08s76 Economics Blog

Hi everyone!

I did an article review on the rise in rice prices. (:
(Not too sure about the part on market failure though..)

Cheers,
Emily (:

Published on Monday, April 7, 2008 by The Guardian/UK

http://www.commondreams.org/archive/2008/04/07/8143/

Food Riots Fear After Rice Price Hits A High

A global rice shortage that has seen prices of one of the world's most important staple foods increase by 50 per cent in the past two weeks alone is triggering an international crisis, with countries banning export and threatening serious punishment for hoarders.

With rice stocks at their lowest for 30 years, prices of the grain rose more than 10 per cent on Friday to record highs and are expected to soar further in the coming months. Already China, India, Egypt, Vietnam and Cambodia have imposed tariffs or export bans, as it has become clear that world production of rice this year will decline in real terms by 3.5 per cent. The impact will be felt most keenly by the world's poorest populations, who have become increasingly dependent on the crop as the prices of other grains have become too costly.

Rice is the staple food for more than half the world�s population. This is the second year running in which production - which increased in real terms last year - has failed to keep pace with population growth. The harvest has also been hit by drought, particularly in China and Australia, forcing producers to hoard their crops to satisfy local markets.

The increase in rice prices - which some believe could increase by a further 40 per cent in coming months - has matched sharp inflation in other key food products. But with rice relied on by some eight billion people, the impact of a prolonged rice crisis for the world's poor - a large part of whose available income is spent on food - threatens to be devastating.

The consequences are visible across the globe. In Bangladesh, government-run outlets that sell subsidised rice have been besieged by queues comprised largely of the country's middle classes, who will queue for hours to purchase five kilograms of rice sold at 30 per cent cheaper than on the open market.

In Thailand yesterday - where the price for lower-quality rice alone has risen by between $70 and $100 per tonne in the past week alone - Deputy Prime Minister Mingkwan Sangsuwan convened a meeting of key officials and traders yesterday to discuss imposing minimum export prices to control export volumes and measures to punish hoarders. The meeting follows moves by some larger supermarkets in Thailand to limit purchases of rice by customers.

In the Philippines, where the National Bureau of Investigation has been called in to raid traders suspected of hoarding rice to push up the prices, activists have warned of the risk of food riots.
Fear is so deep that the country's agricultural secretary, Arthur Yap, this month asked fast-food restaurants including McDonald's and KFC - which generally supply a cup of rice with their meals in Asian branches - to halve the amount of rice supplied, so that none would be wasted. In addition, traders who try to stockpile rice have been warned that they face a charge of "economic sabotage", which in the Philippines carries a life sentence.

The shortage has afflicted India, too: on Monday, the government banned the export of non-basmati rice and also raised the price of basmati rice that can be exported.

And although China has said it is secure in its supplies of rice, the fact that the government has offered to pay farmers more to produce more rice and wheat suggests otherwise.

The sharp rise in rice prices has been driven by many factors, not least by a race between African and South-east Asian countries to secure sufficient stocks to head off the risk of food riots and social unrest.

Fears over the potential impact of the rice crisis has been heightened by estimates by both the UN Food and Agriculture Organisation - which has predicted the 3.5 per cent shortfall - and comments from the World Bank president, Robert Zoellick, on the organisation's website, estimating that "33 countries around the world face potential social unrest because of the acute hike in food and energy prices".

According to the World Bank's figures, the real price of rice rose to a 19-year high last month, while the real price of wheat has hit a 28-year high.

Analysts have cited many factors for the rises, including rising fuel and fertiliser expenses, as well as climate change. But while drought is one factor, another is the switch from food to biofuel production in large areas of the world, in particular to fulfil the US energy demands. A continuing change in the global diet is also putting a further squeeze on rice. In China, for example, 100 million rural migrants to the country's big cities have switched from a staple of wheat to rice as they have become wealthier.

Rapid recent price increases are also likely to have a dangerous secondary effect of stoking further inflation in emerging countries, which are already suffering from record oil prices and surging agricultural commodity prices.

The depth of the crisis for the poorest was underlined in stark terms by the World Bank�s managing director at a meeting of finance ministers from the Asian block. Juan Jos� Daboub said governments needed to take steps to protect the poor and also ensure that long-term solutions were found to relieve shortages. "In virtually every East Asian country, high food prices are raising headline inflation and contributing to a significant decline in the real income of the poor, most of whom spend a big chunk of their income on food," he said last week.

Outline of Article Review:

- Introduction

o Definitions
o Addressing the preamble
o Thesis statement

- Body

o 1. Changes in supply
- Determinants of supply
o 2. Changes in demand
- Determinants of demand
o 3. Impacts of increase in demand and decrease in supply
- Inflation
- Market failure
o 4. Application of Demand and supply - Government intervention
- Government subsidies

- Conclusion

My Article Review

Recently, Southeast Asia has seen a surge in the price of rice. In Bangkok, Thai 100 per cent B grade white rice, considered to be the world's benchmark, hit $950 (S$1,280) per tonne, three times its price at the start of 2007.(1) According to the state news agency VNA in Vietnam, rice was exported at US$460 a tonne last month, up more than 50 percent from a year ago.(2) Rice is a staple food in many parts of the world today.(3) Thus, the rise in the price of rice has significant impacts on the world as it can lead to social unrest(4) and encourage the setting up of black markets. This essay will analyse the determinants of supply and demand. After which, it will evaluate the impacts of the increase in demand and decrease in supply of rice. Last but not least, it will discuss the applications of demand and supply in terms of government intervention and will suggest the short term and long term solutions that can be implemented to ameliorate the soar in rice prices.

Firstly, supply is the relation between price and quantity supplied as expressed by the entire supply curve. In this case, there is a decrease in the supply of rice, and this is shown by a leftward shift in the supply curve of rice. This is illustrated in Figure 1 below.

The determinants of supply shift the supply curve of the rice leftwards.

Firstly, one of the determinants of supply of rice is an increase in the cost of production. The article states "rising fuel and fertiliser expenses" as one of the factors that helps shift the supply curve leftwards. An increase in the price of electricity will raise the cost of operating machines. Thus, suppliers of rice would decrease the supply of rice to lower the cost of production. Another determinant of supply would be changes in climatic conditions, such as a "drought" as cited in the article. A drought will lead to poor harvest for rice, thus decreasing the supply of rice. Besides, this article suggests another important supply factor, which is the "switch from food to biodiesel production in large areas of the world, in particular to fulfil the US energy demands. An oil embargo imposed by the Organization of Petroleum Exporting Countries in 1974 on the US and high oil prices have encouraged the production of biodiesel. Biodiesel is basically ethanol made from corn(5). Since corn and rice use the same factors of production, they are substitutes in production and an increase in demand for corn due to an increase in demand of wheat has led to a diversion of resources used in rice production to corn production. Thus, this results in a decrease in supply of rice. The above determinants of supply cause the supply curve of rice to shift leftwards.

Secondly, demand is the relation indicating the quantity demanded of rice at each price. In this case, because of the decrease in the supply of rice, there is an increase in the demand of rice, and this is shown by a rightward shift in the demand curve of rice. This is illustrated in Figure 2 below.

Figure 2: Demand for rice

The determinants of demand shift the demand curve of the rice rightwards. Firstly, one determinant of demand is the "continuing change in the global diet". This change in tastes and preferences towards rice creates wants for rice so that at every single price, the consumer is now willing to purchase more rice. Hence the demand for rice increases. Another factor of demand is "a race between African and South-east Asian countries to secure sufficient stocks to head off the risk of food riots and social unrest". The shortage in rice could lead to adverse changes such as food riots and chaos in a country. Hence, to prevent this problem, Africa increases its rice imports, leading to an increase in demand for rice. All the above determinants of demand lead to a rightward shift in the demand curve.

Hence, the decrease in supply of rice and the increase in demand of rice have led to a sharp increase in the price of rice, while the equilibrium quantity of rice exchanged has decreased, as illustrated in Figure 3.

Figure 3: Market for rice

The decrease in supply for rice and the increase in demand for rice have many significant applications.

Firstly, it will lead to inflation if the situation is not controlled. Inflation can be defined as the overall general upward price movement of goods and services in an economy, usually as measured by the Consumer Price Index and the Producer Price Index.(6) Inflation distorts the operation of the price mechanism and can result in an inefficient allocation of resources. When inflation is volatile, consumers and firms are unlikely to have sufficient information on relative price levels to make informed choices about which products to supply and purchase.(7) The rise in price of rice is believed to increase by 40 percent in the next few months.(8)

Secondly, if the rise in price continues, market failure might develop. Market failure occurs when freely-functioning markets, operating without government intervention, fail to deliver an efficient or optimal allocation of resources. Thus, economic and social welfare might not be maximized, leading to a loss in economic efficiency.(9) Market failure can be viewed as a scenario in which individuals' pursuit of self-interest leads to bad results for society as a whole. (10) The article talks about the "crisis of the poor". The poor will be the ones who are the hardest to be hit in this crisis. This is because rice is an oligopolistic market where there are only a few exporters of rice in Southeast Asia, such as Thailand and Vietnam. In lieu of the large decrease in supply and increase in demand, these countries might withhold supply of rice so that the output of rice is below the equilibrium quantity. This causes rice prices to increase and thus a larger proportion of the poor�s income has to be spent on food. Hence, the poor will not be able to pay for the rice and will be the hardest hit as they have no other forms of food to turn to.

To reduce the shortage of rice and decrease in price production, government intervention can take place. In the short run, the government can provide subsidies for rice to make rice more affordable for the poor. In the long run, a per unit subsidy is a fixed amount of money given to the producers for each unit they sell. It lowers the cost of production of rice and shifts the supply curve downwards. This, the income of rice producers is raised and consumers can pay a lower price as well. Producers will also be encouraged to increase rice production, thus solving the problem of rice shortage in the long run. In addition, the government can also set rules to ensure that traders do not take advantage of the situation and stockpile rice supplies to set up a black market.

In conclusion, the severe rice shortage is an effect of the various determinants of supply and demand. If this problem is left unchecked, the rice exporters may enjoy market power and inflation and market failure may occur. This problem can only be solved through government intervention in the case of the provision of subsidies for rice producers to ease their burden due to the increase in costs of production.

I would like to acknowledge the following sources:

(1) http://news.asiaone.com/News/Latest%2BNews/Business/Story/A1Story20080417-60383.html
(2) http://www.channelnewsasia.com/stories/afp_asiapacific_business/view/333818/1/.html
(3) http://www.globalvoicesonline.org/2008/04/12/southeast-asia-rising-price-of-rice/
(4) http://elfael.wordpress.com/2008/04/06/peak-food-and-japan-part-2-the-developing-world-erupts/
(5) http://www.foreignaffairs.org/20070501faessay86305/c-ford-runge-benjamin-senauer/how-biofuels-could-starve-the-poor.html
(6) http://www.investorwords.com/2452/inflation.html
(7) http://tutor2u.net/economics/content/topics/inflation/costs_of_inflation.htm
(8) http://www.guardian.co.uk/environment/2008/apr/06/food.foodanddrink
(9) http://tutor2u.net/economics/presentations/aseconomics/marketfailure/IntroductionMarketFailure/default.html
(10) http://en.wikipedia.org/wiki/Market_failure
(11) Hwa Chong Economics Notes
(12) http://www.merriam-webster.com/dictionary/ameliorate (just to double check)