-economy. Policies should also be
designed to keep every sector as healthy as possible by bringing stability in
macroeconomic prices via price stabilization policies). The policy push is also to make
agriculture efficient, to shift resources out of agriculture (example labour). But
substantial income distribution problem may occur due to lagging rural labour
productivity.

4. The maximum stage of agricultural transformation. While agriculture provides a

means for life sustenance, at this stage agriculture is not seen as a means of profit making
sector. In this stage, price of agricultural products decline due to their income inelastic
character and hence farmers face lack of demand for their products. As a result,
agricultural markets also face terms of trade (TOT) problem with the rest of the economy.
Persistent technological advances in agriculture also create excess supply of food relative
to effective demand of the urban households who spend less than 30% of their budget on
food. Moreover, at this stage unemployment in industrial sector creates pressure to keep
labour in agriculture. Therefore, the main concern of policies at this stage should give
concern on farm income problems; decline in agricultural terms of trade issues;
environmental concerns and ways of life sustenance; unemployment problems; and
organic agriculture as a way to maintain healthy life.

In general, managing agricultural protection and its impact on world commodity markets
provides a continuing focus for agricultural policy makers even when the agricultural
transformation is complete. Moreover, as of Theodore Shultz (1964), the first agricultural
economist who won the Nobel Prize, transforming traditional agriculture into the more
productive industrial model requires prices of farm inputs and products to be set at levels that
make it profitable for the necessary investments to be made.

2.6 Sources of Economic Growth in Agriculture (Review of Models)

Prior to the 20th century, almost all increase in food production was obtained by bringing new
land into production. By the end of 20th century, almost all of the increase in world food
production must come from higher yields from increased output per hectare of land. Therefore,
in most of the world, the transition from a resource based to a science based system of

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agriculture is occurring within a single century. In a few countries this transition began in the
19th century while in most of the presently developed and developing countries it did not begin
until the first half of the 20th century. Therefore, most of the developing countries of world have
caught up the transition only since mid 20th century. During the remaining years of the 20th
century, it is imperative that the poor countries design and implement more effective agricultural
development strategies than in the past.

It should also be recalled that, the problem of agricultural development is not that of
transforming a static agricultural sector into a modern dynamic sector, but of accelerating the
rate of growth of agricultural output and productivity, consistent with the growth of other sector
of a modernizing economy. A useful first step in this effort is that after strong investigative
analysis economists have developed different models or theories of agricultural development that
influence the focus of agricultural decision makers. Agricultural policy makers also tried to apply
one or more of these models for the purpose of developing agricultural sector through changing
sources of growth. Review of the broad literature identified nine major classifications of
agricultural development models which explain source of growth: resource exploitation model,
resource conservation model, industrial fundamentalism model, urban industrial impact model,
diffusion model, high pay-off inputs model, induced innovation model, cultural change first and
community development movement model, and neo-Marxist and dependency model. In this sub
section, some of these models and their practical implications to the agrarian economies (such as
Ethiopia) could be analyzed.

2.6.1 Resource Exploitation (Frontier) Model

This is the oldest model in which expansion of the areas cultivated or grazed has been considered
as the main means of increasing agricultural production. The most dramatic example in western
history was the opening up of new continents such as North and South America and Australia to
European settlement during 18th and 19th centuries. With the advent of cheap transports during
the latter half of the 19th century, the countries of the new continents became increasingly
important sources of food and agricultural raw materials for the metropolitan countries of
Western Europe. Similar events were also seen, though at a less dramatic pace, in the peasant
and village economies of Europe, Asia and Africa, and to some extent in the case of Ethiopia in
Derge and EPRDF resettlement programs can be taken as a resource exploitation model.

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According to this model, therefore, opening up of forest and bushes lands for cultivation
(exploitive use of land resource) was believed as strategy to increase agricultural productivity.

The implications of agricultural development in newly settled regions are viewed through the
staple model and the vent-for-surplus model. The staple model developed by Harold A Innes
explains the rapid growth of commodity production and exports in the newly settled areas of
North America. The vent-for-surplus model developed by Myint explains the rapid growth of
production and trade in a number of tropical countries during the 19th century. He further
explained that peasant export production usually expanded as rapidly as that of plantation sector
while remaining self sufficient in production of food crops. The explanation is that surplus land
and labor capacity enabled peasant producers to expand production rapidly under the stimulus of
new markets opened by the reduction of transport cost. This is exemplified in the production of
rice in Asian countries.

Limitations of the model

Agricultural growth based on resource exploitation model has given little insight into the
problem of how to generate growth in productivity. The model is not sustainable over long run
because new land pioneer settlement or plantation development become not available and the
diminishing marginal productivity from additional unit of resources (either land or labour)
constrains growth through intensification. Thus this model Lacks to give due emphasis to the
issue of sustainability.

Hence, in order to sustain agricultural growth it is necessary to make a transition from resource
exploitation to the development of resource conserving or enhancing technologies such as crop
rotation and manuring; substitution of modern industrial inputs such as fertilizers for natural soil
fertility; and development of modern fertilizer responsive crop varieties.

2.6.2 Resource Conservation Model

The conservation model of agricultural development was evolved from the advances in crop and
livestock husbandry practices associated with English agricultural revolution and the notion of
soil exhaustion suggested by the early Germany chemists and soil scientists. This theory was

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reinforced by the concept of diminishing returns to labour and capital applied to land and the
traditions of ethical, aesthetic and philosophical naturalism. The model emphasized the evolution
of a sequence of increasingly complex land – and labour – intensive cropping systems, the
production and use of organic manures, and labour intensive capital formation in the form of
drainage, irrigation, and other physical facilities to effectively utilize land and water resources.

The conservation model calls for the use of organic manure, water resources, and crop and
livestock husbandry practices in agriculture. Until well into the 20th century the conservation
model of agricultural development was the only approach to intensification of agricultural
production available to most of the world‘s farmers. Its application is effectively illustrated by
development of the wet rice cultivation systems that emerged in East and South-East Asia and by
the labour and land intensive systems of integrated crop and livestock husbandry which
increasingly characterized European agriculture during the 18th and 19th centuries.

The new husbandry permitted the intensification of integrated crop-livestock production through
the recycling of plant nutrient and animal manures to maintain soil fertility. Advances in
technology were accompanied by the consolidation and enclosure of farms and by investments in
land management. Thus, according to this model, all input used in the conservation system of
agriculture are produced and largely supplied by the agriculture itself. The most serious recent
effort to develop agriculture within this framework was made by the peoples‘ republic of China
in the late 1950s and early 1960s.

Limitations of the Model

The perspective of agriculture was seen as a relatively self-contained system. Industrial inputs
were not viewed as playing a significant role at either the extensive or intensive margin. As
result, the feasible growth rates in agriculture were not compatible with modern rates of growth
in the demand for agricultural outputs. Therefore, the model lacks capacity to bring the required
level of growth and development in agriculture.

In spite of some of these criticisms, agricultural development efforts carried out within the
framework of the conservation model can continue to make an important contribution to
productivity growth. It also remains as an important source of productivity growth in most poor
countries when viewed against the rise in oil and energy prices or high import prices of
commercial inputs and an inspiration to agrarian fundamentalists and the organic farming

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movement in the developed countries, the necessity to conserve resources within the premature
pastoral farming system, and the need to control negative impacts of industrial based agricultural
chemicals on the various aspects of environmental degradation. The current socio-economic
development policy of Ethiopia also emphasized the guiding principle of conservation based
agricultural development strategy. The model has explicit legal and policy basis of application in
the country.

Agricultural Development Led Industrialization (ADLI), as priority task in the macro-economic

development strategy in the current Ethiopia, emphasized few new inclusions in relation to
agricultural development efforts in the policy frameworks ensuring the application of
conservation model. The inclusions are:

 The establishment of Environmental Protection Authority, with relevant regional and zonal
offices, that formulates and implements rules and regulations regarding the use of land,
water and natural resources of the country.

 The recent regulation enacted to control the use of agricultural chemical impacts on the
control of various diseases, insects, weeds and vegetable pests that will in turn contribute a
lot to the sustainability of agriculture.

 Pertaining Ethiopia being signatory of International Convention on Environmental

Protection, which strengthens efforts to control the existing and potential environmental
degradation.

 The attention given to pastoral farming system, which is practically at a premature, is also
another implication to be looked on environmental conservation issues.

2.6.3 Location Difference (Urban-Industrial Impact) Model

In the previous models, location divergences in agricultural development and impact of

development on non-agricultural sectors are related primarily to differences in environmental
factors; i.e., the location divergences in agricultural development were not brought into
agricultural development process. According to this model, agricultural development can be

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better stimulated by urban industries. Accordingly, areas near industries and town do better
exercise technologies and hence develop rapidly.

Initially, the location model was formulated in Germany by I H Von Thunen to explain
geographic variations in the intensity of farming systems and the productivity of labour in an
industrializing economy. In the United States Schultz extended the model to explain the more
effective performance of the input and product markets linking the agricultural and non-
agricultural sectors in regions characterized by rapid urban-industrial development than in
regions where the urban economy had not made a transition to the industrial stage. Schultz
formulated the implications of the location model for modern agricultural development in 1953
as economic development occurs in a specific location matrix; these existing matrices are
primarily industrial-urban in composition; and the existing economic organization works best at
or near the center of a particular matrix of economic development and it also works best in those
parts of agriculture which are situated favorably in relation to such a center.

Schultz presented a rationale for the urban-industrial impact hypothesis in term of more efficient
functioning of factor and product market in areas of rapid urban-industrial development than in
areas where the urban economy had not made a transition to the industrial stage. Industrial
development stimulate agricultural development by expanding the demand for farm products,
supplying industrial inputs needed to improve agricultural productivity, and drawing away
surplus labour from agriculture. Empirical tests on the model have repeatedly confirmed a strong
non-farm labour market as an essential pre-requisite for labour productivity in agriculture and
improved incomes for rural people.

Limitations of the Model

Development polices based on the urban-industrial impact model of agricultural development

appear to have limited scope or inappropriate in the poorest of the less developed countries
where the growth rate of urban centers is a result of population pressures in rural areas running
ahead of employment growth in urban areas. The implication is that urban centers in many of the
least developed countries result because of population pressures; the expansion of town is not by
itself an implication of development in agriculture but the development of urban industries do
reflect the truth; and the technology necessary for rapid agricultural growth is not available in the
supply side of agricultural sectors in low income countries.

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2.6.4 Diffusion Model

Despite the emphasis placed much on the industrialization during the second half of 20 th century,
governments of many LDCs and donor agencies undertook a number of activities aimed at
increasing agricultural output and rural incomes through direct transfer of agricultural
technologies and knowledge developed in developed countries to least developed countries.
Therefore, the diffusion model emphasizes the diffusion or transfer of technology and knowledge
from advanced countries to developing countries. The assumption is that farmers in LDCs could
substantially increase their agricultural productivity by adoption of agricultural technologies and
knowledge developed in developed countries.

1. The diffusion approach to agricultural development draws on the diffusion of better

husbandry practices and crop and livestock varieties has been a major source of
productivity growth in agriculture.

2. The diffusion approach rests on the empirical observation of substantial differences in

land and labour productivity among farmers and regions

3. The route to development in this view is through more effective dissemination of

technical knowledge and by narrowing productivity differences among farmers and
regions.

The implicit assumption of this model is that farmers in developing countries are tradition bound;
i.e., farmers in developing country are irrational and hence they are inefficient in resource
allocation. Given this, the major attempt of this model is to transform irrational peasants to
economic men or rational farmers.

The diffusion model of agricultural development has provided the major foundation for much of
the research and extension effort in farm management and production economics. A further
contribution to the effective diffusion of knowledge and technology was provided by the
research of rural sociologists on the diffusion process emphasizing the relationship between
diffusion rates and the personality characteristics and educational accomplishments of farm
operators. Besides, it became the source of institutionalization of the process of plant exploration
and discovery in many parts of the world. Therefore, the practical application of the model to
Ethiopia is quite relevant.

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Although the initial efforts of extension activities on disseminating and demonstrating fertilizer
application, partially improved seeds cultivation and new farming practices have shown good
results, it could not be sustained. The effort to acquaint farmers with new farming practices has
not registered significant result even at the beginning. The reason for all is that, on one hand, the
per capita income of farmers is not so much enabling to go beyond the common expenses. On the
other hand, the prices of inputs are continually increasing so that limited further diffusion.
However, the diffusion model has relatively better importance, wider bases for practices as well
as strong sides for applications as compared to others.

Limitations of the Model

The limitation of the diffusion model as a foundation for the design of agricultural development
policies become increasingly apparent as technical assistance and community development
programs failed to generate either rapid modernization of traditional farms or rapid growth in
agricultural output. Hence, the major limitation of this model rests on its assumptions. The pre-
assumption of inefficient resource allocation among irrational traditional bounded peasants is
questionable.

Moreover, the transfer of technologies from advanced to developing countries in some instances
is not compatible to the situations of developing countries. It might face defects such as lack of
skilled man power, environmental variation, and deficit of costs to transfer and adopt the
technologies.

2.6.5 High Pay-Off Inputs (Green Revolution) Model

The inadequacy of policies based on the conservation, location, and diffusion models led to the
development of the high pay-off input model in the 1960s. It was primarily developed by T W
Schultz in “Transforming Traditional Agriculture‖ in 1953. According to Schultz's opinion, the
key to transform traditional agriculture to a productive economic sector was through investment
designed to make modern high pay-off inputs available to farmers in poor countries. To him,
peasants in traditional agriculture are rational and efficient resource allocators but they remained
poor because of limited technical and economic opportunities to which they could respond. This
implies mainly three types of investment for agricultural development which determine the
success of the model in bringing agricultural development.

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 i. In the capacity of private and public sector research institutions to produce new
technical knowledge,

ii. In the capacity of industrial sector to develop, produce and market new technical
inputs, and

iii. In the capacity of farmers to acquire new knowledge and use modern agricultural
inputs effectively.

The high-payoff input model has been accepted and translated widely into an economic doctrine
due to the successful results of the efforts to develop high-yielding modern grain varieties
suitable for tropics. New high-yielding wheat varieties were developed in Mexico beginning the
1950s and new high-yielding rice varieties were developed in Philippines in the 1960s. The
varieties were highly responsive to industrial inputs, such as fertilizers and other chemicals, and
to more effective soil and water management. The high returns associated with the adoption of
the new varieties and the associated technical inputs and management practices have led to rapid
diffusion of the new varieties among farmers in a number of countries including in Asia, Africa
and Latin America. The ‗Sasacawa‘ global model is an extension of this model from East Asia to
Africa.

The significance of the high pay-off input model relies is that development based on the model
appear capable of generating a sufficiently high rate of agricultural growth to provide a basis for
overall economic development consistent with modern population and income growth
requirements. As interpreted generally, the model is sufficient to embrace the central concepts of
the conservation, location, and diffusion models of agricultural development.

Limitations of the Model

The model does not incorporate the mechanisms by which resource are allocated among non-
marketable public goods such as how knowledge is transferred, how research is conducted in the
course of dissemination of high payoff inputs; the model does not explain how economic
conditions induce the development and adaptation of an efficient set of technologies for a
particular society; the model does not explain how economic conditions induce the development
of new institutions that enable both individuals and society to take fuller advantage of new
technical opportunities; the model mainly benefited the landlords and farmers in ecologically

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favourable areas, while small holder farmers and tenants in the marginal areas got impoverished
due to the induced lower grain prices; and the model remains incomplete as a theory of
agricultural development because research and education characterize the nature of public goods
which are not traded efficiently through the market places.

Although the model was criticized for the major problems of inapplicability at the micro level, it
is implicitly applied in Ethiopia by establishing the Rural Technology Center in order to produce
and introduce new inputs and equipments designed for improved agricultural production and
productivity but practically unable to be fully effective. The Rural Technology Centers (started
since long during the Dergue regime and then functional still) have dimensions of diffusion
model as well. In fact, the dissemination of materials produced or installed at demonstration level
also failed mostly because of the activities being carried out without the participation of peasants
from the very beginning.

2.6.6 Induced Innovation Model: Technical and Institutional Innovation

The high pay-off input model remains incomplete as a theory of agricultural development.
Typically, education and research are public goods not traded through the market places. The
mechanisms by which resources are allocated among education, research and other economic
activities were not fully incorporated into the model. It does not explain how economic
conditions induce the development and adoption of an efficient set of technologies for a
particular society. At the same time, it does not attempt to specify the processes by which input
and product price relationships induce investment in research and development activities in a
direction consistent with a nation‘s particular resource endowments.

The limitations in the high pay-off input model led the efforts by Y Hayami and W Ruttan in
1970s to develop a model of agricultural development in which technical changes is treated as an
endogenous to the development process rather than being as an exogenous factor operating
independently of other development processes. The induced innovation perspective was
stimulated by historical evidence that different countries had followed alternative paths of
technical change in the process of agricultural development. It is a model in which introduction
of new techniques, ideas and ways of doing things were considered to increase output in
agriculture. Thus, the model emphasized to find solutions to the difficulties associated with
adopting technologies.

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Technical Innovation

There is clear evidence that technology has been developed to facilitate the substitution of
relatively abundant (hence cheap) factors for relatively scarce (hence expensive) factors of
production. The constraints imposed by an inelastic supply of land have been offset by the
development of high yielding crop varieties designed to facilitate the substitution of fertilizer for
land (example: Japan and Taiwan). The constraints imposed by an inelastic supply of labour
have been offset by technical advances leading to the substitution of animal and mechanical
power for man power (example: USA, Canada and Australia). In some cases the new
technologies embodied in crop varieties, new equipment, or new production practices may not
always be substitutes per se for land or labour rather they are catalysts which facilitate the
substitution of relatively abundant factors such as fertilizer or mineral fuels for relatively scarce
factors of production.

In the private sector it is entirely rational for competitive firms to allocate funds to develop a
technology that facilitate the substitution of increasingly less expensive factors for more
expensive factors. That is, if the demand for agricultural products increases due to the growth in
population and income prices of the inputs for which the supply is inelastic will be raised relative
to the prices of inputs for which the supply is elastic. Likewise, if the supply of particular inputs
shifts to the right faster than that of others, the prices of these inputs will decline relative to the
prices of other factors of production. And thus private entrepreneurs respond accordingly relative
factor prices and input-output price ratios.

The mechanism of induced innovation in the public sector agricultural research is similar to the
induced innovation in the private sector. The innovation inducement mechanism is not only on
the response to change in the market prices of profit maximizing firms but also the response of
research scientists and administrators in public institutions to resource endowments and
economic change. The hypothesis is that technical change is guided along an efficient path by
price signals in the market, provided that the prices efficiently reflect changes in the demand and
supply of products and factors and that there exists effective interaction among farmers, public
research institutions and private agricultural supply firms. Farmers are induced by shifts in
relative prices to search for technical alternatives that save the increasingly scarce factors of
production. They press the public research institutions to develop the new technology and

38 | P a g e
demand that agricultural supply firms supply modern technical inputs that substitute for the more
scarce factors. Perceptive scientists and science administrators respond by making available new
technical possibilities and new inputs that enable farmers profitably to substitute the increasingly
abundant factors for increasingly scarce factors, thereby guiding the demand of farmers for unit
cost reduction in a socially optimum direction.

The dialectic interaction among farmers and research scientists and administrators is likely to be
most effective when farmers are organized into politically effective local and regional farmers
associations. The scientists may, in fact, be motivated primarily by derive for professional
achievement and recognition. Or they may view themselves as a responding to an obvious and
compelling need to remove the constraints on growth of production or on factor supplies. It is
only necessary that there exist an effective incentive mechanism to reward the scientists or
administrators, materially or by prestige, for their contributions to the solution of significant
problems in the society.

Institutional Innovation

Extension of the theory of induced innovation to explain the behaviour of public research
institutions represents an essential link in the construction of a theory of induced development. In
the induced innovation development model, advances in the mechanical and biological
technology respond to changing relative price of factors and to change in the prices of factors
relative to produces to ease the constraints on growth imposed by inelastic supplies of land or
labour. Neither this process nor its impact is confined to the agricultural sector. Changes in
relative prices in any sector of the economy act to induce innovative activity, not only by private
producers but also by scientists in public institutions, in order to reduce the constraints imposed
by those factors of production that are relatively scarce. The hypothesis is that the institutions
that govern the use of technology or the mode of production can also be induced to change in
order to enable both individuals and society to take fuller advantage of new technical
opportunities under favorable market conditions.

A major source of institutional change has been an effort by society to internalize the benefits of
innovative activity to provide economic incentives for productivity increase. In some cases,
institutional innovations have involved the reorganization of property rights in order to
internalize the higher income streams resulting from the innovations. The modernization of land

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tenure relationships involving a shift from share tenure to lease tenure and owner-operator
system of cultivation in much of western agriculture can be explained, in part, as a shift in
property rights designed to internalize the gains of entrepreneurial innovation by individual
farmers.

Institutional innovation occurs because it appears profitable for individuals or groups in society
to undertake the costs. It is unlikely that institutional changes will prove viable unless the
benefits to society exceed the costs. Changes in market prices and technological opportunities
introduce disequilibrium in existing institutional arrangements by creating profitable new
opportunities for the institutional innovations. Profitable opportunities, however, do not
necessarily lead to immediate institutional innovations. Usually the gains and the losses from
technical and institutional changes are not distributed neutrally. The process of transforming
institutions in response to technical and economic opportunities generally involves time lags,
social and political stress, and in some cases disruption of social and political order. Economic
growth ultimately depends on the flexibility and efficiency of society in transforming itself in
response to technical and economic opportunities.

In general, changes in factor endowments, technical change and growth in product demand have
induced change in property rights, and contractual arrangements in order to promote more
efficient resource allocation through the market in a number of countries. This occurrence has a
large exemplary global experience:

1. In England, the agricultural revolution in the 15th and in the 19th centuries involved
substantial increase in the productivity of land and labour. It was accompanied by the
enclosure of open fields and the replacement of small peasant cultivators. The first
enclosure movement in the 15th and 16th centuries resulted in the conservation of open
arable fields to common and private pastures (in areas suitable for grazing). It was induced
by expansion in the export demand for wool. The second enclosure movement in the 18th
century involved conversion of communally managed arable land into privately operated
units. This was largely induced by the growing disequilibria between the fixed installment
rent that landlords received under the old system and the higher economic rents expected
from adoption of new technology which becomes more projectable as a consequence of
higher grain prices and lower wages.

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 2. In Thailand, the opening up of the nation for international trade and reduction in shipping
rates to Europe in the 19th century resulted in a sharp increase in the demand for rice. The
land available for rice production which had been abundant became scarcer. Investment
land development for rice production became profitable. The response was major
transformation of property rights. That is, traditional rights in human property were
replaced by more precise private rights in land (free-single titles).

3. In Japan, at the beginning of 17th century peasants‘ right to crop land had been limited to
the right to till the soil with obligation to pay a feudal land tax in kind. As population grew,
commercialization progressed and irrigation and technology were developed to make
intensive farming profitable. Some peasants divided their holdings into smaller units and
leased them out to former servants or extended family members. Some others accumulated
land through mortgage arrangements, making other peasants de-facto tenants. As a result
of accumulation of illegal leasing and mortgaging practices, peasants‘ property rights in
land approximated those of a free-single title by the end of 1860s. These rights were
readily converted to the modern private property right system in the subsequent periods.

Therefore, if institutions are weak, what so ever technological advancement is brought, it is

costly to achieve success in economic development in general and development in agriculture in
particular. Some countries hence are poor not they are lacking resources but they lack
appropriate institutions (or rules and regulations) which govern the well-functioning of economic
agents.

CORE ELEMENTS FOR AN AGRICULTURAL DEVELOPMENT

2. Investment in Applied Research

The development of productive national research on agricultural technology and institutional

change in the public and private sectors is a fundamental requirement for
accelerating the rate of agricultural development. The location- specific nature of
agricultural production almost always requires some adaptive research, for technological,
institutional, and economic reasons, to more rapidly identify new profitable technologies.
Technological issues requiring research relate to the often-different conditions of the
growing environment, especially the soils, the climate, and pests. The following sequence of the
three phases of technology transfer is likely to be most productive in less developed nations. In
the first phase, direct transfers, testing, and wide distribution of profitable technologies
accelerating agricultural development from abroad would occur. Such material transfers include

41 | P a g e
plant and animal materials, mechanical equipment, and pesticides. In the second phase, the
nation would develop the capacity to design and manufacture new technologies the use of
blueprints, textbooks, and other research materials obtained abroad. This phase requires
significant investments in laboratories, library computers, researchers, extension personnel, and
local production capacity.

3. Investment in Human Capital

Strategic investments in human capital for agricultural development include the following
two. First, primary education is needed for farmers and their families to attain verbal and
mathematical literacy and, as soon as possible, relevant secondary formal or nonformal
education. This education would include especially (1) the basic principles of biology,
chemistry, and physics as they apply to agriculture; (2) production economics and farm
accounting; and (3) an understanding of rural, national, and international economic and
social development. This investment would enable farmers to provide leadership in
agriculture and rural areas and to respond to new economic opportunities, increasing both
their allocative efficiency and the rate at which they adopt more productive technologies
and institutions. And second, for selected individuals, programs are needed at the university level
to train researchers and administrators who would continuously create economic opportunities
for increased productivity in agriculture through the development of more productive
technology, institutions, and government policy. The education needed varies from increasing
abilities to operate a marketing organization to training for postgraduate
degrees, as the nation shifts from largely material transfers of agricultural technologies to
design transfer to capacity research capabilities in appropriate subsectors of agriculture.
Complementary investments in extension and communication systems are also needed to
strengthen the links between researchers and government administrators, on the one
hand, and farmers, on the other, so that productivity increases on farms can be accelerated.
These investments should increase communication skills and the knowledge of how to
design and evaluate more productive extension and other communication activities.

5. Domestic Prices that Reflect Resource Costs

The economic reason for reducing constraints on prices is the law of corporative
advantage. It demonstrates that per capita incomes and rates of growth will generally be
higher with more flexible prices and trade, both internationally and in regions of a nation.
Thus, constraints on trade, including those caused by significantly overvalued or
undervalued exchange rates, slow growth.

The importance of economic flexibility reflects both the need to respond to changing
international markets and the need for domestic economic growth, Hence, governments
should focus on ways to facilitate rapid responses by the agricultural and other sectors to
internal and external price changes. However, a common government response to changes

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in prices, especially in important agricultural products, is to attempt to control the change.
Such control may be useful in preventing shocks and in easing adjustments in an economy
over the short run. However, once put in place, controls often remain too long, increasing
the cost of food and agricultural products. Distorted prices will reduce growth by causing
both overinvestment in agricultural activities that produce low social returns and
underinvestment in those farming and marketing activities that would increase growth
more rapidly. Also, control mechanisms often increase marketing costs. If, however, price
controlling mechanisms have little influence on market prices, then resources expended in
the controlling activities are wasted.

8. Enhancing Government Performance

Governments of less developed nations have immense opportunities to respond creatively

to the problems and opportunities of development by increasing performance. low
capabilities of government may greatly slow development. governments of whatever
persuasion have the opportunity to provide effective leadership, improved management,
and education for their citizens, to help them deal with the social and economic changes
ahead. specifically, government development requires improved performance in the
political, research, planning, and executive functions. In the past, with slowly changing social
and economic environment Nations have had little need for economic analysis and planning of
possible ties and investments, for the most profitable investments would usually same as before.
In contrast, in the dynamic world environment of today governments of less developed nations
must greatly increase their ability to the economic and social implications of changes in relative
prices and new investment opportunities in technology, institutions, and human capital, in to use
their national resources most effectively. Hence, the availability to government of highly trained
researchers and policy analysts can increase the turns to development investments and the extent
to which government policies facilitate or slow desired development. And finally, the
performance of all personnel in carrying out government activities greatly affects the
productivity all government functions and, hence, the overhead costs of development.

Review question on chapter two

1. Analyze the prospective development view of the role of agriculture since 1950
2. Is the resource exploitation model suitable to implement in Ethiopia? What advantages
and disadvantages will be encountered?
3. Compare and contrast the resource exploitation model with the resource conservation
model and comment the superior desirability of each model to the current Ethiopian
development.

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4. Discuss Sources of Economic Growth and Economic Transformation.
5. Identify the core elements for agricultural development.
6. Evaluate the Evolutionary Stages of Agricultural Transformation.

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 CHAPTER: THREE

3. SUPPLY RESPONSE IN AGRICULTURE

In the field of agriculture, a large number of empirical studies are carried out using time series
data to know the responsiveness of the area [acreage] under the crop [Supply] to the changes in
the prices in lagged year. This is known as the supply response/acreage response function.

Supply: Supply of a commodity refers to the quantity of a commodity that is offered for sale in
market at a given price during a particular period of time.

 The definition of supply is complete when it has the following elements;

i. Quantity of a commodity offered for sale

ii. Price of the commodity

iii. Time during which the quantity is offered

Supply in Practice

 Supply of a commodity we mean the amount of that commodity that producers are able
and willing to offer for sale at a given price.

 Supply may be carefully distinguished from stock and production. Stock constitutes the
potential supply but supply at a time is that part of the total produce which the farmer is
willing to sell is the stock and is known as marketable surplus and the portion which is
actually brought to the market at a particular time for sale is the supply of the produce
and is labeled as marketed surplus.

 Similarly, supply of the farm produce, sometimes, may be more than the current
production if past stocks are also brought to the market along with it.

Factors, Influencing Supply

Factors which influence the supply of agricultural commodities are numerous. Given below is a
brief introduction to these factors:

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 1. It would depend upon its cost of production, that is, the prices of factors of production
which are involved in the production of said commodity. For example, a rise in the price
of land will have a large effect on the cost of producing wheat. Thus, a rise in the price of
factors of production will cause the supply of the product to decline and a fall in the
prices of factors production may lead to an increase in supply.

2. It also affected by the price that commodity commands in the market. Other things
remaining the same, the higher the price of the commodity the more profitable will be to
increase its supply.

3. The supply of an individual agricultural commodity will be affected also by the prices of other
agricultural goods. An increase in the price of other commodities will make the production of the
commodity whose price has not risen relatively less attractive than it was previously. This mainly
leads to changes in cropping pattern in agriculture.

4. Supply of agricultural goods also depends upon the state of technology. Agricultural
technology helps in bringing down the cost of production and hence increases the supply.

5. There are a number of other factors which affect the supply of agricultural goods, viz.
adequate and well spread-out rainfall, improvement in irrigation facilities, increased supply of
chemical fertilizers and manure and better and improved methods of production. To summaries
the above discussion as follows:

Factors of production, T is the state of technology and G stands for natural factor.

Low of supply: supply has a functional relationship with price. In order to know how the supply
of agricultural commodity varies with its own price, we will assume other things remain
constant. A supply schedule represents the relation between price and quantities of that seller are
willing to sell in the market.

Table: a supply schedule for potato

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As is evident from the above table, when the price of potatoes is as high as Rs. 120 per quintal,
farmers are ready to offer as much as 122 hundred quintals of potatoes for sale. But the number
of potatoes offered for sale decreases as the price falls. Thus, as the price falls, supply is reduced
and as the price rises, the supply is extended.

Supply Curve: Data contained in the previous table could be plotted on a graph to get the supply
curve as shown in the following figure.

Quantity is measured along OX and price along OY.

SS is the supply curve. The curve SS shows the
relation between the price of the commodity and the
quantity producers wish to sell. It slopes upward
indicating that higher the price, the greater the
quantity producers will supply. Further, it has been
drawn on the assumption of the constancy of all other
factors that influence supply other than price of the
commodity.
 Supply Lags: All supply decisions take time to implement. We may say that supply
reacts with a time lag. In cases where the lag is short, it may not matter if it is ignored but
in the case of many agricultural commodities, the lag is of critical importance. The
simplest possible time lag is one in which this year's price has no effect, whatsoever, on
this year's supply.

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  Farmers while deciding about what crop to plant and how much of it to plant look to the
existing market price and thus next year's supply depends on this year's price, while this
year's supply is based on last year's price. It means: St = f(P t - 1).

that is, supply at time period t depends on the price of the product ruling in the previous time
period.

Need for the supply response function

 Supply responses of primary products vary considerably according to the characteristics

of the crops analyzed.

 Annual/ seasonal and perennial croups have different characteristics and present different
conceptual problems. Therefore, they require the use of different models.

 Most of the econometric studies on supply responses have been carried out on
annual/seasonal crops. These crops form the staple foods of most underdeveloped
countries and as self-sufficiency in food became the overriding aim of most of the
underdeveloped countries, emphasis was placed such crops.

 Policies which could encourage greater production of these staple crops were required
and formulation of these policies necessitated supply response studies on such crops.
What therefore, needed is a comprehensive supply model which can incorporate the
various alternative opportunities open to the farmer.

Perverse Supply Curve

 It has stated that the supply curve of the produce of the small family farmer will be
perverse. The existence of such a supply curve, at least for the peasant farmer in Asia and
Africa, was accepted as a dogma between the period of two great wars. It was based on
the assumption that such farmer had a certain, rather low “target" or cash income and
that, once this was attained, the farmer would only work as hard as was necessary to

48 | P a g e
 maintain it. If the price of his produce rose, he would produce less and enjoy more
leisure, if it fell, he would produce more in an attempt to enjoy the same income as
before. Studies that have been made to test this hypothesis for commercial crops have
not, however, borne it out. There are two types of perverse response of supply to price.
First, supply of farm products may rise in response to price rise to a certain point, but
thereafter, it tends to decline though the price continues to rise. This has been shown
below:

The situation seems to be rather irrational, if we take into

account only the price of the commodity as the sole
determinant of its supply. But mostly, the price of inputs
used in the process of production, the prices or the cost of
production of other agricultural commodities which can be
produced as alternatives undergo a change, and given that
demand is relatively price inelastic, it is just rational for the
producers to reduce production of the first commodity and
produce more of other commodities.

Fig: Perverse Supply Curve.

Secondly, supply may not fall in response to a falling price. This reaction is typical of
agricultural production.

The cobweb model

The Cob-Web Model: is a dynamical system that describes price fluctuations as a result of the
interaction between demand function, depending on current price, and supply function,
depending on expected price.

We now introduce an elementary dynamic theory of price determination of agricultural products.

In this theory, we assume that farmers' output plans are fulfilled but with a time lag and we try to

49 | P a g e
show how planned changes in supply can give rise; to oscillations in market behavior.
Agricultural markets subject to simple one-year time lag are illustrated below.

 In Fig. (I), if in one year t, the price is P2' farmers will plan to produce q 2 in the following
year. In the year t + 1, q 2 will come in the market and in order to sell this quantity, price
must fall to p3 . This level of price (p3 ) will induce/encourage the farmers to produce only
q3. In the following year t+2, q3 quantity will be sold at a price P4. This price in turn will
call forth a supply of q4 the next year, year t+3 and this will depress the price below P4. It is
thus clear from the figure that if nothing further disturbs the market the price and quantity
will oscillate around their equilibrium values.

 In other figure, exactly the same argument as in the previous paragraph applies but, in this
case, the oscillations become larger and larger so that the equilibrium is never restored.

 Thus, while market in Fig. (I) has an adjustment mechanism which is stable, market in Fig.
(II) has one which is unstable. The difference between the two figures is that while the
demand curve in Fig. (I) is flatter due to which an excess demand and supply can be
eliminated with only a small price change.

 In Fig. (II) the supply curve is flatter than the demand curve which causes the quantity
supplied respond more to price changes than does the quantity demanded. In this case, when
there is excess supply, a large price fall is necessary to call forth the required demand.

50 | P a g e
In Fig. (II) the supply curve is flatter than the demand curve which causes the quantity
supplied respond more to price changes than does the quantity demanded. In this case, when
there is excess supply, a large price fall is necessary to call forth the required demand.

Mathematical Representation of Cob-web Model

The Basic Assumptions of cob-web model are:

1. The current demand (Dt) is a function of current price (Pt)

2. The supply in current period (St) is a function of the price in the preceding time period
(Pt-1)' and

3. The condition for equilibrium is satisfied if the current demand (Dt) is equal to current
supply (St)

The above conditions can be expressed algebraically as:

𝑺𝒕 = 𝜶𝟏 + 𝜷𝟏𝑷𝒕−𝟏 …………………………………………………………………………….(𝟏)

𝑫𝒕 = 𝜶𝟐 + 𝜷𝟐 𝑷𝒕 …………………………………………………………………………………. (𝟐)

where the symbols have their usual meanings. It is assumed that the price is set in each
period to clear the market. Note here that this is a model with lagged supply as is evident in
eqn. (1), this period‘s supply depends upon the previous period‘s price or this period‘s price
influences the supply of the following period.

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Let us rewrite (7) as ̅̅̅
𝑄𝑡 = 𝛽1 𝑃̅𝑡−1 = 𝛽2 𝑃̅𝑡 … … … . (8)

Where ̅̅̅
𝑄𝑡 = 𝑄̅ − 𝑄𝑡 = 𝑑𝑒𝑣𝑖𝑎𝑡𝑖𝑜𝑛 𝑄𝑡 𝑓𝑟𝑜𝑚 𝑄̅ .

𝑃̅𝑡−1 = 𝑃̅ − 𝑃̅𝑡−1 = deviation 𝑃̅𝑡−1 from 𝑃̅.

And 𝑃̅𝑡 = 𝑃 − 𝑃𝑡 = deviation of 𝑃𝑡 from 𝑃̅ .

𝛽
From (8), we have 𝑃̅𝑡 = 𝛽1 𝑃̅𝑡−1 ……………………………….(9)
2

Or 𝑃̅𝑡 = 𝐴 ∗ 𝑃̅𝑡−1……………………………………………………………………………………..(10)

𝛽
Where 𝐴 = 𝛽1
2

Equation (10) is a first order difference equation and it gives us 𝑃̅𝑡 as a function of 𝛽1 and 𝛽2
being given and constant. The solution for 𝑃̂ at any time 𝑡 is given by:

𝑃̂𝑡 = 𝐴 ∗ 𝑃̅𝑡−1 = 𝐴𝑡 ∗ 𝑃̂0 … … … … … … … … (11)

The solution (11) may be obtained in the following way:

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 𝑃̂1 = 𝐴 ∗ 𝑃̂0

𝑃̂2 = 𝐴 ∗ 𝑃̂1 = 𝐴2 ∗ 𝑃̂0

𝑃̂3 = 𝐴 ∗ 𝑃̂2 = 𝐴3 ∗ 𝑃̂0 and so on, in this way 𝑃̂𝑡 = 𝐴𝑡 ∗ 𝑃̂0 .

Equation (11) gives the general solution for the linear Cobweb model as given by equation
(1) − (3). This gives 𝑝̂ 𝑡 , given the slopes of the demand and supply functions and the values
of 𝑃̂0. This value of 𝑃̂0 = (𝑝̂ − 𝑃0 ) is called the initial arbitrary disturbance which can take
on any sign and magnitude that would like to give it. The original 𝑃̂0 ≠ 0 might have been
brought about by a shift in either the demand or the supply curve so that 𝑝̂ 0 represents the
difference between the new and the old equilibrium prices.

If 𝛽1 > 0 and 𝛽2 < 0, i.e., the supply function slopes upwards and the demand function
slopes downwards, A to be negative. Thus, A will alternate in sign, being negative in odd-
numbered periods and positive in even-numbered periods. This proves that with the normal-
shaped demand and supply curves, the Cobweb will always produce a two-period
oscillation with the actual price (𝑝𝑡) being alternately above and below the equilibrium price
(𝑝̅). If these oscillations will converge on to, or, diverge from,(𝑝̅ ). But before doing this, note
that in the demand-supply curve diagrams, generally measure quantity along the horizontal
axis and price along the vertical axis.

In that case, the slopes of the supply and demand curves would be, respectively, the
reciprocals of the slopes of the supply and demand functions (i.e., 𝛽1 𝑎𝑛𝑑 𝛽2). Also note that
1
if 𝛽1 is positive, then the slope of the supply curve, , would also be positive and if 𝛽2 is
𝛽1

negative, then the slope of the demand curve, 1/𝛽2, would also be negative. Now, even if the
supply and demand functions and curves have their normal slopes (i.e., positive and negative
respectively), then also to consider three cases in respect of convergence or divergence.

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Example: Find the time path of Q and analyze the condition for its convergence.

Solution: The equation of the given cobweb model are:

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55 | P a g e
Example 2: Consider the following two competitive markets:

 Market I : (i) qdt = 1200 − 6pt; (ii) qst = 2pt−2,

 Market II: (i) qdt = 2700 − 4p, ; (ii) qst = 5pt-1

 where qdt and qst refer to demand and supply functions and t refers to the time
period.

(a) Discover the equilibrium price and quantity in both markets.

(b) Consider the stability of the adjustment to a disturbance in each market.

(c) Draw a time series graph for p in the first five periods following a disturbance that moves
price 200 units above its equilibrium in market I and 20 units below it in market II.

(d) The explosive oscillations in one market cannot go on increasing indefinitely. What
economic limits to oscillation are finally reached?

Solution: (a) the demand and supply function for market I:

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57 | P a g e
58 | P a g e
The price-figure in market I in period 0 (zero) and in the next five period are obtained in (8)
(13), respectively. On the basis of these values, the time-series graph for price in market I has
been drawn in fig. below.

In market II, because of the disturbance that moves price 20 units below its equilibrium:

Now, the time-path of price in market II is:

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Putting t = 0, 1, 2, 3, 4, and 5 in (15), the price-figures for these periods is obtained as: p0 =
280, p1 = 325, p2 = 268.75, p3 = 339.06, p4 = 251.17 and p5 = 361.04. On the basis of these
values, the time-series graph for price in market II is obtained as shown in fig. below.

(d) According to our assumptions, the market price of a good does not have an upper limit,
tort it has a lower limit which is zero. So economic limits to explosive oscillations in market
II are reached when price, ultimately, oscillates down to zero or less than zero, and that
occurs in the 14th period. The following way is obtained. It is evident from (15) that
pt becomes less than p̅ = 300 in even periods, and so, let us remember, pt would approach
zero, or, a negative value in even-numbered periods. But let us, for the time being, put pt = 0
in (15) assuming A = 5/4 which is positive and greater than 1, and, then:

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What will be obtained here is that if t were a continuous variable and if assumed A to be
positive and greater than 1(= 5/4), then p would monotonically move downwards (i.e.,
without any oscillation) and would become zero (0) in period t = 12.14 (approx.). That is, in
period t = 12, p would still be positive (it can be calculated as, p = 9). Therefore, in our
discrete time case, p in t = 13, would oscillate up to p13 which is above =300. And the
process of oscillation comes to an end in period t = 14 because, now p would go down to
become negative [it can be calculated as, p14 = − 154.6 (approx..).]

Review questions on chapter three

1. List and explain factors determining supply of agricultural output

2. Analyze the Need for the supply response function
3. What is the basic idea of Perverse Supply Curve
4. Analyze cobweb model of supply response

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 CHAPTER FOUR

TECHNICAL CHANGE IN AGRICULTURE

Introduction

 In post-WWII era technical change has been most rapidly growing areas of study within
agricultural economics. This is for two major problem areas that have concerned
agricultural economists since the end of WWII.

 The 1st is the secular increase in the supply of agricultural products relative to demand in
the developed countries, particularly the United States, leading to depressed farm prices
and incomes and precipitating severe adjustment problems in the agricultural sector. As a
consequence, agricultural economists identify the sources of this output growth.
Technical change is one such source, indeed a major source, which has become a subject
of economic analysis.

 A 2nd problem area has to contributed the interest in technical change is the difficulty that
the developing nations have experienced in increasing agricultural output. Many of these
nations, particularly those with a rapid rate of population growth, have been faced with
persistent food shortages and widespread malnutrition. It has become evident that
development programs emphasizing the increased use of traditional inputs in agriculture
have contributed only modestly to agricultural output gains.

The Definition of Technical Change

 Technical change generally is defined in terms of either a productivity index or a

production function. In the context of a productivity index, Rattan‘s definition [122] of
technical change as the production of a greater output with a given quantity of resources
would seem to encompass most interpretations of the term. In other words, technical change
results in an increase in output per unit of input.

 In a later article Ruttan [123] views technical change in a production function context and
defines it as a change in the parameters of the production function or a creation of a new
production function. In this case we can view technical progress as an upward shift in the
production function.
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 Of course, these two ways of defining technical change are entirely consistent with each
other. A productivity index implies the existence of a production function and vice versa. In
fact, as Domar [35] points out, a Cobb-Douglas production function is simply a geometric
index of inputs, each weighted by its elasticity of production. Conversely, the popular
arithmetic productivity indexes such as the Laspeyres and Paasche type indexes imply an
underlying linear arithmetic production function.

 It is important to recognize that in order to have changes in output per unit of input or to
have shifts in a production function there must be changes in the quality of the inputs. The
fact that we observe productivity changes means that some inputs have changed in quality
and these quality changes are not reflected in the total input measure.

Forms of Technological Change

 Technological change involves generating useful knowledge pertaining to the art of

production.
 More specifically, it involves a shift in the production function (which relates the quantity
of out- puts to the quantity of inputs) enabling greater output quantity or quality, or both,
to be produced with the same volume of land, labor, and capital or the same output
quantity and quality to be produced with less of at least one of the inputs. Often these
shifts include changes in the quality of inputs, such as improved forms of machinery or
more highly educated labor.
 Some broad classifications of the forms of technological change are biological-chemical,
agronomical, and mechanical. Biological-chemical change is generally land-using and
laborsaving.
 Agronomical change is generally land- saving, whereas mechanical change is usually
laborsaving. Another classification has to do with whether technology is primarily yield-
increasing or labor- saving.
 Many forms of technological change are complementary, and several forms often occur
simultaneously.

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  For example, implementation of the mechanical tomato harvester (a mechanical change
that is laborsaving) gave rise to the need for, and was delayed by the lack of, a tomato
variety (a biological change) suitable for mechanical harvesting.
 This case demonstrates that the type of technology likely to develop is a result of
economic needs and incentives. The use of new technologies and the opportunities they
offer help agriculture in the process of adapting to the new demands of marketing, sales
and crop profitability.
 The technological and digital revolution that is transforming agriculture and its processes
is helping to achieve optimal production yields, which, while traditionally calculated in
terms of quantity of product or kilograms obtained per hectare, today, yields have come to
be calculated in terms of the amount of money produced per hectare.
In addition to applying good, efficient cultivation practices, such as better-quality seeds, or
lowering production costs through partnerships between farmers, technological change is
essential to achieve this profitability. With the use of new technologies applied to agriculture, it
is possible to: Greater efficiency in the use of scarce resources, such as water or energy.
Reduction of environmental pollution. Improved profitability of agricultural activity, producing
higher quality food, healthier and oriented to the tastes and preferences of consumers. Advice on
the most efficient management of irrigation, climate and fertilization. Crop monitoring from
drones, satellites or field sensors. Generate harvest forecasts, or probability of pest incidence.

4.1Source of technical change in agriculture

In this section we consider the attempts to identify the sources of technical change (productivity
growth) in agriculture and to account for the measured productivity growth by the sources
identified. Increase in skills of farm people. This topic falls within the broad area of the
economics of human resources and attempt to survey the literature on the economics of
education, a sub item under human resources. Our modest objective here is to offer a brief sketch
of the work relating specifically to the effect the education and skills of farm people have on
agricultural output.

The idea that education is an investment in human capital which contributes to the output and
income of people, of course, is not new. Marshall [108] argued that "the most valuable of all
capital is that invested in human beings. ―Also, it is reasonable to believe that differences in

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acquired abilities exist because of differences in both quantity and quality of education. Nelson
& Phelps [116] suggest that "education enhances one's ability to receive, decode and understand
information, and that information processing and interpretation are important for performing or
learning to perform many jobs." Along this line Welch [160] offers the hypothesis that the
productive value of education has its roots in (1) the worker effect and (2) the allocative effect.
The 1st increases the marginal product of labor given the level of other inputs.

The 2nd enhances the worker's ability to acquire & interpret information about costs and new
inputs. Welch further argues that the allocative effect is the more important of the two for
agriculture. This may explain why education does not appear to have a high payoff in a
traditional agriculture setting characterized by long-run equilbria in the factor and product
markets. Welch also points out that production function studies which in effect hold other inputs
constant result in a downward bias to the returns to education.If the allocative effect of education
is important, then we should observe the early adopters of new technology to have a higher level
of skills (schooling) than those who lag in the adoption process.

Increase in quality of nonhuman capital: Casual/informal observation leads one to believe that
the quality of machinery, equipment, and buildings has increased. It is important to a large share
of capital improvement is produced by private sector R and D. As such, its supply price is more
likely to reflect quality differences than the case if the R and D were carried out in the public
sector and the knowledge were made freely available. Of course, to the extent that more
productive capital requires more labor and materials to produce, its supply price also will exceed
that of less productive capital. The demand for higher-quality capital also can be expected to
exceed that of less productive capital, resulting in a higher overall market price provided that the
supply curve of nonhuman capital is upward sloping (as we would expect it to be, at least in the
short run).

Increase in quality of other inputs. Among the other inputs (besides labor and nonhuman capital)
that would appear to be sources of productivity growth in agriculture, we can point to
commercial fertilizers with improved nutrient content, new and improved crop varieties, more
efficient breeds of livestock and poultry, and new and improved agricultural chemicals, mainly
herbicides and insecticides.

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Increase in quality of output. In comparison to the attention given to input quality change,
relatively little has been said about output quality. In part, the explanation may be found in the
homogeneous nature of farm products. With the exception of the high-lysine variety of corn, a
bushel of corn is a bushel of corn whether it be produced in 1910 or 1972. The same is true for
wheat and many other field crops. However, in the case of fruits and vegetables and some
livestock products, there is some indication that quality has improved. As examples, one can
point to new and improved varieties of fruits and vegetables that are less subject to attack by
insects and disease, and dairy products that are lower in bacteria count. On the other hand, some
have argued that current varieties of fruits and vegetables are less flavorful than those in years
past.

4.2Adoption and diffusion of technology

New technologies are introduced gradually; diffusion is the process through which technologies
spread throughout the farm sector over time. While adoption is the decision by an individual at a
given moment, diffusion is the aggregate measure of adoption decisions. Technology in
agriculture can be used in different aspects of agriculture such as the application of herbicide,
pesticide, fertilizer, and improved seed.

Why is the adoption of technologies important?

Until recently, the choice of technologies available to farmers was largely determined by the
need to increase production, profits and productivity. The main constraints were the availability
of capital, knowledge of how to use the technology and market risks — risks that in many
countries policies were shielded by government policies. In the past, ―good policy practices‖ was
therefore rather straightforward, relating primarily to increasing output and the aim of
agricultural policies was to increase productivity in agriculture. Agricultural research and
extension services could concentrate, for example, on improving the productivity of small farms.

Now agriculture has to fulfil diverse objectives: it needs to be internationally competitive,

produce agricultural products of high quality while meeting sustainability goals. In order to
remain competitive, agricultural producers need rapid access to emerging technologies. Farmers
are faced with many more constraints — and also more opportunities. In addition to being

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profitable, they need to meet environmental standards and regulations, as well as deal with direct
and indirect consumer and lobby group pressures.

They may also be flooded with information from various government and industry sources, that
make choosing appropriate technologies more difficult. Farmers also need to change their
production and management practices in response to agricultural policies that include
environmental conditions and I am confident that farmers have the capacity to do so. Uncertainty
may increase even more in the future. There may also be uncertainty related to the future policy
environment, especially with respect to support, trade and pressures from the agro- 16 food
sector.

Adopting technologies by farmers is an investment. It takes time, however, for the rewards to
flow and farmers may be reluctant to invest in an uncertain climate with more constraints, where
some of the benefits are for society. Should it be the farmer or society that pays?

Technological change has been the basis for increasing agricultural productivity and promoting
agricultural development. Research affects the productivity of farming systems by generating
new technologies which, if appropriate to farmers‘ circumstances, will be rapidly adopted.

Historically, researchers and extension workers have been primarily responsible for identifying
and injecting economic and environmental factors into the process of developing and introducing
an agricultural innovation. This is typically characterized as a top-down process, whereby
researchers develop the innovation, extension workers promote its use, and farmers either adopt
or reject the innovation based on the features important to them.

Inter farm and Interregional Diffusion

The process of diffusion of new technology among farms traditionally is the domain of rural
sociologists and geographers. The main focus of their studies were the impact of communication
(or interaction) and socio cultural resistance to innovation on the pattern of diffusion over time
and across space. There concern with understanding how the different socio cultural
characteristics of adopters create a spectrum ranging from innovators to laggards and the
resulting S-shaped diffusion curve. In general, to provide information on how such
characteristics determine the means of communication that are most effective in accelerating the
diffusion process.

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In contrast, the main focus of economists in their approach to the diffusion of technology has
been on how economic variables such as the profitability of innovation and the asset position of
firms influence the rate of diffusion (for example, Mansfield.

The study of hybrid corn diffusion by Griliches [50] and the subsequent exchange with
sociologists bring out the contrast between the economic and sociological approaches as well as
the role of economic and sociocultural factors in the diffusion process. Griliches summarizes the
diffusion path for each hybrid corn maturity area by fitting a logistic trend function to data on the
percentage of corn area planted with hybrid seed. The logistic function is described by three
parameters an origin, a slope (which measures the rate of acceptance), and a ceiling (which
measures the level of acceptance at which use of hybrid seed tended to stabilize). Griliches
attempts to measure changes in the demand for hybrid seed. He finds that both the slope and the
ceiling in the heart of the corn belt exceeded those of the marginal corn areas. A similar finding is
reported by Martinez and he interpreted his results as indicating that differences among regions
in the rate (slope) and the level (ceiling) of acceptance are both functions of the profitability of a
shift from open-pollinated corn to hybrid corn.

Maier's study of the adoption of the mechanical cotton picker also reveals that the rate of
acceptance of this machine was closely related to its profitability. Griliches's study was criticized
by a number of sociologists. Brander and Straus as an example the case of hybrid sorghum
adoption, argued that familiarity (congruence) with a technique or an input is the critical factor
explaining the rate of adoption. Havens & Rogers argued that communication or interaction
between people is the important factor.

In reply Griliches argues if congruence and interaction are important, there is no reason to
exclude profitability as a factor explaining the rate of adoption. Indeed, as Griliches points out,
the ―profitability‖ approach can be broadened by allowing for differences in information, risk
preference, and so on, thus bringing it as close to the "sociological" approach as one would want
to. The finding by Griliches points out the critical role of adaptive research for the diffusion of
agricultural technology among ecologically heterogeneous regions. Agricultural technology is
typically location-specific or constrained by the local ecology. Techniques developed in a region
often are not transferable to other regions without further adaptive research. Traditionally most of
the diffusion models have been designed to describe or analyze diffusion among farms within a

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particular area over time. The attributes of technology and of potential adopters often are taken
as given. Nevertheless, such models are not very helpful in explaining or predicting the diffusion
of technology among heterogeneous regions, particularly among countries located in different
climatic zones.

International Diffusion

The transfer of advanced technology existing in the developed countries to the less developed
countries considered as the major means for promoting agricultural growth in the less developed
countries. However, efforts to achieve rapid agricultural growth by the direct transfer of foreign
technology have not been very successful.

Modern agricultural technology has evolved largely in the developed countries of the temperate
zone and is primarily adapted to their ecology and factor endowments. Inadequate recognition of
the location-specific character of agricultural technology would seem to be a major reason for the
lack of effectiveness of much of the efforts directed at international technology transfer. Also the
perspective has resulted from the erroneous application of sociological inter farm diffusion
models to the process of international technology transfer, in which local adaptation is essential.

We have argued that one of the merits of the Griliches model is that it incorporates the
mechanism of local adaptation in the interregional diffusion of hybrid technology. This
mechanism is based on the behavior of public research institutions and private agricultural
supply firms. Modification of the model is needed, however, for the study of international
technology transfer.

The problem of facilitating international technology transfer as an instrument of agricultural

development is, therefore, how to institutionalize a system of adaptive research and development
which is responsive to the opportunities of technology transfer that are profitable to society.
Based on the role of adaptive research in the process of diffusion, Hayami and Ruttan distinguish
three phases of international technology transfer:

1. material transfer 2. design transfer 3. capacity transfer.

 The 1st phase is characterized by the simple transfer or import of new materials such as
seeds, plants, animals, and techniques associated with these materials. Local adaptation is

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 not conducted in an orderly and systematic fashion. The naturalization of plants and
animals occurs primarily as a result of trial and error by farmers, usually involving a long
gestation period.
 In the 2nd phase the transfer of technology is primarily through the transfer of certain
designs (blueprints, formula books, and so on). During this period exotic plant materials
and foreign equipment are imported for use in the development of new plant breeds and
equipment designs, rather than for use in direct production. New plants and animals are
subjected to orderly tests and are propagated through systematic multiplication.

 In the 3rd phase, the transfer of technology is made through the transfer of scientific
knowledge and capacity which enable the production of locally adaptable technology,
following the prototype technology which exists abroad.

 Increasingly, plant and animal varieties are bred locally to adapt them to local ecological
conditions. The imported machinery designs are modified in order to meet climatic and
social requirements and factor endowments of the economy.

 An important element in the process of capacity transfer is the migration of agricultural

scientists, which is often of critical importance because scientific and technical
manpower is in short supply in the less developed countries.

 They conclude that the success of agricultural development via international technology
transfer hinges on the ability to institutionalize the effective supply of adaptive research
in the developing countries, given their limited endowment of research personnel.

Factors affecting the adoption of technologies

Diffusion is the process by which a new idea, practice or technology spreads in a given
population. The characteristics of technologies, such as relative advantage, complexity,
divisibility, observability and compatibility affect their diffusion. Farmers will be encouraged to
adopt appropriate technologies for sustainable farming systems if the dissemination of
information is efficient.

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There is a paradox here one must bear in mind, however. On the one hand, experience in other
sectors undergoing the transition to less polluting or more resource-conserving practices shows
that it is inefficient for governments to be too prescriptive.

Those environmental policies that set performance standards, as opposed to forcing the use of
particular technologies, tend to encourage innovation of a sort that lowers the cost of achieving a
given result. Yet when a really important, useful technology comes along there may be an
interest in encouraging its quick adoption. At that point, it is too late to start educating the
educators, the extension agents and others responsible for explaining to farmers the merits of the
technology.

It is thus important to facilitate the dissemination of improved farming system technology to

farm households through farmer-participatory methods and to strengthen existing resource-
planning capability and improve the research and extension capability. Assimilation and adoption
of new and available technology at the farm level is a function of science, economics and human
behavior. One or more of the physical sciences or biology serves as the foundation for
technology development, and economics usually serves as a strong motivator for adoption.

The psycho-social and human behavioral aspects of technology adoption are less tangible, but
clearly influence the potential adoption of any technology to change. Technology and change
will most likely be assimilated and implemented when: the benefits of implementation will be
quickly realised (within one to two years), the tools for implementation are readily available and
accessible in the local marketplace, the risk of the implementation are small and the change or
new technology can be comfortably integrated into other basic on-going aspects of daily life.
Several ―barriers‖ have hindered the assimilation of new agricultural technology through
extension:

Several ―barriers‖ have hindered the assimilation of new agricultural technology through
extension:

 A perceived fundamental inability to demonstrate a linkage between profitable

technology adoption and sustainable production at the farm level.

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  The limited movement away from a discipline-based or uni-dimensional approach to a
broader system may have reduced the ability to evaluate the economic and environmental
components of technology uptake.
 The instruction and demonstration of new technology within the controlled setting of a
university research farm may not encourage farmers to adopt the technology for their
own farms, which have distinct and different resources.
 The failure to recognize and address the psychological component of technology
adoption as part of the educational process, because generating knowledge is not always
synonymous with diffusing and adopting knowledge.
4.3. The economics of technical change

Understanding the forces shape the rate and direction of technological progress is central to
confronting key challenges facing the world today. Yet there is little systematic evidence on the
factors that determine the evolving patterns of invention across applications, or the impact of
these patterns on productivity and resilience in the face of shocks to production.

The economics of technical change in agriculture involves the study of how new technologies
and innovations in farming methods can increase productivity and efficiency. This can include
the use of new equipment and machinery, genetically modified crops, and precision farming
techniques. Technical change can also have a significant impact on the costs and returns of
farming, as well as on the structure of the agricultural industry. Additionally, the diffusion of new
technologies and innovations can have important implications for food security, rural
development, and the environment. Overall, the economics of technical change in agriculture is a
complex and multifaceted field that requires careful analysis of the costs and benefits of different
technologies and innovations.

However, the adoption and utilization of these new technologies is not always straightforward.
Factors such as the cost of the technology, the availability of skilled labor, and the availability of
government support can all influence the rate at which new technologies are adopted.

Another important aspect of the economics of technical change in agriculture is the impact that
these changes have on the distribution of income and wealth. For example, the use of automated
farming equipment may lead to increased productivity and reduced costs for farmers, but it may

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also lead to job losses for farm laborers. Similarly, the use of genetically modified crops may
lead to increased yields and reduced costs for farmers, but it may also lead to increased
concentration of ownership in the agricultural sector.

Overall, the economics of technical change in agriculture is a complex and multifaceted issue
that has important implications for farmers, consumers, and society as a whole. It is important for
policymakers to consider the potential economic impacts of new technologies and innovations,
and to develop policies that support the adoption and utilization of these new technologies in a
way that promotes sustainable and equitable economic growth.

The economics of technical change in agriculture refers to the ways in which new technologies
and innovations are adopted and utilized in the agricultural sector, and the economic impact that
these changes have on farmers, consumers, and society as a whole. One of the key drivers of
technical change in agriculture is the development of new technologies and techniques, such as
precision farming, genetically modified crops, and automated farming equipment. These
innovations have the potential to increase productivity, reduce costs, and improve the efficiency
of agricultural production.

Technology has played a big role in developing the agricultural industry. Innovations in
technologies have modernized the agricultural filed. Various machineries & tools have helped the
farmers of a given country to play a vital role in developing the economy. How does
technological innovation impact in Agriculture?

• The major technological advancement in agriculture

• Mechanization

• Chemical Fertilizers

• Hybridization

• Biotechnology

Technologies for agricultural development

 Pre & post harvesting technology

 Energy saving technology

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  Environmental protection technology

 Information and communication technology

 GIS and RS technology

 Internet/internet technology

 Use of machines on farms

 In agriculture, time & production are so important; you have to plant in time, harvest in
time & deliver to store in time.

4.4. Induced Innovation

Induced innovation in agriculture refers to the process by which technological advances in

farming lead to changes in farming practices and ultimately result in increased productivity. This
can occur through a variety of means, such as the introduction of new machinery, fertilizers,
pesticides, or seed varieties.

One example of induced innovation in agriculture is the development of mechanized farming

equipment. The invention of tractors and other machinery in the early 20th century greatly
increased the efficiency of farming, allowing farmers to cultivate larger areas of land and
produce more crops per acre. This led to a significant increase in agricultural productivity and
allowed farmers to feed a growing population.

Another example of induced innovation in agriculture is the development of chemical fertilizers.

The use of chemical fertilizers, such as nitrogen and phosphorus, has allowed farmers to increase
crop yields by providing plants with the necessary nutrients for growth. However, the overuse of
chemical fertilizers can lead to negative environmental impacts, such as soil and water pollution.

Although it may be interesting to know whether technical change has progressed in either a
capital-saving or a labor-saving fashion, an even more fundamental question is "Why?" The
induced innovation hypothesis attempts to provide an explanation for the direction of technical
progress. First proposed by Hicks in 1932, the basic idea is that changes or differences in the
level of relative factor prices influences the direction of innovative activity, hence the direction
of technical progress.

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According to Hicks, "The changed relative prices will stimulate the search for new methods of
production which will use more of the now cheaper factor and less of the expensive one". For
example, if labor becomes high priced relative to capital, scientists and engineers will search for
ways to save on the relatively high-priced labor and in so doing develop new forms of capital.
The end result may be called biased technical progress in a labor-saving (capital-using) direction.

The contrasts in the direction of factor-saving bias in technical progress in agriculture b/n Japan
and New Zealand as estimated by Sawada & Johnson seem to support the Hicks hypothesis.
Technical progress biased toward using labor in prewar Japanese agriculture, in which labor
more abundant (cheap) relative to land & capital, whereas it was biased toward saving labor in
New Zealand agriculture, in which labor has traditionally scarce (expensive) relative to land.

However, induced innovation hypothesis has not gained universal acceptance. For E.g., Salter
denies relative factor prices influence the nature of invention: When labor costs rise any advance
it reduces total costs is welcome, &whether this is achieved by saving labor/capital is irrelevant.
There is no reason to assume that attention should be concentrated on labor-saving techniques,
unless, because of some inherent characteristic of technology, labor-saving knowledge is easier
to acquire than capital-saving knowledge.

On the other hand, Kennedy maintains that if per-unit labor costs are high relative to per-unit
capital costs, the entrepreneur will search for a labor-saving innovation because this will reduce
his total cost in the greatest proportion.

Thus, Kennedy argues that it is only the level of relative factor prices and not changes in these
prices that is essential for a theory of induced innovation. Hayami & Ruttan point out that part of
Salter's disagreement with the induced innovation hypothesis stems at least in part from his
broad definition of the production function, which he considers as embracing all possible designs
conceivable by existing scientific knowledge. Hence, a change in relative factor prices would,
according to Salter, amount to "factor substitution― rather than technical change. Much of the
early literature on the induced innovation hypothesis dealt with innovation in the context of the
theory of the firm. Hayami & Ruttan maintain that no theory of induced innovation has been
developed for the public sector. Since much of the new technology in agriculture is a product of
public sector research, a rather large gap exists in our knowledge of how or whether relative

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factor prices in agriculture influence the direction of publicly sponsored research in agriculture.
The gap is by extend in the basic Hicksian theory of induced innovation to the public sector.

4.5. Adoption of new varieties in agriculture

Adoption of new varieties in agriculture is the process by which farmers adopt and begin to use
new crop varieties that have been developed through breeding or genetic engineering. This can
include new varieties of crops that are more resistant to pests and diseases, have higher yields, or
are better suited to specific growing conditions.

There are several factors that can influence the adoption of new varieties in agriculture. One of
the most important is the availability of information about the new varieties. This can include
information on their performance, such as yield data, as well as information on how to grow and
care for the crops.

Another important factor is the cost of the new varieties. If the cost of the new seeds or seedlings
is too high, farmers may be less likely to adopt them. In addition, farmers may be hesitant to
adopt new varieties if they are unsure of how they will perform in their specific growing
conditions.

Economic incentives can also play a role in the adoption of new varieties. For example, if a new
variety has the potential to increase yields or reduce costs, farmers may be more likely to adopt
it. Government policies, such as subsidies or research and development programs, can also help
to promote the adoption of new varieties.

Finally, social factors can also influence the adoption of new varieties. For example, farmers may
be more likely to adopt new varieties if their neighbors or other farmers in their community are
also using them. This can create a sense of community and peer pressure that can encourage
farmers to adopt new varieties.

Overall, the adoption of new varieties in agriculture is a complex process that is influenced by a
variety of factors. By understanding these factors and working to address them, researchers and
policymakers can help to promote the adoption of new varieties and improve the overall
productivity and sustainability of agriculture.

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Review questions on chapter four

1. Define the concept of technical change in agriculture.

2. Identify the source and forms of technical change in agriculture.
3. Explain why adoption of technology is so important in agriculture.
4. What are the factors affecting adoption of technology in agriculture.
5. Explain the moral or economies of technological adoption in agriculture.

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 CHAPTER FIVE
AGRICULTURAL MARKETING

Marketing connotes a series of activities involved in moving the goods from the point of
production to the point of consumption. It includes all the activities involved in the creation of
time, place, form and possession utility.

Agricultural marketing is the study of all the activities, agencies and policies involved in the
procurement of farm inputs by the farmers and the movement of agricultural products from the
farms to the consumers. The agricultural marketing system is a link between the farm and the
non – farm sectors. It includes the organization of agricultural raw materials supply to processing
industries, the assessment of demand for farm inputs and raw materials, and the policy relating to
the marketing of farm products and inputs.
A study of the agricultural marketing system is necessary to an understanding of the complexities
involved and the identification of bottlenecks with a view to providing efficient services in the
transfer of farm products and inputs from producers to consumers. An efficient marketing system
minimizes costs, and benefits all the sections of the society.
The expectations from the system vary from group to group; and, generally, the objectives are in
conflict. The efficiency and success of the system depends on how best these conflicting
objectives are reconciled.

Producers:
Producer-farmers want the marketing system to purchase their produce without loss of time and
provide the maximum share in the consumer‘s money income. They want the maximum possible
price for their surplus produce from the system. Similarly, they want the system to supply them
the inputs at the lowest possible price.
Consumers:
The consumers of agricultural products are interested in a marketing system that can
provide food and other items in the quantity and of the quality required by them at the
lowest possible price. However, this objective of marketing for consumers is contrary to
the objective of marketing for the farmer – producers.

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Market Middlemen and Traders:
Market middlemen and traders are interested in a marketing system which provides them
a steady and increasing income from the purchase and sale of agricultural commodities.
This objective of market middlemen may be achieved by purchasing the agricultural
products from the farmers at low prices and selling them to consumers at high prices.
Government:
The objectives and expectations of all the three groups of society-producers, consumers
and market middlemen – conflict with one another. All the three groups are indispensable to
society. The government has to act as a watch-dog to safeguard the interests of all the groups
associated in marketing. It tries to provide the maximum share to the producer in the consumer‘s
income; food of the required quality to consumers at the lowest possible price; and enough
margin to market middlemen so that they may remain in the trade and not think of going out of
trade and jeopardize the whole marketing mechanism.

Characteristics of Marketing of Agricultural Goods

The marketing of agricultural commodities is different from the marketing of manufactured

commodities because of the special characteristics of the agricultural sector (demand and supply)
which have a bearing on marketing. Because of these characteristics, the subject of agricultural
marketing has been treated as a separate discipline – and this fact makes the subject somewhat
complicated. These special characteristics of the agricultural sector affect the supply and demand
of agricultural products in a manner different from that governing the supply and demand of
manufactured commodities. The special characteristics which the agricultural sector possesses,
and which are different from those of the manufactured sector, are:
Perishability of the Product:
Most farm products are perishable in nature; but the period of their perishability varies from a
few hours to a few months. To a large extent, the marketing of farm products is virtually a race
with death and decay. Their perishability makes it almost impossible for producers to fix the
reserve price for their farm-grown products. The extent of perishability of farm products may be
reduced by the processing function; but they cannot be made non-perishable like manufactured
products. Nor can their supply be made regular.

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Seasonality of Production:
Farm products are produced in a particular season; they cannot be produced throughout the year.
In the harvest season, prices fall. But the supply of manufactured products can be adjusted or
made uniform throughout the year. Their prices therefore remain almost the same throughout the
year.
Bulkiness of Products:
The characteristic of bulkiness of most farm products makes their transportation and storage
difficult and expensive. This fact also restricts the location of production to somewhere near the
place of consumption or processing. The price spread in bulky products is higher because of the
higher costs of transportation and storage.
Variation in Quality of Products:
There is a large variation in the quality of agricultural products, which makes their grading and
standardization somewhat difficult. There is no such problem in manufactured goods, for they
are products of uniform quality.
Irregular Supply of Agricultural Products:
The supply of agricultural products is uncertain and irregular because of the dependence of
agricultural production on natural conditions. With the varying supply, the demand remaining
almost constant, the prices of agricultural products fluctuate substantially.
Small Size of Holdings and Scattered Production:
Farm products are produced throughout the length and breadth of the country and most of the
producers are of small size. This makes the estimation of supply difficult and creates problems in
marketing.
Processing:
Most of the farm products have to be processed before their consumption by the ultimate
consumers. This processing function increases the price spread of agricultural commodities.
Processing firms enjoy the advantage of monopsony, oligopsony or duopsony in the market. This
situation creates disincentives for the producers and may have an adverse effect on production in
the next year.
IMPORTANCE OF AGRICULTURAL MARKETING
Agricultural marketing plays an important role not only in stimulating production and
consumption, but in accelerating the pace of economic development. Its dynamic functions are of

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primary importance in promoting economic development. For this reason, it has been described
as the most important multiplier of agricultural development. The importance of agricultural
marketing in economic development has been indicated inthe paragraphs that follow.
Optimization of Resource use and Output Management:
An efficient agricultural marketing system leads to the optimization of resource use and output
management. An efficient marketing system can also contribute to an increase in the marketable
surplus by scaling down the losses arising out of inefficient processing, storage and
transportation. A well-designed system of marketing can effectively distribute the available stock
of modern inputs, and thereby sustain a faster rate of growth in the agricultural sector.
Increase in Farm Income
An efficient marketing system ensures higher levels of income for the farmers by reducing the
number of middlemen or by restricting the commission on marketing services and the
malpractices adopted by them in the marketing of farm products. An efficient system guarantees
the farmers better prices for farm products and induces them to invest their surpluses in the
purchase of modern inputs so that productivity and production may increase. This again results
in an increase in the marketed surplus and income of the farmers. If the producer does not have
an easily accessible market-outlet where he can sell his surplus produce, he has little incentive to
produce more. The need for providing adequate incentives for increased production is, therefore,
very important, and this can be made possible only by streamlining the marketing system.
Widening of Markets:
A well-knit marketing system widens the market for the products by taking them to remote
corners both within and outside the country, i.e., to areas far away from the production points.
The widening of the market helps in increasing the demand on a continuous basis, and thereby
guarantees a higher income to the producer.
Growth of Agro-based Industries:
An improved and efficient system of agricultural marketing helps in the growth of agrobased
industries and stimulates the overall development process of the economy. Many industries
depend on agriculture for the supply of raw materials.
Price Signals:
An efficient marketing system helps the farmers in planning their production in accordance with
the needs of the economy. This work is carried out through price signals.

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Adoption and Spread of New Technology
The marketing system helps the farmers in the adoption of new scientific and technical
knowledge. New technology requires higher investment and farmers would invest only if they
are assured of market clearance.
Employment:
The marketing system provides employment to millions of persons engaged in various activities,
such as packaging, transportation, storage and processing. Persons like commission agents,
brokers, traders, retailers, weighmen, hamals, packagers and regulating staff are directly
employed in the marketing system. This apart, several others find employment in supplying
goods and services required by the marketing system.
Addition to National Income:
Marketing activities add value to the product thereby increasing the nation‟s gross national
product and net national product.
Better Living:
The marketing system is essential for the success of the development programmes which are
designed to uplift the population as a whole. Any plan of economic development that aims at
diminishing the poverty of the agricultural population, reducing consumer food prices, earning
more foreign exchange or eliminating economic waste has, therefore, to pay special attention to
the development of an efficient marketing for food and agricultural products.
Creation of Utility:
Marketing is productive, and is as necessary as the farm production. It is , in fact, a part of
production itself, for production is complete only when the product reaches a place in the form
and at the time required by the consumers. Marketing adds cost to the product; but, at the same
time, it adds utilities to the product. The following four types of utilities of the product are
created by marketing:
(a) Form Utility: The processing function adds form utility to the product by changing the raw
material into a finished form. With this change, the product becomes more useful than it is in the
form in which it is produced by the farmer. For example, through processing, oilseeds are
converted into oil, sugarcane into sugar, cotton into cloth and wheat into flour and bread. The
processed forms are more useful than the original raw materials.

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(b) Place Utility: The transportation function adds place utility to products by shifting them to a
place of need from the place of plenty. Products command higher prices at the place of need than
at the place of production because of the increased utility of the product.
(c) Time Utility: The storage function adds time utility to the products by making them available
at the time when they are needed.
(d) Possession Utility: The marketing function of buying and selling helps in the transfer of
ownership from one person to another. Products are transferred through marketing to persons
having a higher utility from persons having a low utility.

MARKETING FUNCTIONS

Any single activity performed in carrying a product from the point of its production to the
ultimate consumer may be termed as a marketing function. A marketing function may have
anyone or combination of three dimensions, viz., time, space and form. The marketing functions
involved in the movement of goods from the producer to its ultimate consumer vary from
commodity to commodity, market to market, the level of economic development of the country
or region, and the final form of the consumption.

The marketing functions may be classified in various ways. For example, Thomsen has classified
the marketing functions into three broad groups. These are:

1. Primary Functions: Assembling or procurement, Processing, Dispersion or Distribution

2. Secondary Functions: Packaging, Transportation, Grading, Standardization and

Quality Control, Storage and Warehousing, Price Determination or Discovery, Risk Taking,
Buying and Selling, Demand Creation, Dissemination of Market Information

3. Tertiary Functions: Banking, Insurance, and Communications – posts & Telegraphs, Supply of
Energy – Electricity

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Packaging
Packaging is required for nearly all farm products at every stage of the marketing process. The
type of the container used in the packing of commodities varies with the type of the commodity
as well as with the stage of marketing. For example, gunny bags are used for cereals, pulses and
oilseeds when they are taken from the farm to the market. For packing milk or milk products,
plastic, polythene, tin or glass containers are used. Wooden boxes or straw baskets are used for
packing fruits and vegetables.
TRANSPORTATION:
Transportation or the movement of products between places is one of the most important
marketing functions at every stage, i.e., right from the threshing floor to the point of
consumption. Most of the goods are not consumed where they are produced. All agricultural
commodities have to be brought from the farm to the local market and from there to primary
wholesale mar
kets, secondary wholesale markets, retail markets and ultimately to the consumers. The inputs
from the factories must be taken to the warehouses and from the warehouses to the wholesalers,
retailers and finally to the consumers (farmers). Transportation adds the place utility to goods.
Transport is an indispensable marketing function. Its importance has increased with urbanization.
For the development of trade in any commodity or in any area transport is a sine qua non. Trade
and transport go side by side; the one reinforces and strengthens the other.
Transportation Cost:
The transportation cost accounts for about 50 percent of the total cost of marketing. It is higher
when the produce is transported by bullock carts than when it is carried by other means. The
efficiency of transportation depends on the speed and the care with which goods move from one
place to another, the extent of the facilities provided, and the degree of care with which goods
are handled en route and at terminal stations. However, there is a need for reducing the cost of
transportation.
Factors affecting the cost of transportation
Other things remaining the same, the transportation cost of a commodity depends on the
following factors:

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Distance: With an increase in the distance over which a commodity is transported, the total
transportation cost increases; but the transportation cost per unit quantity of the produce
decreases after a certain distance.
Quantity of the Product: The transportation cost per unit quantity of a commodity decreases
with the increase in the volume. It will be less if a full truckload is available than it would be if
only a few quintals are transported.
Mode of Transportation: The cost of transportation varies with the mode of transportation, e.g.,
bullock cart, tractor, truck, railway etc.
Condition of Road: The cost of transportation is less where metaled or tar roads have been
constructed than in places where graveled roads exist or where there are no roads at all.
Nature of Products: The cost of transportation per unit is higher for the products having the
following characters:
a) Perishability (e.g., Vegetables);
b) Bulkiness (e.g., straw);
c) Fragility (e.g., tomatoes);
d) Inflammability (e.g., Petrol);
e) Requirement of a special type of facility (for example, for livestock and milk).
Availability of Return Journey consignment: If goods are also available for transportation
when a truck is to return to its starting place, the per unit cost of transportation is less.
Risk Associated: The transportation cost is less if the produce is transported at the
owner‘s/sender‘s risk than when the risk is on the agency transporting the produce
GRADING AND STANDARDIZATION
Standardization means the determination of the standards to be established for different
commodities. Pyle has defined standardization as the determination of the basic limits on grades
or the establishment of model processes and methods of producing, handling and selling goods
and services. Standards are established on the basis of certain characteristics-such as weight,
size, colour, appearance, texture, moisture content, staple length, amount of foreign matter,
ripeness, sweetness, taste, chemical content, etc. These characteristics, on the basis of which
products are standardized, are termed grade standards. Thus, standardization means making the
quality specifications of the grades uniform among buyers and sellers over space and over time.

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Grading means the sorting of the unlike lots of the produce into different lots according to the
quality specifications laid down. Each lot has substantially the same characteristics in so far as
quality is concerned. It is a method of dividing products into certain groups or lots in accordance
with predetermined standards. Grading follows standardization. It is a sub-function of
standardization.

STORAGE
Storage is an important marketing function, which involves holding and preserving goods from
the time they are produced until they are needed for consumption. Storage is an exercise of
human foresight by means of which commodities are protected from deterioration, and surplus
supplies in times of plenty are carried over to the season of scarcity. The storage function,
therefore, adds the time utility to products.

Agriculture is characterized by relatively large and irregular seasonal and year – to – year
fluctuations in production. The consumption of most farm products, on the other hand, is
relatively stable. These conflicting behaviors of demand and supply make it necessary that large
quantities of farm produce should be held for a considerable period of time. The storage function
is as old as man himself, and is performed at all levels in the trade.
Producers hold a part of their output on the farm. Traders store it to take price advantage.
Processing plants hold a reserve stock of their raw materials to run their plants on a continuous
basis. Retailers store various commodities to satisfy the consumers day – to – day needs.
Consumers, too, store food grains, depending on their financial status.
The storage of agricultural products is necessary for the following reasons:
1. Agricultural products are seasonally produced, but are required for consumption
throughout the year. The storage of goods, therefore, from the time of production to the
time of consumption, ensures a continuous flow of goods in the market;
2. Storage protects the quality of perishable and semi – perishable products from
deterioration;
3. Some of the goods, e.g., woolen garments, have a seasonal demand. To cope with this
demand, production on a continuous basis and storage become necessary;
4. It helps in the stabilization of prices by adjusting demand and supply;

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 5. Storage is necessary for some period for the performance of other marketing functions.
For example, the produce has to be stored till arrangements for its transportation are
made, or during the process of buying and selling, or the weighment of the produce after
sale, and during its processing by the processor;
6. The storage of some farm commodities is necessary either for their ripening (e.g., banana,
mango, etc.) or for improvement in their quality (e.g., rice, pickles, cheese, tobacco,
etc.); and Storage provides employment and income through price advantages. For
example, middlemen store food grains by purchasing them at low prices in the peak
season and sell them in the other seasons when prices are higher.

PROCESSING:
Processing is an important marketing function in the present-day marketing of agricultural
commodities. A little more than 100 years ago, it was a relatively unimportant function in
marketing. A large proportion of farm products was sold in an unprocessed form, and a great
deal of the processing was done by the consumers themselves. At present, consumers are
dependent upon processing for most of their requirements. Many technological changes have
occurred in the recent past, such as the introduction of refrigeration, modern methods of milling
and baking food grains, new processing methods for dairy products, and modern methods of
packing and preservation.

These technological changes have had a significant impact on the standard of living of the
consumers, on the economic and social organizations of society, and on the growth of trade in
the country.

The processing activity involves a change in the form of the commodity. This function includes
all of those essentially manufacturing activities which change the basic form of the product.
Processing converts the raw material and brings the products nearer to human consumption. It is
concerned with the addition of value to the product by changing its form.

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BUYING AND SELLING:

Buying and selling is the most important activity in the marketing process. At every stage,
buyers and sellers come together, goods are transferred from seller to buyer, and the possession
utility is added to the commodities.
The number of times the selling-and-buying activity is performed depends on the length of the
marketing channel. In the shortest channel where no middleman is involved, this activity takes
place only once, i.e., the producer or farmer sells and the consumer purchases. But, usually, in
the case of farm commodities, selling/buying activities are undertaken each time when the
produce moves from the farmer to the primary wholesaler, from the wholesaler to the retailer,
and from the retailer to the consumer.
The buying activity involves the purchase of the right goods at the right place, at the right time,
in the right quantities and at the right price. It involves the problems of what to buy, when to buy,
from where to buy, how to buy and how to settle the prices and the terms of purchase. The
selling activity involves personal or impersonal assistance to or persuasion of, a prospective
buyer to buy a commodity. The objective of selling is to dispose of the goods at a satisfactory
price. The prices of products, particularly of agricultural commodities vary from place to place,
from time to time, and with the quantity to be sold. Selling, therefore, involves the problems of
when to sell, where to sell, through whom to sell, and whether to sell in one lot or in parts.

MARKET INFORMATION
Market information is an important marketing function which ensures the smooth and efficient
operation of the marketing system. Accurate, adequate and timely availability of market
information facilitates decision about when and where to market products. Market information
creates a competitive market process and checks the growth of monopoly or profiteering by
individuals. It is the lifeblood of a market. Everyone engaged in production, and in the buying
and selling of products is continually in need of market information. This is more true where
agricultural products are concerned, for their prices fluctuate more widely than those of the
products of other sectors. Market information is essential for the government, for a smooth
conduct of the marketing business, and for the protection of all the groups of persons associated
with this. It is essential at all the stages of marketing, from the sale of the produce at the farm

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until the goods reach the last consumer.

Market information may be broadly defined as a communication or reception of knowledge or

intelligence. It includes all the facts, estimates, opinions and other information which affect the
marketing of goods and services.
Market information is of two types:

a) Market Intelligence: This includes information relating to such facts as the prices that
prevailed in the past and market arrivals over time. These are essentially a record of what has
happened in the past. Market intelligence is therefore, of historical nature. An analysis of the past
helps us to take decision about the future.

b) Market News: This term refers to current information about prices, arrivals and changes in
market conditions. This information helps the farmer in taking decisions about when and where
to sell his produce. The availability of market news in time and with speed is of the utmost value.
Sometimes, a person who gets the first market news gains a substantial advantage over his
fellow-traders who receive it late. Market news quickly becomes obsolete and requires frequent
updating.

FINANCING

There is a long interval between the time of production and consumption. Between these
two points, the ownership of commodities shifts many times – a fact which necessitates financial
arrangements. Middlemen need finance not only for the purchase of stocks, but for the
performance of various marketing functions, such as processing, storage, packaging, transport
and grading. The financing function of marketing involves the use of capital to meet the financial
requirements of the agencies engaged in various marketing activities. No business is possible
nowadays without the financial support of other agencies because the owned funds available
with the producers and market middlemen (such as wholesalers, retailers and processors) are not
sufficient. The financial requirements increase with the increase in the price of the produce and

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the cost of performing various marketing services. In the words of Pyle: ―Money or credit is the
lubricant that facilitates the marketing machine.‖

AGRICULTURAL MARKETING POLICY

Marketing policy is concerned with the transfer or movement of farm outputs from the farmgate
to the domestic consumer or to ports of export. Therefore, the marketing of farm output is
typically thought to play a dual role.
 The transmission of price signals between consumers (demand) and producers (supply).
For example, an increase in demand for maize causes prices to rise in an urban center and
this information is passed back to producers through the marketing system.
 The physical transmission of the commodity from points of production by farmers to
points of purchase by consumers.

Objectives of Marketing Policy

The objectives of government intervention in agricultural marketing are closely related to
perceptions about the structure (number, size and diversity of participants), conduct (reliability,
timeliness, quality) and performance (speed and accuracy of price adjustment, the stability of
prices and margins, etc) of private marketing channels. The view that private traders are able to
exploit farmers or consumers by the exercise of local monopoly power is widely prevalent as a
reason or as an excuse for marketing policy interventions. The objectives most commonly
advanced for government marketing policies are as follows:
a) To protect farmers or consumers from parasitic traders: This is the age-old reason for
marketing interventions based on the idea that middlemen are able to extract monopoly profits
from their position between scattered and ill-informed producers, on the one hand and captive
consumers, on the other hand. According to this view, the marketing margin is wider under
typical systems of private trade than would be possible either with a truly competitive marketing
system or with a state-run marketing system. Most governments have opted for the latter rather
than the former solution to the purported problem.
b) To stabilize or increase farm-gate price: output price policies designed to stabilize or increase
producer prices may require state marketing interventions to achieve their aims. This certainly
applies to fixed producer prices which can only be implemented if all marketed output is sold
through the same channels. Even with lesser degrees of intervention there is often an implicit

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view that private traders have a destabilizing effect on prices due to hoarding and speculation.
The advent of state systems of floor and ceiling prices linked to buffer stocks is designed to place
limits on instability caused by such reasons.
c) To reduce the marketing margin: this links to the first objective stated above. The state may
intervene specifically to narrow the gap between consumer and producer prices. Reducing the
size of the gross marketing margin may be part of trying to raise producer prices by increasing
the producer share of a given retail or export price, or it may be related to trying to reduce urban
food prices for consumers.
d) To improve quality and minimum standards of outputs: A common objective of marketing
interventions is to try to raise the quality of farm output, especially for export crops which
confront rigorous quality norms in international markets. Quality control and minimum standards
are often considered as regulatory rather than as direct intervention functions of governments,
but this distinction may not always be apparent in the practical implementation of quality
standards.
f) To increase food security: Food security is often put forward as an important reason for
marketing intervention. Originating in the first reason above is the idea that private traders take
advantage of incipient food shortages to buy up and hoard grain for speculative purposes. The
argument goes that this behaviour, while rational enough for the traders involved, exacerbates
food shortages and increases price instability. Therefore, means must be implemented for
avoiding these detrimental effects on national food security.
Instruments of Marketing Policy
Governments of developing countries have used many different instruments to influence the
working of agricultural marketing channels. These ranges from attempts to replace private
channels almost entirely by state institutions, through partial involvement of state bodies,
licensing of approved traders and processors, and minor regulatory functions like quality
standards, grading and hygiene. The following list describes various types of intervention:
i. Monopoly parastatal: This category includes all those government owned institutions that
represent some form of monopoly control over one or other stage of the marketing system. It
includes the marketing boards which are widely prevalent throughout the developing countries,
especially for the traditional export crops such as coffee, tea, cocoa, rubber, tobacco, etc.

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Organizations in this category vary widely in the number of stages of marketing in which they
may be involved.
 At one hand, they may handle just the final sale to foreign buyers at FOB export, while
also regulating the way the export price is passed back down the marketing chain and
policing of the relevant quality standards involve.
 At the other end, they may handle all stages of marketing, processing, and final sale from
the producer to the consumer or to export. In some countries, crop parastatals have also
been responsible for crop development functions including output subsidies, crop
specific research, credit provision, extension work, etc.
ii. Non monopoly parastatal: This category includes a wide range of different institutions that
provide one particular channel, but not the exclusive channel, through which crop sales by
peasants are transferred to consumers. The predominant form of non-monopoly parastatals is the
state buffer-stock authority for staple food grains. The tasks of such an authority are to
implement floor and ceiling prices for major food grains. This is done by buying in all grain
offered by farmers or traders at a floor price or delivery price, and by selling grain out of public
store in order to prevent retail market prices from going above an agreed ceiling. There are many
different ways that this basic idea of keeping prices within a present range can be implemented in
practice.
iii. Farmer cooperatives: marketing cooperatives are usually found in conjunction with one or
other of the parastatal systems already listed in the above points. The task of farmer cooperatives
is to undertake procurement (assembly) stage of marketing for onward delivery to licensed
processors or to the designated parastatals. Sometimes it is compulsory for all farmers in a
particular location, or growing a particular crop like coffee, tealeaf and others to belong to
designated cooperatives.
iv. Trader licensing: where the state does not take itself direct responsibility for marketing, it
sometimes tries to control the private trade by licensing designated enterprises. Licenses are both
a source of state income and a threat. The source of income is the license fee, often
supplemented by the bribes needed to secure the license in competition with other traders. The
threat is the loss of the license if the trader is perceived not to be playing the game according to
the way that state officials wish to see it played.

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v. Instruments to improve market conduct and performance: There are three distinct types of
instruments within this category of state intervention in marketing. These are:
a. Provision of improved information to marketing system participants through media such as
newspaper, radio, Television, etc.
b. The regulatory function of setting and enforcing quality standards, weights, measures, and
hygiene.
c. Provision of marketing facilities such as floor spaces in towns and villages for retail and
wholesale markets, auction rooms, weighing equipments, etc. To some degree this is a type of
public infrastructure investment.
vi. Instruments to improve market structure: Various types of state marketing enterprises
already listed above under i and ii are often described by those who have decided on that type of
intervention as improving market structure, however, a different sense in which improving
market structure could be interpreted is to increase the amount of competition in the marketing
system by encouraging new private entrants at each level of the system. This has not been the
preferred method of increasing marketing efficiency in developing countries. However, it is
becoming a more popular method under pressure for deregulation by external agencies like the
World Bank or the IMF. The most effective means of increasing participation and reducing
barriers to entry appears to be for the government to provide creditor seed money to enable new
entrants to get started.

Marketing Growth Strategies

Businesses can follow many growth strategies when they wish to expand. These strategies
typically focus on new products and new markets. Three broad categories of growth strategies
are: a) Intensive Growth Strategies
b) Integrative Growth Strategies
c) Diversification Growth Strategies

a) Intensive Growth Strategies: An intensive growth strategy is a growth strategy that focuses
on cultivating new products or new markets and sometimes both. Businesses use an intensive
growth strategy when they believe they haven‘t fully realized their strengths or their markets.
This strategy is best described as "doing more of what you are good at doing." The three most

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common types of intensive growth strategies are:
• Market penetration
• Market development
• Product development

Market penetration is an intensive growth strategy that emphasizes more intensive marketing of
existing products. This strategy has two goals: sell more to existing customers and sell to new
customers in existing markets. However, market penetration is a way for a business to increase
its profits by taking advantage of its existing skills, experience, and knowledge about its target
markets like advertising, and promotions. It is a popular growth strategy for small businesses.
Existing customers may be convinced to buy more of a product if the business advertises new
uses for that product. The makers of dry soup mixes could, for example, publish recipes for party
dips made from their products. Businesses can also try to convince existing customers to buy a
product more often. Toothbrush manufacturers advertise that dentists recommend replacing a
toothbrush every three months. Existing customers may also buy more and more often if they are
offered incentives, such as frequent‐buyer programs. Market penetration can also involve
pursuing new customers in current target markets. Basically, the business uses marketing tactics
to try to gain customers from its competitors. This increases a business's market share. Market
share is the percentage of the total sales captured by a product or a business in a particular
market. In other words: (Sales by Business /Total Sales in Market) x 100 = Market Share, If a
company sells $1,000 worth of tennis rackets in a town where total sales of tennis rackets are
$5,000, the company has a one‐fifth, or 20%, market share.($1,000 /$5,000) x 100 = 20%
Once a business has the largest market share it believes it can capture, the next step is usually to
find new markets.

Market development is an intensive growth strategy that focuses on reaching new target markets,
such as customers in another geographic area or customers who have different demographics
from current customers. A retail store might open a branch in a new city or develop a Website to
sell its products online.

Product development is an intensive growth strategy in which businesses develop new products
or enhance (improve the quality, value, or extent of) their existing products. Enhancements may

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include bonus features or new packaging for products. For example, they could add small toys as
extras to cereal boxes. Product development is typically costly for a business but can be a
successful means of growth if the new or enhanced offering is popular with customers.
b) Integrative Growth Strategies: It is a growth strategy that emphasizes blending businesses
together through acquisitions and mergers. Integrative growth strategies are typically more
expensive than intensive growth strategies and are usually practiced by mature businesses with
large cash flows. There are two types of integrative growth strategies:
• Vertical integration: is an integrative growth strategy in which one business acquires another
business in its own supply chain, but not at the same supply chain level. It occurs when a firm
performs more than one activity in the sequence of the marketing process. It is linking together
of two or more functions within a single firm or under a single ownership. An example of this
type of growth strategy is when a wholesaler performs the activities which are performed by the
retailer or if the reverse happened. It also has two types.

A. Forward integration: Eg, Wholesaler buys the store of retailers.

B. Backward Integration: Eg, when retailers purchase the store of wholesaler.

• Horizontal Integration: An integrative growth strategy in which one business acquires

another business at the same supply chain level as itself is a horizontal integration strategy. One
manufacturing company buys another manufacturing company product that‘s a horizontal
integration growth strategy. The acquired business may be a competitor or a business in a
completely different industry.
c) Diversification Growth Strategies
A diversification growth strategy is a growth strategy in which a business grows by offering
products or services that are different from its core business. Every business has a core business,
which is the most important focus of the business. For example, the core businesses of hotels are
selling fast food and drinks then if they start to provide ATM service; it is said to be
diversification. There are two types of diversification growth strategies:
• Synergistic Diversification. A growth strategy in which a business adds new products or
services that are related to its existing products or services is a synergistic diversification. A

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clothing store that begins selling shoes practices this type of growth. So does an event‐planning
business that begins to offer catering services.

• Horizontal Diversification. A growth strategy in which a business adds new products or

services that are not related to its existing products or services but appeal to its existing target
market is called horizontal diversification. Recently some large grocery stores have begun
offering credit cards to their customers. This is an example of horizontal diversification. Another
example would be a gas station that sells food.

Transaction costs and marketing efficiency

Transaction cost is the costs involved in the transfer of ownership from one individual to
another or it is the cost of running the economic system. Transaction cost as the cost associated
with the transfer, capture and protection of rights. For instance, market information is needed
or required to inform buyers and sellers of the existence of a supply or demand for a commodity,
and of the price. Transactions occur whenever a good or service is transferred from a provider to
a user.

Marketing efficiency: It is the ratio of market output (satisfaction) to marketing input (cost of
resources). Increase in ratio represents improved efficiency and vice versa. It is essentially the
degree of market performance. It is a broad and dynamic concept.
Elements of efficiency
1. Technical or Physical efficiency: It is the physical ability of farmers to produce a maximum
level of output with the given inputs and technology.
2. Pricing / Allocative efficiency: It is also the ability to allocate farm products by combining
different inputs with the given price.
3. Economic efficiency: It is the product of technical and allocative efficiency. Efficient market
is one where the market price is an unbiased estimate of the true value of the investment or the
best estimate of value. Market efficiency does not require that the market price be equal to
true value at every point in time. All it requires is that errors in the market price be unbiased,
i.e., that prices can be greater than or less than true value, as long as these deviations are random.
Randomness implies that there is an equal chance that stocks are under or over valued at any
point in time.

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Marketing efficiency is essentially the degree of market performance. Marketing efficiency is the
movement of outputs from producers to the final consumer at a lower possible cost
• It is the ratio of market output (satisfaction) to marketing input (cost of resources). = MOP/MIP
• An increment in the ratio represents improvement in efficiency and vice versa.
• It can also be defined as the maximization of participant‘s satisfaction with the least cost
incurred in providing that satisfaction through the system of marketing.
It can be measured through following criteria:
– Prices (it reflects cost plus profit margin) – low is good
– Service provided – e.g, repair, replacement, etc.
– Structure (the relationship or business connection among firms in the marketing channel) –
long channel may add inefficiency (via more cost & mark-ups)
– Conduct – e.g., good valuation, +ve feedbacks, …
– Performance – e.g., number, volume, value etc performed, achieved

Review question on chapter five

1. Discuss the Characteristics of Marketing of Agricultural Goods and manufacturing good

in Ethiopia.
2. Would you think that agricultural marketing is importance. If so, explain the importance
of agricultural marketing.
3. Identify primary, secondary and tertiary marketing functions.
4. Differentiate between market intelligence and market news.
5. Discuss the objective and instruments of marketing policy in Ethiopia.
6. List and explain the marketing growth strategies.
7. Explain the elements of marketing efficiency and discuss how efficiency would measure.

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 CHAPTER 6
AGRICULTURAL FINANCE RURAL CREDIT MARKET

Agricultural finance generally refers to examining and analyzing the financial aspects pertaining
to farm business. The financial aspects include money matters relating to production of
agricultural products and their disposal. Agricultural finance can also be understood as a study of
borrowings by farmers, the organization and operation of farm lending agencies and of society‘s
interest in credit for agriculture.
Sources of Agricultural Finance
Credit in the farm sector is available from following two sources;
1. Non-Institutional Sources/ Informal Sources
The major non-institutional sources of farm credit are money lenders, friends, relatives,
shopkeepers and commission agents. The lenders of the informal sources (friends, relatives etc)
have certain advantages over the formal credit sources. The informal lenders usually know the
borrowers personally. They require little security for advancing loans. The loans are given for
consumption as well as production purposes. The lenders are approachable at all times. They are
also lenient in rescheduling loans. However, informal lenders are also accused of charging higher
rates of interest. They extract monopoly profits from the borrowers.
2. Institutional Sources/ Formal Sources
The major institutional sources of agricultural credit are Agricultural Development Banks,
State Banks, Commercial Banks, Cooperative banks, etc
Such institutions have the capacity to provide short, medium and long term credits for farm and
off farm activities in the form of development loans, production loans, agri-business loans,
cottage industry loans and off- farm- income-to-farmers generating activities loans.

Agricultural Credit Markets

In most developing countries, the agriculture sector is the mainstay of the economy. Though
agriculture is an important large market and industry, yet it is far away from the availability of
financial resources.
The word ―credit‖ comes from the Latin word ―Credo‖ which means ―I believe‖. Hence credit is
based up on belief, confidence, trust and faith. Credit is otherwise called as loan.

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Definition: Credit / loan is certain amount of money provided for certain purpose on certain
conditions with some interest, which can be repaid sooner (or) later. According to Professor
Galbraith credit is the ―temporary transfer of asset from one who has to other who has not‖
Credits are loans obtained by a farmer to start or expand his farming business. It may be in kind
or cash. Before credit is given out to a farmer, the lender needs detailed information about the
borrower. The main sources of agricultural credit are banks.
Agricultural credit is linked with growth of agriculture, whereas rural finance covers all the
aspects of socio-economic life of rural area. It covers a wide variety of farm and non-farm
productive activities such as agriculture, animal husbandry, fisheries, forestry, small agro-based
industries as well as development of physical and social infrastructure in the form of transport
and communication, water and power, education and health.

Need for Agricultural Credit

Credit is required in every type of business and agriculture is not exception of it. The need for
agriculture credit becomes more important when it moves from traditional agriculture to modern
agriculture. The agriculture sector at present is best with number of handicaps. The land holding
is very small. The population is growing at a fast rate. Agricultural labour is often under
employed. Production suffers from weather risks. The capacity of farmers to save and invest is
very low. The agricultural productivity is low due to low use of inputs. The farmers therefore,
need credit to increase productivity and efficiency in agriculture. This need is increasing over the
years with the rise in use of fertilizers, mechanization and rise in prices. Briefly the need for
agricultural credit can be summed up as follows.

1. Purchase of new inputs: The farmers need finance for the purchase of new inputs which
include seeds, fertilizers, pesticides, irrigation water etc. If the seed of high yielding varieties and
other modern inputs are made available to the farmers they can increase productivity not only of
land but also of labour.
2. Purchase of implements: Credit is required by the farmers for the purchase of tractors,
threshers, harvesters, water pumping sets etc. The use of appropriate machinery in land will
increase production by growing more than one crop on the same piece of land at the same time.

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3. Better management of risk: Credit enables the farmers to better manage the risks of
uncertainties of price, weather etc. They can borrow money during raining days and pay back the
loans during peak years of crops.
4. Permanent improvement in land: Credit also helps the farmers to make permanent
improvements in land like sinking of wells, land reclamation, horticulture, rotation of crops etc.
5. Better marketing of crops: If timely credit is available to the farmers, they will not sell the
produce immediately after the harvest is over. At that time the prices of agricultural goods are
low in the market. Credit enables the farmers to withhold the agricultural surplus an sell in the
market when prices are high.
6. Facing crises: The credit is required by the farmers to face crisis. The crisis can be caused by
failure of crop, flooding of fields, etc
7. Balanced development: Agricultural sector generally remains neglected compared to
industrial sector in the country. For balanced development, it is essential that credit should be
provided at concessional rates to the agriculture sector so that it should also expand and help in
―take off‖ process of the country.

Types of Agricultural Credit:

Agriculture requires the following three types of credit.
1. Short-Term Credit:
The short term credit ranges up to one year. The farmers need short term credit for meeting the
working capital arrangements of agriculture. For instance, they need short term credit for the
purchase of seeds, fertilizers, pesticides, bullocks and other casual expenses. Sometimes short
term credits are also raised for paying rents, revenue and also meeting the financial requirements
of the family. The short term credit is repaid after marketing the produce of next crop.
2. Medium Term Credit:

The medium term loan extends from 1 to 5 years. The farmers require medium term credit for the
purchase of cattle, purchase of implements, improvements in water courses etc. The loan is
obtained on the security of movable and implements.

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3. Long Term Credit:

The duration of long term credit exceeds five years. The farmers need long term credit for
making improvements of permanent nature in land such as sinking of tube wells, reclamation of
land, building, purchase of machinery and implements etc.

The Challenges of Agricultural Credit

The following factors apply primarily to rural and agricultural markets and constrain both the
supply of and demand for financial services:

• Generally lower population density, dispersed demand, low literacy rates, and inadequate
transportation
and communication infrastructure
• Limited economic opportunities for local populations
• High risks faced by potential borrowers and depositors due to the variability of incomes,
exogenous
economic shocks, and limited tools for managing risk
• Seasonality of crops and production schedules, leading to spikes in loan demand and shortages
in both funding and labor in certain periods
• Heavy concentration on agriculture and agriculture-related activities, exposing clients and
providers to multiple risks, both idiosyncratic (one household) and covariant (entire region or
country)
• Women farmers, who are constrained by lack of land, loss of land when the husband dies, or
inability to borrow without the husband‘s permission
• Lack of reliable information about borrowers
• Lack of market information and market access
• Weak institutional capacity, including poor governance and operating systems and insufficient
skills
among staff and management of service providers
• ―Crowding out‖ effect of subsidies and directed credit.

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Credit Policy

Poor performance of the agricultural sector in less developed countries has resulted in
incapability of farmers to produce surplus marketable output for acquiring some investable
capital for adoption of modern inputs and technology. In line with this reality, governments and
private financial institutions, and donors are involving in the provision of credit to peasant
households. The role of credit policy therefore concerns mainly, but not exclusively, on the
provision of working capital for the purchase of variable inputs and technologies used in farm
production. Accordingly, credit is not capital but it can be used, among other things, to make an
investment such as buying an irrigation pump, which is capital. Similarly, credit is not farm
input but it can be used, among other things, to improve the ability of farmers to buy critical farm
inputs. Therefore, credit fills investable capital limits by providing working capital for investors.
Generally, credit policy aims at alleviating a critical constraint which hampers growth in
agricultural output, replacing the fragmented and incomplete rural financial market dominated by
selfish private money-lenders, accelerating the adoption of new technology by peasant farmers,
and achieving equity goals, whether these are intra-rural, inter-regional, or rural-urban income
distribution.

The market for credit contains a demand schedule, a supply schedule and a price of capital
(interest rate) that adjusts to bring demand and supply into balance. Hence, the provision of
credit involves two parties: A lender (the one who supplies) and a borrower (the one who
demands). It also involves a price for the transfer or control over money, which is the interest
rate charged by the lender to the borrower. Therefore, credit transactions are not costless, and
there is no single rate of interest that covers the costs of and returns to the three principal actors -
borrowers, lenders and savers in the system. Costs on credit include interests charged on credit,
transaction costs, etc.

In addition to lenders and borrowers, the other main actors in the rural financial system are
savers. The saver is a person, household or any organization that is prepared to supply funds to
be held by a financial institution in return for an income flow in the shape of interest payments.

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The process of saving, lending and borrowing is called financial intermediation. The institutions
that enable this to take place by bringing together savers and borrowers with differing needs in
space and time are called financial intermediaries.

Credit may be informal, or formal, private or state in origin. Informal credit channels refer to the
financial services provided by money lenders (as an example the rich farmers, landlords,
traditional money lenders, traders and others); formal credit channels are those bound by the
legal regulations of a country (as an example private commercial banks, state commercial banks,
registered cooperatives, and a host of other financial institutions such as microfinance
institutions). The entire system of institutions and the way they work is called financial system.
A typical device for selecting borrowers is to demand that the borrower provide some collateral
for the whole or a proportion of the loan. Collateral might be a plot of land, a piece of equipment,
a draft animal, or a proportion of the crop. Historically there are two arrangements observed in
the world credit transaction, mainly in developing countries: the old and the new credit policies.
The inability of tenants and poor farmers to provide collateral in the private or informal financial
systems is one of the main reasons for creating institutional credit schemes.
Objectives, Instruments and Defects of Old Credit Policy

Objectives of Old Credit Policy

In the 1950s and early 1960s, credit provision was considered as a key instrument for breaking
the vicious circle of poverty (low incomes, low savings, and low productivity). However, in that
period emphasis was far more on market-oriented farmers and commercial agriculture than on
peasants. From the mid 1960s and up to the present time, small farmers and the rural poor has
increasingly become the chief target of credit interventions. Therefore, credit has always a
special place in mainstream thinking on agricultural development in developing countries.
Indeed, the sector was the largest recipient of donor assistant and aid. The objectives of old the
credit policy and the reasons for their popularity with governments and
aid donors alike are summarized as follows:

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  To alleviate a critical constraint hampering growth in agricultural output, this constraint
being lack of cash to make needed for farm investment (irrigation, drainage, pumps,
tractors, buildings) and to purchase modern variable inputs (fertilizer, pesticides, fuel,
feeds, etc);
 To replace the fragmented and incomplete rural financial market represented by private
money lenders, these credit sources supposedly having the effect of impoverishing their
clients rather than assisting them to improve productivity;
 To accelerate the adoption of new technology by peasant farmers, by providing working
capital for the seasonal purchase of variable inputs, and then optimizing the
complementarities between inputs essential for the success of green revolution
technology;
 To assist small farmers to overcome their inability to borrow from commercial or
informal credit sources, due to lack of collateral and lack of information;
 To provide short-term credit in order to bridge seasonal and temporal cash shortfalls of
small farmers, compared to the medium and long-term lending preferences of commercial
financial institutions;
 To achieve equity goals, whether these are related to intra-rural, interregional, or rural-
urban income distribution;
 To offset the disincentive effects for small farmers of policies unfavorable to them
including low output prices, over-valued exchange rates, and inefficient market
interventions by state;
 To gain favor with farmers for political purposes, including forthcoming elections,
 To take advantage of the sometimes-overwhelming generosity of foreign aid donors, who
seem to be, prepared to pump large amounts of money endlessly into rural credit projects.

Instruments of Old Credit Policy

The institutions created or regulated by the state (state agricultural banks, multipurpose
development agencies, crop and project authorities, commercial banks, cooperatives and farmer
groups) in order to deliver credit to farmers represent by themselves a type of instrument for
implementing credit objectives. The ways these institutions operate, and the constraint imposed

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on them by government policy, also involve more specific instruments for achieving goals such
as output growth, equity, small farm coverage, and short-term credit.

Some main instruments of state credit policy in developing countries are:

Low interest rate: one of the popular instruments of credit policy in developing countries has
been to subsidize the rate of interest on loans to farmers. The reason for this is the belief that the
demand for credit by small farmers is highly sensitive to the interest rates, i.e. demand for credit
is very elastic. If this believe is true, then the only way to get farmers to make more use of credit
is to lower interest rates.
Credit targeting: the orientation of credit policy towards small farmers involves extensive use of
targeting devices. Evaluation of earlier subsidized credit schemes commonly showed that larger
farmers were their chief beneficiaries, for a variety of reasons. In this case, the target group may
be defined according to various criteria such as farm area or family income.
Loan portfolio regulations: governments to restrict the decision-making flexibility of financial
institutions or to try to enforce compliance with state objectives may use various devices. One
device is to set a minimum to the proportion of agricultural sector loans out of total loans.
Another device is to stipulate maximum permissible loan sizes, in order to avoid too large a
share of total loans going to large borrowers. A third device is to place restrictions on the term
structure of the loan portfolio, such that the major proportion of total loans is short-term loans.
The reason for this is the view that small farmers mainly require short-term loans, i.e., as
working capital for input purchase, while large farmers require medium and long-term loans for
capital investment.
Miscellaneous instruments: governments can use many other instruments in order to try to
fulfill specified goals related to the provision of credit to farmers. Sometimes credit is provided
in kind such a bag of fertilizer. This is in order to overcome the problem of fungibility, but it is
unlikely to be successful, because if the farmer really wants to realize money for other purposes,
the physical credit will be sold for cash. Another common instrument for credit provision is to
link it to crop marketing, especially for export crops which are sold through a marketing board.
The repayment of the credit can then take the form of a deduction from the price received by the
farmer, thus avoiding problems of the recovery.

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Defects of old credit policy
Since 1970s, a considerable volume of literature concerning credit policies in developing
countries has appeared. The central components of the critique are set out as follows.
Fungibility: the fungibility attribute of credit, and of loanable funds generally, invalidates most
state targets and regulations for credit delivery. Fungibility exists in all types of the credit
system, from the farmer to the farmer financial intermediary and to the credit banks. At the
farmer level, fungibility means that loans targeted for specific purposes (example – fertilizer use
in cotton cultivation) may be used by the household for quite different ends (example – purchase
of sewing machine to make garments). At the lender level, it means that cheap funds can be
substituted for own funds in the preferred loan portfolio,
usually biased towards low-risk established clients. Loan portfolio regulations can easily be
evaded. At the central bank level, fungibility means donor funds for rural credit schemes mean
more foreign exchange. While the credit itself may be channeled towards small farmers, thus
satisfying donor wishes, the extra foreign exchange may be used to buy non-agricultural goods
and services such as heavy agricultural equipments, swimming pool pumps for the rich, etc.
Low interest rate: subsidized interest rates create several negative effects for the long-run
viability of rural financial institutions, as well as for borrowers and savers in the following ways.
First, a negative real rate of interest virtually causes a transfer of real resource from lending
institutions to borrowing farmers, thus undermining possibly the viability of lenders. A negative
rate of interest virtually makes the loan a gift from the lender to the borrower.
Second, low interest rate to borrowers makes it impossible to offer attractive interest rates to
savers. The rate offered to savers must be below the borrower‘s rate by an amount reflecting
transaction costs.

Third, low interest rates may mean that it is impossible for the lending institution to cover the
transaction costs of making loans within the margin between the borrower interest rate and the
rate the lender must pay for securing funds from the central bank, or from its own savers. This
further damages lender viability and may result in transaction costs being transferred, as non-
interest costs, to borrowers. In addition, it may result in diversion of loans to big borrowers since
unit transaction costs are always much lower for big loans than for small loans.

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Fourth, low interest rates cause an excess of demand over supply of credit, resulting in formal or
informal credit rationing which tends to favor the big and rich borrower over the small and poor
borrower.

High transaction costs: high transaction cost was a critical defect of credit policies in the past.
This was partly due to large number of small borrowers and lengthy paper works. High
transaction costs threaten the viability of lending institutions, cause transfer of costs to borrowers
or savers, and result in lender preference for few big loans rather than many small ones. Lending
to large numbers of small borrowers costs more per unit of money than lending to small numbers
of big borrowers.

Loan recovery: studies published in the early 1970s indicated that average loan failure rates
across samples of credit schemes at around 25 percent, rising to 20 percents in some cases. Loan
default is typically considered to be caused by two main factors; these are inability to repay (due
to crop failure) or unwillingness to repay (due to viewing the loan as a grant or political
patronage).
Saving failure: Saving was some time ago dubbed "the forgotten half of the rural finance".
The argument is that since rural credit agencies fail to encourage rural saving, they also fail to
possess funds that can make them independent of central or external funding. Thus they are also
incapable of surviving as self-sustaining financial institutions in the long term. There are many
arguments about this issue of saving:

 Some credit schemes are entirely supply driven and envisage no role for savings from
outset;
 Even those credit institutions that are permitted savings deposits do not encourage them
because they are heavily orientated themselves to external funds;
 Some formal credit institutions deliberately discourage saving by imposing high
transaction costs upon savers; and
 Some credit agencies may try to encourage savings deposits but are unsuccessful due to
the unrealistic levels of interest they can offer.

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Objectives and Instruments of New Credit Policy

We have seen that the major defects of the old credit policy lies in the objectives and
instruments. The outcome of those problems of the old traditional credit policy schemes is that in
most countries credit systems need rethinking as to their methods of operation, viability, and
sustainability. However, the redefinition of the objectives, instruments, and institutions of credit
policy means neither that the small-farm or rural poor orientation of policy needs to be
abandoned, nor that the state has no role in the fostering and regulation of new instruments. The
most important attribute of a successful credit system is that it should be self-sustaining in the
long run, not reliant on ever increasing subsidies to cover losses, and not dependent forever on
injections of external funds from foreign aid donors. The critical new objective of credit policy is
therefore the creation of a self-sustaining rural financial system. Nonetheless, this does not
exclude the continued pursuit of various older objectives, especially those related to small
farmers and poor rural people. In all, the major directions of changes in the objectives and
instruments of the new credit policy are summarized in the following four important points.

Savings mobilization: The generation of funds from savers is considered a key feature of self-
sustaining credit institutions.
 First, a strong savings base reduces the reliance on external funding.
 Second, savers and borrowers are often the same people at different points in time in the
community, reducing the information costs of transactions.
 Third, people to an institution for both saving and borrowing are less likely to default on
loans.
 Lastly, farmers with savings can often self-finance small outlays so that loans become
oriented to bigger outlays with lower transaction costs per unit of money.
A traditional view that small farmers and poor rural people are unable to save has been shown to
be wrong in several experiments. The main features of the rural poor in this context are:
 Their income is uneven
 Their potential to save often involve very small amounts
 They cannot afford costs associated with saving (including time and distance costs)

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  They are naturally concerned with the security of savings.

For peasants who are not so poor, lack of saving is much more to do with lack of opportunity or
distrust of the alternative available, than to do with low savings capacity. Households keep their
assets in goats or cattle rather that in bank, especially when the bank discourages savings, or
appears to be run by untrustworthy officials.

Interest rate level: A self-sustaining financial system requires an interest rate on loans sufficient
to cover the three components of:
 The interest rate paid to savers
 The average cost of making transaction, and
 A risk margin to cover the probability of default.

Loan recovery: it is now widely acknowledged that poor loan recovery performance is an
unacceptable feature of any credit scheme. Some big small farm credit schemes in certain
countries have had default rates as high as 80 percent in the past. It is possible that such credit
schemed had an overall negative effect on the capacity of farmers to sustain their livelihoods in
the long term, which is certainly not what development efforts should be about. There are many
reasons for low rates of loan recovery. For example, natural calamities such as floods or drought
can make repayment impossible in the locations and seasons where they occur. Therefore, there
is no single solution to the problem, though tougher recovery discipline (example new loans until
old loans are repaid), more realistic interest rates (which ensure that loans cannot be mistaken for
gift), and more joint saving and borrowing operations (which give borrowers a long term stake in
the lending agency) all have a role to play.

The changes of emphasis with respect to the success criteria from the point of view of the new
objectives and instruments include:
 The number of clients reached at both savers and borrowers, with the normal expectation
for a viable institution being many small savers and fewer, large, borrowers,
 Declining transaction cost over time, reflecting expansion of services and successes in
attracting new clients,

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  Improved loan recovery, and
 Total volume of savings achieved, and significance of savings in sources of funds for
onward lending
These instruments lead to changes in the criteria by which success or failure of a credit scheme
may be measured.

Institutional innovations: The successful re-orientation of credit away from the mainly supply-
led, state agricultural bank type of scheme requires imagination and experimentation in devising
new credit institutions. Credit provision needs to be located in a context of diverse institutions
providing several different services, not a single bureaucracy providing just one kind of service.
The required elements of more appropriate and efficient institutions reside partly in the changed
agenda of credit policy (saving, loan recovery, self sustainability), and partly in the experience of
credit institutions that have proved successful in such terms. Key elements are viability, self
sufficiency, access and efficiency. Some successful institutional innovations can therefore be
generalized as follows:

 Small farmers and poor people can save if the saving needs are organized in a special
way (regular, once a week, fixed amounts, door-to-door collection etc)
 Group lending, and group responsibility for repayment, seems promising ways of
organizing loans. Groups are formed according to predetermined criteria reflecting
homogeneity of interest (example - land ownership under 0.5 hectare); they are small so
that everyone knows what the others are doing (example - numbers should be between 5-
7 members).
 Lending institutions need to reduce administrative costs, reduce bureaucracy and
paperwork to minimum reporting standards, and create incentive and promotion
structures according to the performance of officers.

Review question chapter six

1. List and explain the Sources of Agricultural Finance which are available in Ethiopia and
identify which of them are useful for small holder farmer.

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 2. Put your suggestion of the role of agricultural credit in Ethiopia.
3. What is your critique on Objectives and Instruments of New Credit Policy
4. Explain the Objectives, Instruments and Defects of Old and new Credit Policy
5. Analyze The Challenges of Agricultural Credit in Ethiopia

CHAPTER SEVEN
UNCERTAINTY AND FARM DECISION MAKING
7.1. Definition of risk and uncertainty

Risk is measurable uncertainty and uncertainty is unmeasurable risk.

Risk is restricted to situations where probabilities can be attached to the occurrence of events,
which influence the outcome of decision-making process.

Uncertainty: is a situation where it is not possible to attach probabilities to the occurrence of

events.

Risk= known

Uncertainty= unknown

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7.2. Sources of risk in agriculture

Risk is an important aspect of the farming business. The uncertainties inherent in weather, yields,
prices, Government policies, global markets, and other factors that impact farming can cause
wide swings in farm income. Risk management involves choosing among alternatives that
reduce financial effects that can result from such uncertainties.

Five general types of risk are described here: production risk, price or market risk, financial risk,
institutional risk, and human or personal risk.

 Production risk derives from the uncertain natural growth processes of crops and
livestock. Weather, disease, pests, and other factors affect both the quantity and quality of
commodities produced.

 Price or market risk refers to uncertainty about the prices producers will receive for
commodities or the prices they must pay for inputs. The nature of price risk varies
significantly from commodity to commodity.

 Financial risk results when the farm business borrows money and creates an obligation
to repay debt. Rising interest rates, the prospect of loans being called by lenders, and
restricted credit availability are also aspects of financial risk.

 Institutional risk results from uncertainties surrounding Government actions. Tax laws,
regulations for chemical use, rules for animal waste disposal, and the level of price or
income support payments are examples of government decisions that can have a major
impact on the farm business.

 Human or personal risk refers to factors such as problems with human health or personal
relationships that can affect the farm business. Accidents, illness, death, and divorce are
examples of personal crises that can threaten a farm business.

7.3. Source of uncertainty in agriculture

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The following points highlight the four main types of uncertainties experienced in agriculture.
The types are: 1. Yield uncertainty 2. Price Uncertainty 3. Tenurial Uncertainty 4. Uncertainty
with regard to Input Prices/Quality.

Type # 1. Yield Uncertainty:

In-spite of technical progress, crop yields is still very much dependent on natural factors and
hence are highly uncertain. Modern livestock husbandry is less dependent on weather in
comparison to crop farming but a hard winter or a dry summer can still have a marked influence
on livestock production.

Move over, the possibility of livestock epidemics is always there. Fluctuations in crop yield take
place over which the farmer has no control and which he is unable to foresee. The extent of yield
fluctuation is, however, likely to be greater in some regions as compared to others. For example,
tropical regions are more prone to yield uncertainty than the temperate areas.

Moreover, the yield of some crops such as cotton is variable than that of others like wheat. These
differences in the relative degree of uncertainty apart, the important fact is that the individual
farmer is unable to predict accurately the output that he will obtain from a particular input
combination.

This happens because of the biological nature of agricultural industry which makes the yield
much more dependent on natural factors in comparison with the products of non-farming
industries. Yield uncertainty is also termed as technical uncertainty, as it refers to the variability
in the production coefficient of a given technique.

Type # 2. Price Uncertainty:

In additional to yield or technical uncertainty, uncertainty also exists with regard to the prices of
agricultural products. Price is more or less an uncontrolled or exogenous variable so far as the
individual farmer is concerned.

The farmer operates in a market structure which approximates to perfect competition and,
therefore, the price he receives for a product of a given quality is altogether unaffected by any

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plan or courses of action that he or any other farmer might adopt. He is a price taker and not a
price maker.

The outside factors which affect prices are:

(a) The behaviour of other farmers taken together;

(b) weather-induced random fluctuations in output;

(c) fluctuations in national income and prosperity; and

(d) discontinuous production cycles of the cobweb type.

Product prices faced by the non-farm industries are also subject to fluctuations, but the degree of
price uncertainty in these industries is much less than in agriculture.

The main reason for this is that not only are the non-farm industries much less affected by
weather generated price fluctuations but also that the monopolistic market structure in which
they operate enables them to exercise greater control over prices of their products. Price
fluctuations are likely to be reduced further in case of industry because it is easier to adjust the
supply of its products to changes in demand when compared with agriculture.

Type # 3. Tenurial Uncertainty:

Another type of uncertainty that is quite conspicuous in agriculture is the tenurial uncertainty.
We know that land is generally leased out to tenants. The tenant, as farmer, does not know for
how long he will be able to retain the land in his possession. He may thus hesitate to make long-
term improvements in land as he may not be sure about earning the additional return from such
improvements.

Type # 4. Uncertainty with regard to Input Prices/Quality:

Yet another type of uncertainty is that which exists in regard to the price and quality of inputs.
This type of uncertainty is particularly important in the case of capital inputs which are generally

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costly and subject to frequent qualitative improvements. The farmers generally react to this type
of input price uncertainty by postponing the purchase of such inputs.

Some economists, in order to be more comprehensive, have suggested six ‗Ps‘ indicating
uncertainties. These are Trice uncertainty, production uncertainty, Production technology
uncertainty, Political uncertainty, Personal uncertainty and people‘s uncertainty. Some of these
need further explanation. Political uncertainty refers to the uncertain political conditions in the
country.

Under normal circumstances, this type of uncertainty may not be there. However, Government‘s
policy about land reforms and other institution may create some uncertainty which may be
included under ‗Political uncertainty.‘

Personal uncertainty refers to the uncertainty about the welfare of farmer‘s family. People‘s
uncertainty refers to the relationships of the farmer with persons he helps with. These persons
include labourers (both family & hired), bankers, landowners., neighbouring farmers from whom
the farmer leases in land or to whom the farmer leases out his land or other resources.

Most of the remedial measures that have been discussed below are concerned with the price
uncertainty or the yield uncertainty as these two directly and immediately affect the earnings of
the farmers and the farmers can also take some commonly accepted steps to meet these types of
uncertainty.

For some types of uncertainty, no suggestion can be made to the farmer because nothing can be
done at his own level e.g., Political uncertainty. For others, like Personal uncertainty or people‘s
uncertainty, no suggestion of a general nature can be offered simply because the problem is too
personal to be generalized.

7.4. Decision Making under Uncertainty

The implications of risk for the neoclassical model of farm production can be studied as follows.

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There are three different response curves( TVP) of output to a single variable input, say units of
purchased fertilizer. The response curves are in value terms; they are total value product (TVP)
curves, so that features of profit and loss are shown.

Assuming that the risk situation, which it describes, is one of uncertainty about the weather, there
are only two events, which can occur:

1. The weather may be good (best crop yield)

2. The weather may be bad (poor crop yield

Figure: analysis of risk behaviour

TVP1 = TP*P; TVP is the total value product response to increasing level of fertilizer input in
good year. TVP2 is the total value product response to increasing level of fertilizer input in bad
year. Total Factor Cost (TFC) traces out the cumulative cost incurred as fertilizer use increases.
E (TVP) The expected total value product given the farmer‘s subjective views about the
likelihood of occurrence of good and bad seasons.

In this example the farmer expects 3 years out of every 5 years to be good, and 2 years out of 5
years to be bad. Hence,

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P1 = Probability of good season = 3/5 = 0.6 = 60%

P2 = probability of bad season = 2/5 = 0.4 = 40%

E (TVP) = P1 (TVP1) + P2 (TVP2)

E (TVP) = 0.6 (TVP1) + 0.4 (TVP2)

The three alternative operating positions X1, X2 and XE, each of which is allocatively rational
depending on the farmer‘s subjective preferences with respect to risk can be further analyzed as
follows:

A. Input use X1

 Consistence with allocative efficiency on TVP1, it occurs that the largest possible profit,
aa1 is obtained.

 If TVP2 occurs a substantial loss, a1a2 is occurred.

 A farmer choosing to operate at this position is described as risk-taking.

 He / She prefers to take the largest possible profit will come

[where aa1> a1a2]

B. Input use X2

Consistence with allocative efficiency on TVP2, the farmer makes a small profit, c1c2 is
obtained.

 If TVP1 occurs a profit, cc2 is obtained.

 A farm operating at this position is described as risk-averse.

 He / She prefers to act as if the worse possible outcome will happen.

C. Input use XE

 Consistence with allocative efficiency on balanced assessment of the average outcome

of good and bad seasons,

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 if TVP1 occurs a profit, bb2, is obtained but this is not the largest possible profit on
TVP1.

 If TVP2 occurs a loss, b2b3, is occurred and this is not the smallest lose possible on
TVP2.

 A farmer choosing to operate here is described as risk-neutral.

Economic rationality in the pure neoclassical sense demands that the farmer should operate at
the point where: E (MVP) = MFC [the expected MVP of input equals the price of the
input]. A device called decision tree analysis facilitates further understanding of decision
theory. A simple decision tree is set out and it contains example figures, which are
compatible with the earlier analysis of a production decision.

What is Decision tree?

 A decision tree is a diagram that people use to determine a course of action or show a
statistical probability. Each branch of the decision tree represents a possible decision,
outcome, or reaction.

 A decision tree is a decision support tool that uses a tree-like model of decisions and
their possible consequences, including chance event outcomes, resource costs, and
utility.

 A decision node, represented by a square, shows a decision to be made

 A chance node, represented by a circle, shows the probabilities of certain results

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Act: This is the set of alternative actions between which a choice must be made.

States: these are uncertain events or states of nature, which may occur, and influence the
outcome of whatever decision is taken.

Good weather (S1)

Bad weather (S2)

Probabilities: degrees of belief held likelihood of each state occurring.• P1 and P2 are 0.6 and
0.4.

Outcome: The decision between two or more decisions (acts) leads to specific outcome (payoff)

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The major steps that should be followed in coming the solution procedures are:

Step 1: Calculating the EMV [expected money value] of the outcome of each node.

Step 2: Eliciting from the farmer the certainty equivalent (CE). It is the certain level of
income from non-risky/neutral act which corresponds to the risky outcomes of each act.

Step 3: Reject the act with the lower CE.

A) Calculating the EMV [expected money value] of the outcome of each node.

• Chance node A

0.6 x 2000 - 0.4 x 375 = 1050 EMV

•Chance node B: 0.6 x 1300 + 0.4 x 300 = 900 EMV

B) Eliciting from the farmer the net income which corresponds to the risky outcomes of each
certainty equivalent (CE act:

• The farmer will have a risk-averse CE for a1 of 850 birr because it is less than 1050 birr.

• The farmer will have a risk-neutral CE for a2 of 900 birr because it is equal to 900 birr.

C) Rejecting the alternative, which has the lower CE: in the above example act a1 is eliminated
and the farmer would maximize utility by choosing act a2.

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In summary the outcome of risk-averse decision-making is different from profit maximization.
The profit-maximizing alternative in the above problem is act a1 [Expected Money Value
(EMV) came as the result of the above calculation as 1050 birr], but risk aversion means that act
a2 is chosen using certainty equivalent calculation. Act a2, maximizes the utility of the farmer
with respect to uncertainty, it does not maximize profit.

7.5. Mechanisms of Mitigating Risk and Uncertainty

I. Irrigation:

 is not only just for risk avoidance strategy; it also has a major impact on output via its
complementarities

II. Crop insurance

 Establishing insurance scheme to save the times of disaster

III) Price stabilization (in case of market risk)

 State intervention ranging in setting minimum floor prices for key strategic staples to
fixed producer prices across a wide range of crops.

 Where crop yields remain highly variable, price stabilization may serve to exacerbate
rather than reduce income variance.

Iv. Marketing information

 Where risk-aversion is attributed to inadequate information [about prices, about new

seeds, etc] then information provision is considered a useful component of risk policy.

V. Diffusion of information to peasants

 It can take many forms through extension work, training and visit programs, radio,
leaflets, and farmer education in schools

VI. Provision of credit for consumption is a means of reducing risk aversion in farm households
subject to wide seasonal variations in income.

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V. Adoption of new technologies

Risk Management – on the Farm

 Crop Diversification

 Share cropping

 Contract Farming

 Innovation and New Technologies

 Management Plans

 Associations and Cooperatives

Crop diversification is the most common and effective risk management strategy that is
employed by the farmers. The farmer spreads risk across multiple crops and even if one crop
fails, it is compensated by another crop.

Tenancy or share-cropping helps to minimize risk in production.

Share cropping is more beneficial particularly when the tenant is a small farmer and averse to
risk, as the tenant has to share a fraction of output to the land owner and he is insulated against
the fluctuations in output.

Contract farming is a contractual arrangement between farmers and the processor, whether oral
or written, specifying one or more conditions of production and/or marketing of an agricultural
produce.

Review question on chapter seven

1. Explain the meaning of risk and uncertainty with agriculture.

2. Analyze the sources of risk and uncertainty in Ethiopian agriculture.
3. List and explain mechanisms of mitigating risk and uncertainty in agriculture.

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