Economics of Agriculture

Econ:3111

Chapter 1: Introduction
Definition and scope of Agricultural Economics
• Before we attempt to define agricultural economics, let us
begin with splitting the two words ‘Agriculture’ and ‘Economics’
• Agriculture is the production, processing, marketing, and
distribution of crops & livestocks.
• Economics as a science of analyzing the use of scarce
resources to achieve the desired wants/satisfy human wants.
Bringing both definition agricultural economics defined as
follows;
• Agricultural Economics is a discipline that adopts economic
principle to the problems of agricultural production and people
engaged in agriculture and allied activities.
• Agricultural Economics is an applied science dealing with how
humans choose to use scarce productive resources and technical
knowledge to produce agricultural output to distribute them to
various members of society over time.
• Agricultural production has several general characteristics
that distinguish it from other forms of production. These
are:
– The existence of many but small production units (despite
differences among countries, agriculture employs by far the
largest share of the world population).
– The large number of products from one producing unit
(individual unit or typically farm engage in production of
several different types of commodities).
• The biological nature of the production process (production
processes are geared to the life cycle of the particular plant or
animal that requiring considerable quantities of heat,
moisture, and soil nutrients)
• The nature of location decision (decision is how best to use the
land)
• The existence of considerable degree of production for self
sufficiency (majority of farmers in the world plan their
activities in terms of production for home consumption rather
than for the market. In other words it does not enter
commercial channels)
• Its sensitivity to natural forces such as rainfall, climate,
drought, temperature and the like.
• The entire objective of studying agricultural economics is that
resources, like land, labour, capital, time, etc are limited or too few to
satisfy all human wants and that as a consequence of this scarcity
choice must be made.
• The problems of "constrained choice”(socio-economic influences such
as, land tenure, farm size, market system, infrastructure,
government actions, cultural influences);
– that is how limited quantities of inputs are allocated between
alternative production uses of agricultural as well as non-
agricultural activities,
– and how limited income are allocated between the many products
consumers may buy.
• Agricultural economists make extensive use of
microeconomics theory in which propositions on the
functioning of markets in terms of
 Production,
 Consumption, and
 Exchange are developed from hypothesis about the behaviors
of individual producers and consumers.
1.2.Historical Development of Agriculture
• The origin of the field, now known as Agricultural Economics
get back in many directions and over a long period of time.
• The filed came from two separate sources from the physical
sciences and from economic theorists.
• Since agriculture and its production systems are influenced by
physical factors
 (Topography, climate),
 Social (tradition, culture) and
 Economic (market, infrastructure) factors, a comprehensive
body of science, which includes physical science, social
science, and economic theory is fundamental.
• Agricultural Economics is an important subject area because it
is concerned with society's basic needs.
• Getting food and other agricultural products to all people in
the world in the right form at the right time is an extremely
complex process.
1.3.Role of agriculture in Economic Development
• The contribution of agriculture to economic development is
crucial so that its contribution are:
– Providing food to the rapidly expanding population
– Increasing the demand for industrial products and thus
necessitating the expansion of secondary and tertiary
sectors,
– Providing additional foreign exchange earnings for the
import of capital goods for development through increased
agriculture exports,
– Increasing rural incomes
– Providing productive employment
– Improving the welfare of the rural people
• According to Kuznet (1960), the contribution of agricultural
sector to economic development constitutes three basic
elements:
1. Product contribution
2. Market contribution

3. Factor contribution
A. Product contribution:developing countries mostly specialize
in the production of a few agricultural goods for exports. As
output and productivity of exportable goods expand, their
exports increased and result in large export earnings.
• Thus agricultural surplus leads to capital formation when
capital goods are imported with foreign exchange.
• Foreign exchange earnings can be used to build the efficiency
of other industries and help the establishment of new
industries by importing scarce raw materials, machines, capital
equipment and technical know-how.
• This is what is called the product contribution of agriculture,
which first augments the growth of net output of the economy,
and then the growth of per capita output.
B. Market contribution: rise in rural purchasing power, as a
result of increased agricultural surplus stimulates
agricultural development.
• The market for manufactured goods is very small in
developing countries where peasants, farm laborers and their
families are too poor to buy factory goods.
• Increased rural purchasing power caused by expansion of
agricultural output and productivity will tend to raise the
demand for manufactured goods and extend the size of the
market. This will lead to the expansion of the industrial sector.

• Moreover, the demand for such inputs as fertilizers, modern

farming tools, tractors, irrigated facilities in the agricultural
sectors will lead to the expansion of the industrial sector.
Besides, transport and communications will expand.
• The long-run effect of these expansions will be higher profits,
which tend to increase the rate of capital formation through
their investment.
C. The factor contribution:
• Most developing country needs large amount of capital to finance
the creation and expansion of the infrastructure and for the
development of basic and heavy industries.
• In the early stages of development, increasing the marketable
surplus from the rural sector without reducing the consumption
levels of population can provide capital.
• Labor as the principal input can be a source of capital formation
when it is reduced on the farm and employed other productive
works.
• One major possibility of increasing farm receipts and thus capital
formation is by
• mobilizing increased farm incomes through agricultural taxation,
land taxes, agricultural income tax, land registration charges,
school fees, fee for providing agricultural technical services and
other types that cover the cost of services provided to the farm
population.
Theories about the Role of Agriculture for Economic Development

• To begin with, the history of agricultural development ideas

can be divided in to three periods.
I) The Economic Growth and Modernization Era (1950-
1960s)
II) The Growth-with-Equity Period (1970s)
III) The Economic Growth and Policy Reform Period (1980s)
I. The Economic Growth and Modernization Era
• Economists traditionally analyzed agricultural development
in terms of its relationship to the growth of overall economy.
• The first notable Physiocrats viewed agriculture as the
engine of economic growth, arguing that agriculture was the
only activity capable of generating a surplus large enough to
stimulate growth in other sectors of the economy.
• Classical economists, on the other hand, believed that
diminishing marginal returns to agricultural land would
eventually lead to overall economic stagnation.
• Most Western Development Economists of the 1950s didn’t
analyze agriculture as an important contributor to economic
growth, and assigned passive role of agriculture to economic
development.
• Moreover, many development economists of 1950s and 1960s
concluded that economic growth facilitated by structural
transformation of the economy in the long run, rapid
transfer of resources (especially surplus labor) from
agriculture to industry was an appropriate short-run
economic development strategy.
Arthur Lewis
• The first important event of development economics
throughout the 1950s and 1960s was by W. Arthur Lewis’s
1954 article “Economic Development with Unlimited
Supplies of Labour.”
• In this article, Lewis presented a general equilibrium model of
expansion in an economy with two sectors; a modern
capitalist exchange sector and an indigenous non-capitalist
sector, which was dominated by subsistence farming.
• The capitalist sector is characterized by its use of reproducible
capital, hiring of labour, and its sale of output for profit.
• The subsistence sector was pictured as the ‘self-employment
sector’.
• His model focused on how the transfer of labour from the
subsistence sector (where MPL=0 as a limiting case) to the
modern sector expansion through reinvestment of profits.

• The labour supply facing the capitalist sector was ‘unlimited’

in the sense that when the capitalist sector offers additional
employment opportunities at the existing wage rate, the
willingness to work at the existing wage rate will be greater
than the demand.

• Then, expansion in the capitalist sector continued until

earnings in the two sectors were equated, at which a point
dual-sector model was no longer relevant.
Hirschman
• The second important event affecting development
economists’ view of agriculture was the publication of Albert
Hirschman’s influential book The Strategy of Economic
Development (1958).
• He introduced the concept of linkages as a tool of
investigating how the course of development, during
investment in one type of economic activity brings subsequent
investment in other income-generating activities.
• He also defined the linkage effects of a given product line as
the investment generating forces that set in motion through
input-output relations.
• According to him, investment should be concentrated in
activities where the linkage effects were greatest, since this
would maximize indigenous investment in related or linked
activities.
• So He asserted that agriculture lacks direct stimulus in setting
up of new activities through linkage effects and he concluded
the superiority of manufacturing sector.
• He argues that investment in industry would generally lead
to a more broadly based economic growth than investment
in agriculture.
• In an article entitled "The role of agriculture in economic
development“ (1981) by Johnston and Mellor draw insights
from the Lewis model to stress the importance of agriculture
as a motive force to economic growth.
• They argued that apart from playing a passive role in
development, agriculture could have paramount contributions to
the structural transformation of third word economies through;
– Provide labor, capital, foreign exchange, food to growing
demand for industrial sector
– Suppling market for domestically produced industrial products
• William H. Nicholls's influential article "The place of agriculture
in economic development" (1964) were instrumental in
encouraging economists to view agriculture as a potential positive
force in development, and it helped to stimulate debate on the
interdependence of agriculture and industrial growth.

• In addition, Western development economics was challenged

(1960-70s) by the emergence and rapid growth of Radical
Political Economy and Dependency Models of Development and
Underdevelopment
• The radical political economy models have their roots in the
writings of Lenin (on imperialism), Kautsky (on agriculture),
Paul Baran and other Marxist economists.
Baran
• Baran argued that in most low-income countries it would be
impossible to bring about broad-based capitalist development
without violent changes in social and political institutions.
• Accordingly, small-scale agriculture is incapable of making
major contributions to economic growth and he stressed on the
need for farm consolidation.
• Baran Identified institutional and structural barriers to
development and stressed on the need to put effective demand
at the centre of development programs.
• He also accepted the view that the marginal product of labour
often approached to zero in agriculture and therefore there is
no way of employing it usefully in agriculture.
• The dependency interpretation of underdevelopment was
first proposed in 1950s by economic commission for Latin
America under the leadership of Raul Prebisch.
• The basic hypothesis of his perspective is that
underdevelopment is not a stage of development but the result
of the expansion of the world capitalist system.
• It is a condition of impoverishment brought by the integration
of the Third World economies in to the world capitalist
system.
• Dependency theorists argued that low-income countries were
beggared through both a process of unequal exchange with the
industrialized world and returning of profits from foreign
owned businesses.
• These policies is limited to internal market for consumer
goods (including food and other agricultural products) and led
to impoverishment of mass of small farmers.
• Radical political economists made several important
contributions of agricultural and rural development.
• First, they stressed on the importance of understanding each
country’s economic development in the context of country’s
historical experience.
• Second, they argue that rural poverty in the third world resulted from
the functioning of global capitalist economy, the focus attention was on
the relationships between villagers and the wider economic system.
• Third, they attacked ‘mutual benefit claim’ of international trade by
development economists; the assertion that economic relations
between high and low-income countries could shaped to yield benefits
for all.
• Both the western dual-sector model economics and the radical
analysis of the 1960s suffered from the following shortcomings:-
– Inadequate attention to the need for technical change in
agriculture.
– Lack of attention to the biological and location-specific nature of
agricultural production process.
– Lack of a solid micro foundation based on empirical research at the
farm and village level.
II. The Growth-with-Equity Period (since 1970s)
• Then around 1970 mainstream Western Economics began to
give greater attention to employment and the distribution of
real income. This shift results from the following three
reasons:-
– The goal of economic growth for third Word countries
was seriously questioned and the need to redefine the goal
of development more broadly was required.

– From the 1960s onwards it became apparent that rapid

economic growth in some countries (Pakistan, Nigeria and
lran) had harmful and in some cases disastrous results.
The development disasters ranged from civil war to the
establishment of murderous authoritarian regimes.
 – Though in countries were rapid economic growth had not
attributed to social disorder, 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 a number of important
theoretical and policy debates.
• The first concern about the interactions between income
distribution and rates of economic growth.
• Their analysis focused on changes not only in the size of
distribution of income during the course of development but in
the functional distribution as well (for example impact of
economic growth on small farmers, on women…).
• The second concern on employment generation and the
possible existence of employment-output trade-offs in
industry and agriculture (for eg, 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…).
 III. The Economic Growth and Policy Reform Period of 1980s
• This period found a major shift in development economics
towards economic growth, policy reform and market
liberalization.
• The shift from microeconomic analysis of agricultural projects
to macro policies was considered as a cutting edge of
development in food policy analysis, and it was the dominant
development theme of the 1980s.
• In Africa, policy reform was strongly advocated in the Word
Bank's report, and structural adjustment programs were
launched in the mid of 1980s.
• In Asia, agricultural development move ahead 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.
• In the policy reform era, a major analytical advance of economists viewed
policy was the development of the Food Policy Analysis Approach.

• These approach synthesized work in a number of areas, outlining how to

trace the effects of macroeconomic adjustments as well as sectoral level
policies on food production, income generation, and consumption patterns
of the poor.
• The food policy analysis approach has set two distinguishing
characteristics apart from the production incentive school, and
the basic needs school.
• The production incentive 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 Food Policy Analysis Approach recognized that the
production concerns of the production incentive school and the
consumption concerns of the basic needs school were both
legitimate, and it showed how they will be linked through food
prices.
• Food policy analysis hence forms a bridge between the two
approaches.
1.4.Interdependence of Agriculture and Industry
• Industry and agriculture are the lifeline of an economy.
• Agriculture meets peoples demand for food .
• Industry meets peoples demand for clothes, houses, electricity,
shoes, books, transport vehicles etc.
• both food and non-food items are essential for human beings.
• Industry and agriculture are complementary as far as
satisfactions of wants of peoples are concerned and both must
grow simultaneously.
• Industry alone can not progress without agriculture progress.
• Similarly agriculture can’t progress without industry progress.
• They are depend on each other with respect to demand and
supply. thus, it is clear-cut interdependency between them.
• Agriculture help the industry in the following aspects:
– Industry receives raw material from agriculture like(cotton
for textile, oil from oilseeds, sugar from sugarcane, etc.)
– Population engage d in agriculture is source of demand for
industrial goods
– Agriculture is a source of labour for industry
– Agriculture provides food to the population engaged in
industrial sector
– Agriculture might be a source of fund for industrial sector,
i.e. people in rural area deposit their saving in to banks and
other financial institution.
– These fund going to urban industries trough banks as a
result rural saving become source of fund to the industrial
sector.
• Also Agriculture depend on industry through the following ways
– Industrial sector provides improved seed to agriculture since
improved seed is an input for agriculture which could be pest
resistant, provide high yields, etc
– Industry provides chemical fertilizers
– Industries produce equipment and instrument for irrigation
– It provides pesticides and modern equipment
– It provide material for building infrastructure for agricultural
marketing and storage
– It supplies manufactured goods to the population engaged in
agriculture
– It can a potential source of finance to agriculture
Note that:
• See the Empirical result of dual(agriculture & Industry) economic
growth in Ethiopia for the past 5 years and prepare a short
summary of it and present by groups