Agricultural Economics and Rural Policy Group

Exercises 2024/2025

Economics of Agribusiness
AEP-33306

Dr. Esther Gehrke

Dr.ir. Jack Peerlings
September 2024
Contents

0 Refresher calculus / economics 1

1 Position of agriculture and agribusiness within the economy 5

2 Production and technological change 7

3 The objective of the firm 10

4 Investments 14

5 Consumer behaviour and demand 17

6 Co-ordination mechanisms in agribusiness 19

7 Imperfect competition in agribusiness 22

8 Income and family farms 26

9 Policy 29

10 Policy analysis 32

11 International trade 37
Chapter 0 Refresher calculus / economics

1. Derivatives functions
Determine the derivatives of the following functions:
𝑑𝑦
a) 𝑦 = 3𝑥 3 + 4𝑥 2 + 2𝑥 + 203 =
𝑑𝑥

𝜕𝑦 𝜕𝑦
b) 𝑦 = 2𝑥14 + 4𝑥23 + 2𝑥13 + 100𝑥1 + 51𝑥1 𝑥2 =; 𝜕𝑥 =
𝜕𝑥1 2

𝜕𝜋 𝜕𝜋
c) 𝜋 = 2𝑤12 + 4𝑤22 + 2𝑝1 − 100𝑤1 + 51𝑤2 =; 𝜕𝑝 =
𝜕𝑤1

𝑑𝑦
d) 𝑦 = 2 𝑙𝑛 𝑥1 =
𝑑𝑥1

5𝑥 4 +2𝑥 𝑑𝑦
e) 𝑦 = =
3𝑥 2 𝑑𝑥

𝜕𝜋 𝜕𝜋 𝜕𝜋
f) 𝜋 = 2𝑤12 + 4𝑤1 𝑤22 + 100𝑤1 𝑧 =; 𝜕𝑤 =; 𝜕𝑧 =
𝜕𝑤1 2

𝑑𝑦
g) 𝑦 = (2𝑥 + 3)0.5 =
𝑑𝑥

2. Optima
Given is the following function: 𝑦 = −𝑥 2 + 10𝑥 − 5

Questions:
a) For what value(s) of x is the value of this function equal to 4?
b) What is the optimum (x* and y*) of this function?
c) Is it a maximum or a minimum (proof this mathematically)?
d) Draw this function in a diagram.

3. Output elasticities
Given is the following production function: 𝑦 = 𝑥10.25 𝑥20.3 𝑥30.4

With:
y production; x input quantities

Questions:
a) What is the derivative of y with respect to 𝑥2 (i.e. marginal product: extra output in case
you marginally increase input)?
b) Determine the output elasticity of y with respect to 𝑥2 (percentage change of output when
input is changed 1%).
c) If x3 increases with 10%, how much % does y increase?

Given is the following production function: 𝑙𝑛 𝑦 = 0.25 𝑙𝑛 𝑥1 + 0.3 𝑙𝑛 𝑥2 + 0.4 𝑙𝑛 𝑥3

d) Determine the output elasticity of y with respect to 𝑥2 . What do you conclude looking at
3b?

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4. Constrained optimisation I
Given is the following optimisation problem (i.e. a firm minimizing cost given a production
function):

min 𝐶 = 𝑤1 𝑥1 + 𝑤2 𝑥2 subject to 𝑦 = 𝑥10.25 𝑥20.75

𝑥1 ,𝑥2

With:
C cost; y production; w prices of inputs; x input quantities

Questions:
a) Write down the Lagrangian.
b) What are the first order conditions for the optimum?
c) When y=100, w1=1 and w2=2; what are the optimal values of x1 and x2?

5. Constrained optimisation II
Given is the following optimisation problem (i.e. a household maximizing utility given a
budget constraint):

𝑚𝑎𝑥 𝑈 = 𝑥10.75 𝑥20.25 subject to 𝐼 = 𝑤1 𝑥1 + 𝑤2 𝑥2

𝑥1 ,𝑥2

With:
U utility; I income; w prices consumer goods; x quantities consumer goods

Questions:
a) Write down the Lagrangian.
b) What are the first order conditions for the optimum?
c) When I=24, w1=2 and w2=2; what are the optimal values of x1 and x2?

6. Some calculations

What value does ? take?

𝑥 0.5
a. = 𝑥?
𝑥 −0.5

𝑥 −0.25
b. = 𝑥?
𝑥 −0.5

1 2
c. 𝑥 3 × 𝑥 3 = 𝑥 ?
1
3
d. 𝟒 =?
𝟐

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7. Profit maximisation

Suppose we have a production function with one input. The first order condition of profit
maximisation indicates that the value of the extra production you get from one additional unit
of the input (i.e. the price of the output times the first order derivative of the production
function with respect to the input) equals the value (i.e. price) of that input. Suppose we have
the following production function:

𝑦 = 2 + 2𝑥 + 𝑥 0.5

With:
𝑦: quantity of output in tonne, 𝑥: quantity of input in tonne.

Moreover, the price of the output equals 2 €/tonne (𝑝 = 2) and the price of the input equals
4.5 €/tonne (𝑤 = 4.5).

Asked:
Calculate in case of profit maximisation the optimal level of the input, output and profit
Notice that optimal profit is where the value of the marginal product equals the price of the
𝜕𝑦
input: 𝑝 × 𝜕𝑥 = 𝑤.

8. Cournot
In case of a Cournot oligopoly the optimal supply of a firm depends on the (optimal) supply
of the other firms. Optimal supply as a function of the supply of another firm is given by so-
called reaction functions. Suppose we have two firms whose reaction functions are given by:

𝑦1 = 4 + 12𝑦2; 𝑦2 = 2 + 13𝑦1

With:
𝑦𝑖 : supply of firm i in tonne, i=1,2.

Questions:
Determine the optimal supply of both firms.

9. Marginal revenue
Suppose we have the following demand function for a product X:

𝑦 𝑑 = 20 − 2𝑝

With:
𝑦 𝑑 : demand for product X in tonnes, 𝑝: price of product X in €/tonne.

Questions:
a) Determine the inverse of the demand function (i.e. the price equation).
b) Suppose there are two firms producing product X. Calculate for each firm its revenue
function.
c) Calculate for each firm the marginal revenue function.

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10. Trade

Suppose we have two countries both producing and consuming product X. The supply and
demand functions of both countries for product X are given by:

𝑦1𝑠 = 30 + 3𝑝 𝑦1𝑑 = 40 − 2𝑝
𝑦2𝑠 = 15 + 2𝑝 𝑦2𝑑 = 29 − 𝑝

With:
𝑝: price in €/tonne, 𝑦𝑖𝑠 : supply of country i in tonne, 𝑦𝑖𝑑 : demand of country i in tonne, i=1,2

Questions:
a) Calculate the market equilibrium (price and quantities demand and supplied in both
countries).
b) Calculate the trade volume.
c) Calculate the price elasticities of demand and supply.

11. Utility maximization

Maximise utility given budget constraint:

Max 𝑈 = 𝑥10.3 𝑥20.7 𝑝1 = 5; 𝑝2 = 3; 𝐼 = 50

Such that: 𝐼 = 𝑝1 𝑥1 + 𝑝2 𝑥2

With:
𝑈: utility, 𝑥𝑖 : quantity of consumption good i in kg, 𝑝𝑖 : price of consumption good i in €/kg,
i=1,2.

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Chapter 1 Position of agriculture and agribusiness within the economy

1. Share of agriculture in food production

Questions:
a) Calculate (see Table below) the ratio between agricultural and food production (see
equation 1.1).
b) What can be concluded, given the results of question 1a, on the degree of processing of
agricultural products?
c) Suppose the gross value added of agriculture (GDPagri) as percentage of gross agricultural
production decreases from 24.1% to 20.0% in the Netherlands. What is then the contribution
of agriculture to Gross Domestic Product (GDP) in the Netherlands (keeping all other ratios
constant)?

Table Development of the share of agriculture in GDP

𝑮𝑽𝑨𝒂𝒈𝒓𝒊 𝒀𝒇𝒐𝒐𝒅 𝑪𝒇𝒐𝒐𝒅 𝑪𝒕𝒐𝒕 𝑮𝑽𝑨𝒂𝒈𝒓𝒊
𝒀𝒂𝒈𝒓𝒊 𝑪𝒇𝒐𝒐𝒅 𝑪𝒕𝒐𝒕 𝑮𝑫𝑷 𝑮𝑫𝑷
Belgium 1995 0.250 2.568 0.091 0.742 0.015
2011 0.191 3.182 0.059 0.801 0.007
Brazil 1995 0.478 2.090 0.118 0.740 0.058
2011 0.400 2.087 0.114 0.753 0.056
China 1995 0.433 2.902 0.080 1.450 0.200
2011 0.383 2.712 0.061 1.836 0.101
France 1995 0.329 2.355 0.070 0.787 0.033
2011 0.265 2.445 0.066 0.764 0.021
Germany 1995 0.283 2.599 0.064 0.707 0.013
2011 0.238 3.082 0.044 0.753 0.010
Great-Britain 1995 0.311 2.495 0.071 0.790 0.018
2011 0.320 3.020 0.036 0.756 0.010
Hungary 1995 0.287 2.072 0.141 0.936 0.080
2011 0.290 2.394 0.083 0.806 0.057
Indonesia 1995 0.698 2.685 0.148 0.744 0.154
2011 0.640 2.694 0.160 0.773 0.147
Japan 1995 0.342 2.737 0.053 0.840 0.017
2011 0.306 2.586 0.060 0.825 0.013
Netherlands 1995 0.311 2.498 0.116 0.699 0.035
2011 0.241 2.973 0.087 0.689 0.018
Russia 1995 0.346 2.191 0.097 0.826 0.078
2011 0.306 2.555 0.066 0.887 0.042
United States 1995 0.235 2.246 0.061 0.750 0.012
2011 0.267 2.173 0.058 0.683 0.012

Source: own calculations from WIOD dataset.

2. Employment
Calculate the percentage change of the share of agriculture in total employment for the following
three situations (see equation 1.2):
a) Annual increase in labour productivity: agriculture 5%; total economy 2.5%.
b) Annual increase in production: agriculture 6%; total economy 7%.
c) Annual increase in prices keeping the value of production constant: agriculture 2%; total
economy 3.5%.

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3. Position of agriculture
In 2020 the share of Dutch agriculture in Gross Domestic Product (GDP) equalled 1.3%.

Questions:
a) What is meant by GDP?
b) If Dutch agriculture would stop its production (so agricultural production equals 0) would that
imply that the GDP in the Netherlands decreases in 2020 with 1.3%?
c) Mention three drawbacks of GDP as a measure to determine the importance of agriculture.

4. External effects of agricultural production

Questions:
a) What are external effects?
b) Mention two positive external effects and two negative external effects.
c) To curb down negative external effects local, national, international and global policies are
implemented. What determines the optimal level (local, national, etc.)?
d) If emissions of a pollutant are taxed what are then the effects for the level of pollution?

5. Landscape
One positive external effect of agricultural production is ‘beautiful landscape’.

Questions:
a) Which economic agents value a beautiful landscape positively?
b) Contributes a beautiful landscape to national income?
c) How could a beautiful landscape be expressed in money terms?

6. True or false, please mark the correct statements.

□ Without government intervention, the quantity of a commodity of which the production
causes a positive externality, is below the social optimum.
□ Production of ‘agribusiness based on domestically produced raw products’ in the
Netherlands equals the production that would disappear if there would be no longer
agricultural production in the Netherlands.
□ Differentiation is dividing the production process horizontally.
□ Final demand consists of consumer expenditure, public expenditure and investment.

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Chapter 2 Production and technological change

1. True/false
Mark the propositions that are true. Note that more than one proposition may be correct!

□ The production set contains all combinations of inputs and outputs that are technologically
feasible.
□ The production function passes through all points in the production set.
□ Neoclassical theory assumes that the production function is concave in input prices.
□ Neoclassical theory assumes that the second derivative of the production function with
respect to the quantity of a variable input is positive.

2. Key concepts
Give a concise description of the following concepts:
• production function
• substitution elasticity
• marginal product
• returns to scale

3. Thinking about the production function

Questions:
a) Why assumes neo-classical theory that the production function is non-decreasing in
inputs?
b) Why assumes neo-classical theory that the production function is concave in inputs?

4. Land in agriculture out of production

Data on Dutch agricultural farms lead to an estimated Cobb-Douglas production function. The
estimated production elasticities are shown in table 2.1.

Table 2.1 Production elasticities Dutch agriculture

Variable inputs Land Labour Capital goods

Production elasticities 0.65 0.16 0.17 0.12

Questions:
a) What are variable inputs? Why is land mostly not considered as a variable input?
b) Are there decreasing, constant or increasing returns to scale?
c) What is a substitution elasticity? What is the value of the substitution elasticity in case of
the Cobb-Douglas production function?
d) The government wants to take land out of production to reduce output. Does a decrease of
10% in the quantity of land lead to a decrease of 1.6% in production? Justify the answer.

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5. Quadratic production function in dairy
Suppose the production function of Dutch dairy farms is approximated by the following
quadratic function:

𝑦 = −1.7 + 3.2𝑣 + 1.4𝑔 − 1.0𝑣 2 − 0.6𝑣 × 𝑔 − 0.3𝑔2

With:
y: dairy production, v = variable input (all inputs except land), g: land

Initially, all variables are scaled having a value of 1.

Questions:
a) Is this production function non-decreasing in inputs and concave?
b) How big are the production elasticities of variable input and land at the original values?
Write down the values in the table below.
Give an interpretation of these elasticities.

v g y  vy  gy Scale parameter (u)

1 1 1
1 0.8

c) Calculate the value of the scale parameter at the original values for v, g and y.
d) Suppose that g drops to 0.8. Recalculate the production elasticities and the scale parameter
and insert the values in the second row of the table.
e) Why is the quadratic functional form a flexible function form in contrast to a Cobb-
Douglas function?

6. Cobb-Douglas production function

Data on Dutch dairy farms lead to an estimated Cobb-Douglas production function of the
form: 𝑦 = 𝐴 𝑉 𝛼 𝐿𝛽 𝐶 𝛾 𝐾 𝛿 𝐺 𝜆 𝑒 𝜇𝑡
The estimated values are shown in table 2.2.

Table 2.2 Estimated production elasticities of dairy farming

Constant Variable input Labour Cattle (𝛾) Capital goods Land (𝜆) Technique (𝜇)
(𝑎0 ) (𝛼) (𝛽) (𝛿)
Coefficient 0.25 0.39 0.07 0.37 0.13 0.10 0.012
Standard 0.08 0.002 0.01 0.01 0.01 0.01 0.001
Deviation

Questions:
a) Are the basic assumptions of the neo-classical theory met?
b) What are the production elasticities? Give an interpretation.
c) What is the size of the scale parameter? Give an interpretation.
d) Calculate and give an interpretation of the coefficient of technique.

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7. Technical development of agriculture and horticulture
A continuing technical development takes place in agriculture and horticulture.

Questions:
a) Some technical developments are established in business by R&D. Give examples.
b) Some technical developments are established by R&D supported by government. Give
examples.
c) What is price endogenous technical development? Can you give an example in
horticulture?
d) Suppose that the use of pesticides has to be reduced drastically because of governmental
regulation. To which extend will this affect total production, the use of other inputs and
technological change? What concepts are necessary to make a prediction on such effects?

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Chapter 3 Profit maximisation

1. True/false. Mark the propositions that are true

In neoclassical theory the profit function:
□ is homogenous of degree 1 (linear homogeneous) in inputs
□ is a function of variable input prices, output prices and quantities of quasi-fixed inputs
□ is continuous
□ can be used to derive the shadow price of quasi fixed inputs

2. Key concepts
Give a concise description of the following concepts:
• profit function
• shadow price
• producer surplus
• cross-price elasticity

3. Thinking about optimisation

Questions:
a) Economics can be defined “the study of how scarce resources are or should be allocated”.
Explain how profit maximisation and cost minimisation connect to this.
b) What is profit maximisation with output quantities fixed, e.g. due to binding production
quotas (e.g. the pig and poultry quotas in the Netherlands)?
c) We often argue that farms are price takers. What does this imply for the optimization of
profits?

4. Profit maximisation with one input

The production process of a given firm is represented by the following production function:
1
𝑦 = 4𝑥 − 8 𝑥 2 . Moreover, the output price p is 2 and the price of a unit of x is 3.

Questions:
a) Calculate the marginal product and check whether it is non-increasing in input. What is
the consequence of this property for the value of the marginal product (VMP)?
b) Calculate the optimal (profit-maximizing) input level. Also calculate the value of
revenues, costs and profits at that input level.
c) Calculate the input level where sales are maximised. Also calculate the value of revenues,
costs and profits at that input level.

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5. Supply function of horticulture under glass
Suppose a researcher has done research at the supply function of horticulture under glass by
collecting and analysing data of several years. The following result can be shown:

𝑦 = −2.0 + 3.1𝑝 − 1.9𝑤 + 0.2𝑎

With:
𝑦: production in horticulture under glass (𝑦 = 1.8), 𝑝: production price (p=1.67), 𝑤: variable
input price (𝑤 = 1.3), 𝑎: quantity of fixed input measured in billion of euro (constant prices)
glass coverings (𝑎 = 5.5).

Questions:
a) Do the signs of the supply function comply with the conditions of the neo-classical theory
(increasing in own price, decreasing in input price, increasing in fixed inputs)?
b) Calculate price elasticities of supply related to:
- production price;
- variable input price.
Also calculate the supply elasticity with respect to the quantity of fixed input.
c) What variables are missing in the supply function?
d) Is the supply function the same as a production function?

6. Cost function and profit maximisation

Suppose that total production costs of a production process are reflected by the following cost
function:

1
𝐶 = 𝑦 3 (𝑤1 + 𝑤2 ) + 𝐺
3

With:
C: total costs, y: quantity of product, 𝑤1: price variable input 1, 𝑤2 : price variable input 2, G:
constant (fixed) costs

Questions:
a) Suppose that profit maximisation applies (marginal costs = marginal revenues) and the
product price is given. Derive the supply function of this production process.
b) Find out if the supply function derived in 6a:
- is increasing in production price;
- is decreasing in the price of variable inputs;
- is homogenous of zero degree.
c) What does it mean – in words – that a supply function is homogenous of degree zero?

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7. Normalised quadratic profit function

Consider the following profit function:

𝜋 = 10 + 4𝑝2 + 2𝑤 2 − 𝑧 2 − 2𝑝𝑤 + 0.5𝑝𝑧 + 0.25𝑤𝑧

With:
𝜋: profit, 𝑝: output price, 𝑤: price of the variable input, 𝑧: quantity of quasi-fixed input.

Questions:
a) Derive the supply function. Check the sign for the output price.
b) Derive the demand function for the variable input (x). Check the sign for the price of the
variable input.
c) Derive the shadow price (q) for the quasi-fix input. Check the sign for the quantity of the
quasi-fixed input.
d) Are the variable input and the quasi-fixed input substitutes or complements?

8. Quadratic cost function

This is a quadratic cost function:

1/2 1/2
𝐶(𝑤1 , 𝑤2 , 𝑦) = 𝑎1 𝑤1 + 𝑎2 𝑤2 + 𝑎11 𝑤1 𝑦 2 + 𝑎22 𝑤2 𝑦 2 + 2 𝑎12 𝑤1 𝑤2 𝑦 +

𝑎1𝑦 𝑤1 𝑦 + 𝑎2𝑦 𝑤2 𝑦

With:
C: costs, w1: price variable input 1, w2: price variable input 2, y: production

Questions:
a) Derive demand functions of inputs on the basis of this cost function.
b) Under which conditions is the cost function concave in prices? What does this imply for
the demand functions?
c) If the inputs are complementary what are the conditions for a12?
d) Derive the marginal cost curve and the supply curve

9. Profit function of agriculture

The behaviour of a farmer can be described by the following normalised quadratic profit
function:

𝜋 = 200𝑝 − 50𝑤 + 1350𝐿 + 10𝑝2 − 10𝑤𝑝 + 3𝑤 2 − 1.5𝐿2 + 8𝑝𝐿 − 3𝑤𝐿

With:
: profit, p: price output, w: price variable input, L: number of hectares of land, y: quantity of
output (potatoes, sugar beets, grains, etc.), x: quantity of variable input, p = 1, w = 1, L = 50

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Questions:
a) Why is quantity of land (L) in the profit function and why is the quantity of variable inputs
(x) not in the profit function?
b) Derive the output supply function and the demand function for variable inputs.
c) Calculate optimal supply, optimal input demand and total profit.
d) What is the effect in percent of a land reduction of 10% to:
1) output supply;
2) demand for variable inputs.
e) Give the shadow price of land. What does the shadow price of land reflect? Suppose that
this farmer can rent extra land of 1500 euro per hectare. Will the farmer rent extra land?

10. Total variable costs and producer surplus

Consider the following profit function:

𝜋 = −27 − 5𝑝 − 8𝑤 + 4𝑝2 − 3𝑝𝑤 + 𝑤 2 + 3𝐿 + 𝐿2

With:
𝜋: profit, 𝑝: output price, 𝑤: price of the variable input, 𝐿: quantity of quasi-fixed input.

Questions:
a) Derive the output supply function
b) From the supply curve, derive the inverse supply curve

It is given that p = 2, w = 1 and L = 5

c) Draw the marginal cost curve. (Hint: Since we calculate marginal costs in y,p space,
variable input price w and the quantity of the quasi-fixed input L are kept fixed)
d) Calculate the producer surplus and variable costs.
e) Calculate the change in variable costs and producer surplus if p rises from 2 to 3.

11. Change in producer surplus

Suppose we have the following supply function:
𝑦 = 20 + 2𝑝

Assume that originally 𝑝 = 3 but that because of market developments the price becomes 𝑝 =
5.

With:
𝑦: output, 𝑝: output price.

Questions:
a) Calculate the change in profit.
b) Calculate the change in variable costs.

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Chapter 4 Investments

1. Which of the following propositions is true?

□ replacement investments are so-called net investments

□ a decreasing output price leads to lower acquisition costs of a fixed input
□ the real option theory explains why it is sometimes optimal to wait with investing if there
is uncertainty about prices or government policies
□ land is a homogenous production factor

2. Key concepts
Give a concise description of the following concepts:
a) salvage value
b) solvency
c) adjustment costs
d) option value of waiting
e) net present value

3. Questions about investment

Questions:
a) What is the difference between net investments and gross investments?
b) How would a graph of total investment at the firm level differ from a graph at the sector
level?
c) Mention three groups of indirect government measures that may affect firm investments.

4. Fixed asset theory

Questions:
a) Draw in a figure a linear shadow price equation of capital. Make sure that the dimensions of
the graph are correct. Also draw lines that indicate acquisition costs and salvage value.
b) Explain why investments are zero in the case the shadow price of capital lies between the
salvage value and acquisition costs.
c) Show the level of investment in the case the shadow price of capital is higher than the
acquisition costs.

5. Investment in the fixed asset theory

Consider the following profit function:
𝜋 = −16 + 3𝑝 − 5𝑤 + 9𝐾 + 2𝑝2 − 3𝑝𝑤 + 2𝑝𝐾 + 3𝑤 2 − 𝑤𝐾 − 2𝐾 2
With:
π is profits, p is output price, w is the price of variable inputs and K is capital. Initially, p, w
and K are scaled at value 1.

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Questions:
a) Derive the shadow price equation for capital and calculate the shadow price of capital.
b) Are the signs of the shadow price equation in accordance with what you expect? Justify your
answers.
c) Determine whether the firm should invest, do nothing or disinvest if acquisition cost are 4
and salvage value 2. If you advise to invest or disinvest, then also calculate how much to
invest or disinvest.
d) Consider a shadow price curve drawn in K, pk space where pk is the price of capital.
- Indicates what happens in terms of this curve when K goes up.
- Indicates what happens in terms of this curve when p goes up.
- Indicates what happens in terms of this curve when w goes up.
e) Starting from your answer at c, indicate what the firm should do when w rises to 4 two years
later.

6. Investment in a bio diesel plant

Given the high fuel prices in a particular year it seems attractive to invest in a plant that produces
bio diesel. However, it is uncertain whether the fuel prices will stay at the current high level or
not. Another obstacle for investment is the fact that the investment costs are to a large extent
sunk since the alternative use of such a plant is very limited. So, the investment decision can be
considered to be irreversible. The potential investors (e.g. a farmers cooperative) know that the
current investment costs are 20 million Euros. The plant should be finished at the end of the
year. Yearly production of 1 million litres would start next year. They expect with a probability
of 0.5 that diesel prices will stay at the current level of €1 per litre. They think that diesel prices
may rise to €1.5 with a probability of 0.25 or may decrease to €0.5 with a probability of 0.25.
For the years following, the investors expect the price to stay at the level reached next year. The
interest rate is 0.05.

Questions:
a) Calculate the NPV for this investment and decide whether or not to invest.
b) How can the investors decide whether or not to invest?

7. Investment in environmental rights

A firm that wants to expand currently needs to invest in environmental rights. With these rights
the firm has a licence to ‘produce’ a particular quantity of pollution. However, the government
considers to abolish these rights two years from now. With the additional rights the firm expects
to have higher yearly profits of 5 million Euros. If the system is abolished, which the firm
expects to happen with a probability of 0.20, then all firms can freely choose their production
levels again so that output prices drop and current expected additional profits for this firm
disappear. It costs 100 million Euros now to buy these rights. The interest rate is 4%.

Questions:
a) Calculate the standard NPV and decide whether the firm should buy additional rights or not.
b) Does a positive NPV always imply that the firm should invest?

15
8. Demand and supply of agricultural land
Questions:
a) To analyse supply of agricultural land, is it important to distinguish analysis on sector level
and analysis on individual farm level? (Think of shape of supply curves).
b) Give at least three factors determining demand for agricultural land.
c) Do supply factors determine the development of agricultural land prices more than demand
factors do in the short run? Justify your answer.

16
Chapter 5 Consumer behaviour and demand

1. In neoclassical consumption theory:

□ demand functions are homogeneous of degree 1 in prices and income

□ the substitution effect on the consumer’s demand, as result of a price increase is always
negative
□ in the optimum, the marginal utility of two different commodities is equal

2. Key concepts
Give a concise description of the following concepts:
a) transitivity
b) uncompensated demand function
c) compensated demand function
d) indifference curve
e) income effect
f) consumer surplus

3. Utility function consumers

The utility function of a consumer is as follows: 𝑈 = 𝑞1𝛼 + 𝑞2𝛼

With:
𝑈: utility, 𝑞𝑖 : consumer demand for good i, 𝛼: coefficient.

Questions:
a) For which values of  does this function meet the neo-classical conditions of a utility
function?
b) Determine the marginal rate of substitution MRS12 and show that the MRS12 decreases if
an increasing number of q1 is substituted for q2.

4. The optimum demand

𝟏/𝟓 𝟑/𝟓
The utility function for a consumer is: 𝑼 = 𝒒𝟏 𝒒𝟐 . The income m=100 and prices are:
p1 =1; p2=2.

Questions:
a) Determine the demand for quantities q1 and q2 in the optimal point given this income and
these prices.
b) Recalculate the optimal demanded quantities when income m=200 and prices are: p1 =2;
p2=4.
c) Compare the outcomes of a) and b) and explain your findings.

17
5. Demand equations consumer
The utility function of a consumer is similar to function (5.22) in the reader. The consumer
spends his/her constant budget on the two goods q1 and q2. The consumer’s demand functions
are:

60 − 9𝑝2 40 − 4𝑝1
𝑞1 = 4 + 𝑞2 = 9 +
𝑝1 𝑝2

Questions:
a) Calculate the quantity demanded if p1 = 1, p2 = 2.
b) Calculate the quantity demanded if p1 = 3, p2 = 2.
c) How much is the given constant budget? How much is the budget share of each good for
the two different price sets?
d) What are the parameters of the corresponding LES utility function?
e) Calculate the own demand price elasticity of each good for the two different price sets.
f) Calculate the income elasticities for the two price sets.
g) Are q1 and q2 necessary or luxury goods?
h) Calculate both cross-price elasticities at the two price sets.
i) Check the homogeneity degree of zero property. What does this property imply?

6. Linear market demand equations

The market demand equation of a good is: 𝑞 = 100 − 0.5𝑝

Questions:
a) Describe what happens with the own price elasticity if price decreases.
b) What is the demand if the own price elasticity is -1?
c) Suppose the price changes from 10 to 20. Calculate the change in the consumer surplus.

7. Market demand, taxation and consumer surplus

The market demand for a good is given by 𝑞 = 16 − 0.25𝑝 (income and other prices are fixed
and therefore part of the intercept).

Questions:
a) Draw the demand curve
b) How big is demand if p = 20?
c) Calculate the consumer surplus (CS) at this point
d) Suppose the government wants to reduce the consumption of q (e.g. fat food or gasoline)
and introduces a tax. As a result the price changes to 28.
e) Calculate the reduction in consumer surplus.

18
Chapter 6 Co-ordination mechanisms in agribusiness

1. Adverse selection and moral hazard

Give an example of an incomplete contract. Give the (possible) problems of adverse selection
and moral hazard in the contract. What transaction costs are made to reduce these problems?

2. Factors determining the choice of co-ordination mechanism

Discuss four factors determining the choice of co-ordination mechanism.

3. Market equilibrium
Supply and demand of poultry is given by:
𝑦 𝑠 = −10 + 0.8𝑝 + 0.5𝑍
𝑦 𝑑 = 100 − 0.4𝑝 + 0.5𝑀
𝑦 𝑠 = 𝑦𝑑

With:
𝑦 𝑠 : supply; 𝑦 𝑑 : demand; 𝑝: normalised price; 𝑍: fixed inputs; 𝑀: normalised income.
𝑦 𝑠 , 𝑦 𝑑 are measured in thousands of tons. The price is measured in euro per ton and M in
millions of euros. It is given that Z = 120 and M = 200.

Questions:
a) Calculate the market equilibrium (price and quantity).
b) What is the change in equilibrium quantity and price if income increases with 10%?
c) Calculate the loss in consumer surplus if supply is limited to 100 thousand tons?

4. Externalities
Questions:
a) Give two examples of as well positive as negative externalities caused by agriculture.
b) Mention two possible alternatives of reaching the optimal production of both externalities.

5. Margins
The demand function of milk at the consumer level is 𝑦𝑐𝑑 = 25 − 10𝑝𝑐𝑑
The margin M of the processing industry is: 𝑀 = 0.8 + 0.2𝑝𝑐𝑑

With:
𝑦𝑐𝑑 : consumer demand in 1000 tons; 𝑝𝑐𝑑 : normalised consumer price euro per 1000 ton.

Questions:
a) What is the demand function of the processing industry on farm level? (The quantity
demanded is identical on both levels. Only the stage of processing is different.)
b) Calculate the elasticities of demand with respect to price (price elasticities of demand) at
both levels when consumer demand equals 10. What can be concluded?

19
6. Pork market
Suppose the pork market in the European Union can be described by:

𝑦 𝑠 = 3𝑝 − 10
𝑦 𝑑 = 25 − 2𝑝
𝑦 𝑠 = 𝑦𝑑

With:
𝑦 𝑠 : supply; 𝑦 𝑑 : demand; 𝑝: normalised price.

Because of the environmental problems related to manure (surpluses of nitrate), the

government wants to reduce pork production to 8. Therefore, the government wants to
introduce a tax to the producers.

Questions:
a) Give price, supply and demand in the initial situation.
b) How large is the tax needed to realise the desired reduction in production?
c) Calculate changes in producer and consumer surplus and government revenues when the
tax is introduced.

7. Futures market I
The table below discusses the working of a futures market in case of decreasing prices (see
syllabus).

Questions:
a) Show in the table the effect of the introduction of a basis equal to 3.
b) Make a table for the demander of the product (e.g. flour industry).
c) Why is in July the price on the spot market equal to the price on the futures market?
d) Some people argue that short selling causes low prices, argue why this is not likely.

Trade on futures and spot market of wheat in order to hedge against future price risk: the case
of a decreasing price.
Spot market Futures market
September ‘Desired’ price in July: 170 Price for July: 170 €/ton
€/ton Sell contract of 1 ton

July Actual price: 150 €/ton Price in July: 150 €/ton

Sell 1 ton Buy contract of 1 ton
Spot market: Revenue: 150€
‘loss’ 20€ (170-150)
Futures market: 170-150 = 20€ profit
Total: 150€ from sales on spot
market + 20€ profit on
futures market = net 170€

20
8. Futures market II

Suppose the following data for wheat (basis is zero)

Spot market Futures market
January Desired price for July: 300 Price for July: 300 €/ton
€/ton
July

Questions:
a) Show that trading on the futures market can help the farmer to get a price of 300 €/ton in
July despite the fact that the price on the spot market has gone down to 270 €/ton in July.
b) The same question as a) but now for a mill processing wheat and a price of 320 €/ton in
July.
c) Suppose on the futures market the price of wheat is higher than on the spot market. Is this
possible? Show what would happen if the price on the futures market is 290 €/ton and on
the spot market 270 €/ton in July.
d) It is argued that speculators drive up the price. Is this possible given the answer under c)
e) Why can a futures market be instrumental for the establishment of forward selling
contracts in which a fixed price is agreed for a transaction somewhere in the future?

9. Cobb-Web model
Suppose we have the following supply and demand function of poultry:
𝑦𝑡𝑠 = 10 + 𝑝𝑡−1 + 𝑊𝑡
𝑦𝑡𝑑 = 50 − 4𝑝𝑡

Where:
𝑦𝑡𝑠 : supply in year t, 𝑦𝑡𝑑 : supply in year t, 𝑝𝑡 : price in year t, 𝑊𝑡 : weather shock in year t.

Asked:
a) Please fill in the table below.
b) Are the price fluctuations damped or explosive?

𝑦𝑡𝑠 𝑦𝑡𝑑 𝑝𝑡 𝑊𝑡
t=0 18 18 8 0
t=1 4
t=2 0
t=3 0
t=4 0
t=5 0

10. True or false, please mark the correct statements.

□ As result of market margins in the chain, the price elasticity of demand at farm level is
always larger than the price elasticity of demand at retail level.
□ The call option gives the holder the right to buy the underlying asset by a certain price.
□ A futures contract is an instrument to support prices and income.
□ Forward selling contracts are contracts traded on a futures market.

21
Chapter 7 Imperfect competition in agribusiness

1. Monopoly versus free competition

Suppose the demand function and inverse marginal cost function of the single producer of
potato starch in The Netherlands are given by:

𝑦 𝑑 = 400 − 𝑝
𝑦 𝑠 = 100 + 2𝑀𝐶
𝑦𝑑 = 𝑦 𝑠

With:
𝑦 𝑑 : quantity demanded in 1,000 tonnes; 𝑦 𝑠 : quantity supplied in 1,000 tonnes; 𝑝: price of potato
starch in 1,000 euros per 1,000 tonnes; MC: marginal cost in 1,000 euros per 1,000 tonnes.

Questions:
a) Calculate price and quantity (market equilibrium) in the case of perfect competition. Recall
that the supply function equals the inverse marginal cost curve.
b) Calculate price and quantity (market equilibrium) in the case of a monopoly.
c) Draw a figure with the market equilibrium of monopoly and perfect competition.
d) Calculate the difference in consumer surplus of the consumers of potato starch between
perfect competition and of monopoly.
e) Calculate the total difference in social welfare for the Netherlands between perfect
competition and of monopoly

2. Cournot I
The demand equation of fresh milk and the constant marginal cost functions of the only two
producers of fresh milk in The Netherlands (FrieslandCampina and Arla) are given by:

𝑌 = −2𝑝 + 48
𝐶1 = 20 + 10𝑦1 and 𝐶2 = 50 + 8𝑦2
𝑌 = 𝑦1 + 𝑦2

With:
𝑌: total quantity in 1,000 tonnes
𝑦𝑖 : production of producer i, i=1,2
p: price in 1,000 euros per 1,000 tonnes
𝐶𝑖 : costs of producer i, i=1,2

Questions:
a) Derive in the case of Cournot competition the reaction curves of firms 1 and 2. Calculate
the Cournot equilibrium (i.e. price and quantity produced by firms 1 and 2). Discuss all
steps made in the calculation.
b) Calculate profit in the Cournot equilibrium for both firms.
c) What is the economic interpretation of the reaction curves? Are we dealing with strategic
substitutes or complements and why?
d) How large are the mark-ups for producer 1 and 2 in this example? Discuss the different
steps in the calculation.

22
e) Is it possible that in the case of perfect competition marginal costs are not equal between
producers in the market equilibrium? Justify your answer.
f) Calculate the Herfindahl index for the Cournot equilibrium. What are the minimum and
maximum values of the Herfindahl index with two producers?
g) Are there any reasons for government intervention in above-mentioned example? Justify
your answer.

3. Cournot II
The demand equation of fresh milk and the constant marginal cost functions of two producers
of fresh milk in The Netherlands (FrieslandCampina and Arla) are given by:

𝑌 = −𝑝 + 60
𝑀𝐶1 = 𝑦1 − 10 and 𝑀𝐶2 = 4𝑦2 − 20
𝑌 = 𝑦1 + 𝑦2

With:
Y: total quantity in 1,000 tonnes, yi: production of producer i, i=1,2, p: price in 1,000 euros per
1,000 tonnes, MCi: marginal costs of producer i, i=1,2

Questions:
a) Derive in the case of Cournot competition the reaction curves of firms 1 and 2. Calculate
the Cournot equilibrium (i.e. price and quantity produced by firms 1 and 2). Also calculate
marginal costs for both firms. Discuss all steps made in the calculation.
b) Why is it in this case not possible to calculate profit without additional information?

4. Co-operation I
Suppose there are two suppliers of a certain product. The inverse demand function of the
product is given by:

𝑝(𝑦1 + 𝑦2 ) = 120 − 4(𝑦1 + 𝑦2 )

With:
𝑝(𝑦1 + 𝑦2 ): price as function of quantities in 1,000 euros per 1,000 tonne, y1 : production of
firm 1 in 1,000 tonnes, y2 : production of firm 2 in 1,000 tonnes.

Both firms have the same cost function:

𝐶1 = 50 + 20𝑦1 and 𝐶2 = 50 + 20𝑦2

With:
𝐶𝑖 : costs of firm i.

Questions:
a) Derive the reaction curves of firm 1 and 2 in the case of Cournot competition. Calculate the
Cournot equilibrium (price of the product and quantities produced by firm 1 and 2). Discuss
all steps made in the calculation.
b) Calculate profit in the Cournot equilibrium for both firms.
c) What is the economic interpretation of the reaction curves? Are we dealing with strategic
substitutes or complements and why?

23
Suppose there is co-operation instead of Cournot equilibrium.
d) Calculate the market equilibrium in the case of co-operation (tip: both firms operate together
as one monopolist).
e) Calculate profit in the new equilibrium for both firms.
f) Discuss the difference in profits between the Cournot equilibrium and the co-operation
equilibrium.
g) Why is market equilibrium unstable in the case of co-operation?
h) Why is co-operation between oligopolists not allowed in the EU and the US? Justify your
answer.

5. Co-operation II
The demand equation of fresh milk and the constant marginal cost function of the only two
producers of fresh milk in The Netherlands (FrieslandCampina and Arla) are given by (see
question 3):

𝑌 = −𝑝 + 60
𝑀𝐶1 = 𝑦1 − 10 and 𝑀𝐶2 = 4𝑦2 − 20
𝑌 = 𝑦1 + 𝑦2

With:
Y: total quantity in 1,000 tonnes; yi: production of producer i, i=1,2; p: price in 1,000 euros per
1,000 tonnes; MCi: marginal costs of producer i, i=1,2

Question
Calculate the equilibrium in case of co-operation.

6. Stackelberg
Suppose there are two producers in the market of sugar. The inverse demand function of sugar
is given by:
𝑝(𝑦1 + 𝑦2 ) = 120 − 4(𝑦1 + 𝑦2 )

With:
p( y1 + y2 ) : price as function of quantities in 1,000 euros per 1,000 tonnes, y1 : production of
firm 1 in 1,000 tonnes, y 2 : production of firm 2 in 1,000 tonnes.

Costs of both firms are given by:

𝐶1 = 20 + 40𝑦1 and 𝐶2 = 100 + 8𝑦2

with: 𝐶1 : costs of firm 1; 𝐶2 : costs of firm 2.

Questions:
a) Derive the reaction curves of firm 1 and 2 in case of Cournot competition. Calculate the
Cournot equilibrium (price of the product and quantities produced by firm 1 and 2). Discuss
all steps made in the calculation
b) Calculate profit in the Cournot equilibrium for both firms.

24
Suppose there is leadership of firm 2 instead of Cournot equilibrium.

c) Calculate equilibrium in case of leadership (Stackelberg; tip: use the reaction function of
firm 1 to determine revenues for firm 2). Discuss all steps made in the calculation.
d) Calculate profits in the new equilibrium for both firms.
e) Discuss the difference in profits between the Cournot equilibrium and Stackelberg
equilibrium.
f) How can a firm built-up leadership in time?
g) Why are oligopoly and monopoly profits not desirable from a social perspective?

7. Heterogeneous oligopoly
In the reader and previous questions we assumed a homogenous product so. Suppose now we
have two varieties of the same product each produced by a separate firm. The two price
equations are:

𝑝1 = 40 − 6𝑦1 − 8𝑦2
𝑝2 = 30 − 8𝑦1 − 3𝑦2

The two marginal cost curves are:

𝑀𝐶1 = 8 + 4𝑦1
𝑀𝐶2 = 6 + 2𝑦2

With:
𝑝𝑖 : price of product i (i=1,2) in 10,000 euro/tonne, 𝑦𝑖 : production of firm i (i=1,2) in 1,000
tonnes, 𝑀𝐶𝑖 : marginal cost of firm i (i=1,2) in 10,000 tonnes.

Question
Calculate the market equilibrium (quantities and prices) in case of an oligopoly (so-called
Bertrand duopoly with horizontal product differentiation or monopolistic competition).

8. True or false, please mark the correct statements.

□ In case of perfect competition the marginal costs of all producers are equal in the market
equilibrium.
□ In case of Cournot competition oligopolists make a mutual agreement about quantities to
produce and price.
□ In case of Stackelberg and Cournot the products produced by different producers are
heterogeneous.
□ If the price elasticity of demand is -0.5 a monopoly cannot exist.
□ Co-operation leads to an unstable market equilibrium because each firm can increase
profit by producing additional units if it assumes that the other firms will not react.

25
Chapter 8 Income and family farms

1. Income in agriculture
a) Give a concise description of:
• Producer surplus;
• Short term profit;
• Farm household income;
• Savings.
b) Suppose a farm. Is the household income from this farm equal to the value added created
by agricultural activities on that farm?
c) Fluctuations in income in dairy farming are smaller than in pig farming and horticulture in
the EU. What is the explanation for this?

2. Factor reward parity

a) Discuss three theories that try to explain income disparity in agriculture.
b) In The Netherlands there is a saying ‘farmers live poor but die rich’. Explain this saying.

3. Family farms I
a) Mention the advantages and disadvantages of family farms compared to non-family farms
(e.g. large commercial firms).
b) How agricultural specific are these advantages and disadvantages? Are they also relevant
in other industries?

4. Family farms II
Discuss if it is reasonable to assume that in the long term family farms are still dominant in:
• Organic farming. Organic farms are mixed farms (both arable farming and livestock
production) that do not use chemical crop protection products and artificial fertilisers. In
general organic farms are land and labour intensive.
• Pig fattening. Pig fattening can be computerised and automised completely.
• Ornamental plant growing. Ornamental plant production can be, and already is too a large
extent, computerised and automised and labour division is possible.

5. Endogenous labour supply I

Suppose a firm produces wheat and has the following normalised profit function:

𝜋 = 4𝑝2 + 𝑝𝐿 + 5𝐿

With:
 : normalised profit = income of the farm household, p : normalised price of wheat, L : labour.
The farm can only attract labour from the farm household. The supply function of labour is
given by:
𝜋
𝐿 = 2𝑝𝑙 −
50

26
With:
𝑝𝐿 : normalised price of labour.
The normalised price of wheat p equals 5.

Questions:
a) Derive the supply function of wheat.
b) Derive the shadow price equation of labour. Calculate the shadow price of labour.
c) Calculate the amount of labour supplied and the level of income of the farm household.
d) Calculate the supply of wheat.

6. Endogenous labour supply II

Suppose a farm produces pigs and has the following normalised profit function:
𝜋 = 2𝑝2 + 𝑝𝐿 − 0.5𝐿2 − 80

With:
 : normalised profit = income of the farm household, p : normalised price of pigs, 𝐿: labour.

The farm can only attract labour from the farm household. The supply function of labour is
given by:
𝐿 = 2𝑝𝐿 − 3𝜋

With:
p L : normalised price of labour.
The normalised price of pigs p equals 6.

Questions:
a) Derive the supply function of pigs.
b) Derive the shadow price and demand equation of labour.
c) Calculate the amount of labour supplied and the level of income of the farm household.
d) Calculate the supply of pigs.

7. Household production model

Suppose labour is completely mobile between on-farm and off-farm activities. Production on
a farm can be described using the following profit function:
1
𝜋 = 𝑝2 + 𝑤 2 + 𝑞 2 − 𝑝𝑞 + 𝑤𝑞 − 𝑝𝑤
2

With:
p: output price; q: wage, w: price of variable input, p=10; q=4, w=2
The household supplies labour on-farm and off-farm. It has a labour endowment of 10 units.

Questions:
a) Calculate supply, variable input demand and on-farm labour use.
b) Calculate off-farm labour supply.
c) Calculate total household income.

Suppose the output price increases to 12.

d) Calculate the change in total household income.

27
8. True or false, please mark the correct statements.
□ The shadow price of labour employed on-farm gives the additional profit if an extra unit
of labour is employed on-farm.
□ If labour is perfectly mobile between farm and non-farm activities then the shadow price
of labour employed on-farm equals the external wage.
□ Small grocery shops exploited by families lost competition from supermarkets mainly
because of economies of scale.
□ The treadmill theory tries to explain the rat race between managers to increase their staff
size.
□ If we have to compare the concept of profit of a large multinational like Unilever than this
concept is more similar to the concept of ‘income from farming’ than of value added of
farming.

28
Chapter 9 Policy

1. Short questions
Give a concise description of:
a) Negative external effects;
b) Market regime (policy interventions in the market);
c) Direct income payments;
d) Non-tariff trade barriers;
e) Intervention price;
f) Deficiency payment;
g) Conditionality.

2. Welfare theory
The EUs Common Agricultural Policy (CAP) causes welfare losses. The losses can be divided
into allocation losses (deadweight losses) and terms of trade losses.
a) What is meant with allocation losses?
b) What is meant with terms of trade losses?
c) Are the allocation losses of the CAP large or not? Justify your answer.
d) Is the mere fact that the CAP of the EU causes welfare losses enough reason to abolish it?

3. Why price and income support?

Demand and supply of potatoes are given by:

(𝐵𝑡 − 𝐵𝑡−1 ) (𝐼𝑡 − 𝐼𝑡−1 )

𝑦𝑡𝑑 = −2𝑝𝑡 + 200 + 50 + 50
𝐵𝑡−1 𝐼𝑡−1

(𝑇𝑡 − 𝑇𝑡−1 )
𝑦𝑡𝑠 = 𝑝𝑡 + 300 + 20
𝑇𝑡−1

𝑦𝑡𝑑 = 𝑦𝑡𝑠

With:
𝑦𝑡𝑑 : demand in tonnes in year t; 𝑝𝑡 : price in euro/tonne in year t; 𝐵𝑡 : population in year t; 𝐼𝑡 :
income per capita in year t; 𝑦𝑡𝑠 : supply in tonnes in year t; 𝑇𝑡 : indicator of technology.

Questions:
a) Calculate price and demand and supply of potatoes under the following assumptions:
• No population growth;
• No increase in income per capita;
• No technological change (change in technology is zero).
b) Calculate price and demand and supply of potatoes under the following conditions:
• Technological change of 3% per year;
• Population growth of 1% per year;
• Increase in income per capita of 2% per year.
c) Is the resulting price development reason for government intervention?

29
4. Price and income support
Suppose we have the following demand and supply functions for two products I and II in the
EU. There is no trade in these products with other countries (autarky).

𝑦𝐼𝑠 = 3𝑝𝐼 − 10 𝑦𝐼𝐼𝑠 = 0.2𝑝𝐼𝐼 + 4

𝑦𝐼𝑑 = −2𝑝𝐼 + 15 𝑦𝐼𝐼𝑑 = −0.1𝑝𝐼𝐼 + 5.5
𝑦𝐼𝑠 = 𝑦𝐼𝑑 𝑦𝐼𝐼𝑠 = 𝑦𝐼𝐼𝑑

With:
𝑦𝐼𝑠 , 𝑦𝐼𝑑 , 𝑝𝐼 supply, demand and price of product I respectively; 𝑦𝐼𝐼𝑠 , 𝑦𝐼𝐼𝑑 , 𝑝𝐼𝐼 supply, demand and
price of product II respectively;

Questions:
a) Calculate the price elasticities of demand and supply for both products.
b) Give examples of products with low and high price elasticities of demand and supply.
c) Calculate the effect on price of a 1% increase in supply (e.g. because of better weather
circumstances).
d) For which product price and income support could be best justified?

5. Capitalisation
Suppose the following normalised profit function for agriculture:

𝜋 = 𝑝2 + 𝑝𝑧 − 𝑧 2

With:
𝜋: normalised profit; 𝑝: normalised price of agricultural products; 𝑧: quasi-fixed input land.

Suppose the price of agricultural products is 10. Moreover the amount of land is constant and
equals 3.

Questions:
a) Derive the supply function of agricultural products and the shadow price equation of land.
How large are supply and the shadow price of land?
b) Suppose that the government is buying agricultural land for infrastructural works (like
roads), for housing and for development of nature (create a nature reservation). As a
consequence the amount of land is decreasing to 2. Calculate the effect on the shadow price
of land.
c) Suppose that the government decides to reduce agricultural price support. As a consequence
the price of agricultural products is decreasing to 8. Calculate the effect on the shadow price
of land.
d) Economists have been arguing that price support does not lead to income support because
support is capitalised in land prices. Justify their reasoning.

30
6. Market regulation versus direct income payments
Suppose the following normalised profit function for agriculture:

𝜋 = 1⁄2 𝑝2 + 10𝑝𝑧 − 1⁄2 𝑧 2

With:
𝜋: normalised profit; 𝑝: normalised price of agricultural products; 𝑧: quasi-fixed input land.
z equals 10 and p equals 2.

Questions:
a) Derive the supply function of agricultural products and the shadow price equation of land.
How large are supply, the shadow price of land and profit?
b) Suppose that the government decides to give price support to farmers. As a consequence
the price of agricultural products increases to 4. Calculate the effect on production, the
shadow price of land and profit.
c) Suppose that the government decides to support farmers by means of a direct income
payment that leads to the same increase in profit. How large should the direct income
payment then be per unit of land?
d) Show that the direct income payment in c) does not affect production. How could a direct
payment linked to land affect production in the long run?

7. True or false, please mark the correct statements.

□ Public-private arrangements (i.e. convenants) are complete contracts between
governments and private organisations aiming to reach one or a few targets.
□ Rural development policy aims solely at increasing productivity in agriculture.
□ Import tariffs are an example of an economic instrument.
□ With high factor mobility there is no reason to implement market and price policies in
agriculture.
□ Government failure refers to the high implementation costs of policies.
□ Without government intervention, the quantity of a commodity of which the production
causes a positive externality, is below the social optimum.
□ Quasi-collective goods can be characterised by excludability and non-rivalry.
□ In the case of ‘pure individual goods’ free rider behaviour is a problem.
□ Assigning property rights is a way to internalise external effects.

31
Chapter 10 Policy analysis

1. Criteria of good policy

a) Give six criteria of good government policy.
b) Why is often legislation implemented that does not comply with these criteria?

2. Social welfare function

a) What is meant by a Pigouvian social welfare function?
b) Why do politicians attach in the EU and US more weight to changes in producer surplus
and government budget than to changes in consumer surplus?

3. Tax on herbicide
Suppose that supply of the chemical industry and demand of agriculture of a certain kind of
herbicide (weed killer) is given by:

𝑦 𝑠 = 100 + 2𝑝 𝑠
𝑦 𝑑 = 160 − 𝑝𝑑
𝑦 𝑠 = 𝑦 𝑑 and 𝑝 𝑠 = 𝑝𝑑

With:
𝑦 𝑠 , 𝑦 𝑑 : supplied and demanded quantity respectively in tonnes
𝑝 𝑠 , 𝑝𝑑 : supply and demand price respectively in 1,000 euros per tonne.

The government wants to reduce consumption of the herbicide. For that purpose it introduces a
tax on demand of 15,000 euro per tonne. Suppose there are no imports and exports of the
herbicide.

Questions:
a) Calculate the market equilibrium (quantities and prices) before tax introduction.
b) Calculate market equilibrium after tax introduction.
c) Show the old and new market equilibrium in a demand and supply scheme.
d) Calculate the change in producer surplus for both suppliers and demanders of the herbicide.
e) Calculate budget revenues and total welfare effect of the tax introduction. What is the
economic interpretation of this total welfare effect?
f) Does it make any difference for the calculated welfare effects if suppliers or demanders pay
the tax? Justify your answer.
g) What other reasons could exist for governments to tax either demanders or suppliers?
h) Suppose that the government wants to compensate demanders for the tax paid. Therefore,
the government gives the tax revenue to the demanders. Are the demanders over-
compensated or under-compensated if this happens? How large is this over-compensation
or under-compensation?

32
4. Subsidy on substitute for meat
Suppose there are a number of Dutch firms producing a substitute for meat. The market for this
meat substitute is described by:
𝑦 𝑠 = 40 + 𝑝 𝑠
𝑝𝑑 = 20
𝑦 𝑠 = 𝑦 𝑑 and 𝑝 𝑠 = 𝑝𝑑

where:
𝑦 𝑠 , 𝑦 𝑑 : supplied and demanded quantity respectively in 100 kg.
𝑝 𝑠 , 𝑝𝑑 : supply and demand price respectively in euro per 100 kg.

Suppose the Dutch government wants to support the firms producing the substitute for meat.
Therefore the government introduces a subsidy of 5 euros per 100 kg of the final product.

Questions:
a) Give a reason why the price of the meat substitute is given for the producers.

b) Calculate supply of the meat substitute by the Dutch producers before and after the
introduction of the subsidy.

c) Show the old and new equilibrium in a demand and supply scheme.

d) Calculate the change in producer surplus of the producers of the meat substitute. Calculate
the change for the government budget. Calculate the change in consumer surplus.

e) What is the total welfare effect of the subsidy introduction? What is the economic
interpretation of this total welfare effect? Are there any welfare losses for the demanders?

f) Why do you think does the EU not allow price support in individual member countries? But
why does the EU allow taxes?

5. Subsidy on grain
Suppose that the supply of grain is constant in a country. However demand depends on price.
The country does not trade in grain (autarky). The market for grain is given by:

𝑦 𝑠 = 100
𝑦 𝑑 = 120 − 𝑝𝑑
𝑦 𝑠 = 𝑦 𝑑 and 𝑝 𝑠 = 𝑝𝑑

With:
𝑦 𝑠 , 𝑦 𝑑 : supplied and demanded quantity respectively in tonnes
𝑝 𝑠 , 𝑝𝑑 : supply and demand price respectively in 1,000 euros per tonne.

Suppose that this country decides to support producers with a subsidy of 10,000 euros per 1,000
tonnes.

Questions:
a) Why is the production of grain almost price inelastic in most EU countries?
b) Calculate the price elasticity of supply.

33
c) Calculate market equilibrium before and after the introduction of the subsidy.
d) Show the old and new equilibrium in a demand and supply scheme.
e) Calculate the change in producer surplus and consumer surplus. Calculate budget costs.
f) Calculate the total welfare effect. What is the economic interpretation of this total welfare
effect? Would this welfare effect be larger or smaller if supply would not be completely
price inelastic?
g) If we know that supply of agricultural products is rather price inelastic, is price support
causing large negative total welfare effects? How about the size of the income distribution
effects?

6. Milk quotas
Till 2015 the Netherlands had milk quotas. Suppose that milk supply in the Netherlands in 2014
was given by:
𝑦 𝑠 = 7500 + 25𝑝

With:
𝑦 𝑠 : milk supply, 𝑝: price of milk

• Milk price (paid by the EU) is 300 euros per tonne.

• The milk quota of the Netherlands equals 11,000 tonnes.
• The world market price of milk is 230 euros per tonne.

Questions:
a) Calculate the shadow price of milk production. Give a definition of the shadow price of
production.
b) Calculate the shadow price of the milk quota and the quota rent. Give a definition of both.
c) Calculate milk production when the milk quotas are abolished and the milk price equals the
world market price.
d) Draw in a demand and supply scheme the effects of abolishing the milk quota.
e) Calculate the change in producer surplus when the milk quota is abolished and the milk
price equals the world market price.
f) What is the advantage for the government of quotas compared to levies as an instrument to
control production?

7. Pig quota
The Netherlands has pig quota. Suppose that the marginal cost function of a pig producer is
given by:
1
𝑀𝐶 = 𝑦 𝑠 − 300
8

With: MC: marginal cost; 𝑦 𝑠 : supply.

The pig farmer has a supply quota of 3000 pigs. The pig price is €200/pig.

Questions:
a) Give a definition of the shadow price of production. How large is the shadow price of
production of this pig producer?
b) Give a definition of the shadow price of the quota. How large is the shadow price of the
quota of this pig producer?

34
c) Give the definition of quota rent. How large is the value of the quota rent?
d) How many pigs would this farmer produce without the quota?
e) If the market price of the quota would be 100 would the farmer then sell or buy quota
rights?

8. Quota versus tax

Suppose we have the following demand and supply function of a product for a country that does
not trade (autarky):
𝑦 𝑠 = 10 + 𝑝 𝑠 𝑦 𝑑 = 40 − 2𝑝𝑑
𝑦 𝑠 = 𝑦 𝑑 𝑝 𝑠 = 𝑝𝑑

With:
𝑦 𝑠 and 𝑦 𝑑 : supply and demand in tonnes respectively
𝑝 𝑠 and 𝑝𝑑 : supply and demand prices in 1,000 euro per tonne respectively.

Suppose the government wants to reduce production to 15. It has two options. First introduce a
supply quota of 15, second introduce a tax.

Questions:
a) How large has the tax to be to get a production level of 15?
b) Which option is for the producers the most attractive option (compare changes in producer
surplus for both options).

9. Import tariff
Suppose we have the following demand and supply function for a product in the EU:
𝑑 𝑠
𝑦𝐸𝑈 = 30 − 2𝑝𝐸𝑈 ; 𝑦𝐸𝑈 = 10 + 3𝑝𝐸𝑈

With:
𝑑 𝑠
𝑦𝐸𝑈 , 𝑦𝐸𝑈 : demand and supply respectively, 𝑝𝐸𝑈 : price in the EU.
The world market price equals 𝑝𝑤 = 3 and there is free trade.

Questions:
a) The government wants to achieve autarky (i.e. no trade) by means of the introduction of an
import tariff 𝑡 (𝑝𝐸𝑈 = 𝑝𝑤 + 𝑡). How large should be the import tariff be to reach autarky?
b) What are the welfare effects of the introduction of this import tariff?

35
10. Trade
Suppose the following demand and supply functions for a product in the EU:
𝑦 𝑑 = 60 − 2𝑝𝑑 𝑦 𝑠 = 15 + 𝑝𝑑
𝑠
Supply by the rest of the world is given by: 𝑦𝑟𝑜𝑤 = 10 + 2𝑝𝑤
Market equilibrium is given by: 𝑦 𝑑 = 𝑦𝑟𝑜𝑤
𝑠
+ 𝑦𝑠

With:
y d : demand; y s : supply; p d : domestic price, yrow
s
: supply by the rest of the world; p w : world
market price.

Questions:
a) Calculate demand and supply in the case of free trade for both the EU and rest of the world.
b) Calculate the market equilibrium when the EU introduces an import tariff of 2.
c) Show in a figure the old and new market equilibrium (prices and quantities) for the EU.
d) Calculate the welfare effects (change in producer surplus, consumer surplus and
government budget costs and total welfare effect) of introducing the import tariff of 2 for
both the EU and the rest of the world.
e) Give a definition of allocation losses and terms of trade losses. How large are they in this
example for the EU?

11. True or false, please mark the correct statements.

□ Efficiency as a criterion for good policy refers to the costs made by producers only.
□ The terms of trade effect only occurs in the case of a large country (i.e. when a country’s
action influence the world market price.
□ Positive external effects are external conditions a firm is confronted with and has no
influence on and that positively influence the functioning of the firm.
□ Trade liberalisation implies abolishment of economic trade restrictions.

36
Chapter 11 International trade

1. Competitive position
In the press it is regularly mentioned that there is hardly any future for Dutch agriculture.
However research on the competitive position of Dutch agriculture shows it is a very
competitive sector compared to agriculture in other countries. Strengths are e.g. vicinity of
markets, infrastructure (roads, etc.), natural production circumstances (e.g. weather), external
economies of scale and several institutional factors.

Questions:
a) What are internal and external economies of scale?
b) What is meant by institutional factors?

2. Exchange rate I
Suppose the exchange rate between the euro and dollar is 0.8 and the world market price of
strawberries is 1.5 dollar/kg.

Questions:
a) Give the definition of the exchange rate.
b) What is the world market price expressed in euro/kg?
c) What is the world market price expressed in euro/kg after a 20% depreciation? Assume
the world market price expressed in dollar/kg remains the same.
d) What is the world market price expressed in euro/kg after a 20% appreciation? Assume
the world market price expressed in dollar/kg remains the same.
e) If this country would be large (the small country assumption does not apply) how would
an appreciation and a depreciation affect the world market price expressed in dollar/kg?

3. Exchange rate II
Suppose the price of oranges within the EU is held constant at a price of 1200 euro per tonne.
Import tariffs are used to keep the price constant. Suppose the world market price of oranges is
1000 dollar per tonne. It is given that to buy 1 dollar 1.10 euro is needed (i.e. exchange rate).
Moreover, it is given that the EU imports 1000 tonnes of oranges.

Questions:
a) What is the value of import tariffs received by the EU every year?
b) Suppose the euro depreciates with 10% compared to the dollar. What is now the value of
import tariffs received by the EU every year?
c) Suppose the euro appreciates with 10% compared to the dollar. What is now the value of
import tariffs received by the EU every year?

4. Introduction of the euro and cost of living

With the introduction of the euro in 2002 many consumers in the Netherlands believed their
cost of living increased. There are some explanations for this (perceived) higher cost of living.
The first would be money illusion. The second would be that the Netherlands depreciated de
facto its currency. Discuss how both explanations lead to the (perceived) higher cost of living.

37
5. Percentage PSE
Suppose the price of wheat within the EU equals 120 euro per tonne. The EU implements an
import tariff on wheat. Suppose the world market price of wheat is 100 dollar per tonne. The
EU produces 105 million tonnes of wheat at 17 million hectares. Imports equal 10 million
tonnes. Farmers receive a direct income payment of 150 euro per hectare. Moreover, it is given
that to buy 1 dollar 1.10 euro is needed (i.e. exchange rate).

Questions:
a) Calculate the value of import tariffs and direct income payments paid by the EU (in euro
and dollar).
b) Are these costs the real costs of the EU policy of wheat?
c) Calculate the percentage PSE for wheat.
d) Mention and shortly discuss two disadvantages of the percentage PSE as protection
measure.

6. Economic integration
a) Give the different forms of economic integration and rank them in order of increasing
integration.
b) What are the most important characteristics of these forms of economic integration?
c) By what form of economic integration is the EU characterised nowadays?

7. Autarky, small country and large country

Suppose we have three different models for a product in the EU.

Model symbols are given by:

𝑦 𝑠 : supply by EU in 1,000 tonnes; 𝑦 𝑑 : demand of EU in 1,000 tonnes; 𝑦𝑟𝑑 : demand by the rest
of the world in 1,000 tonnes; 𝑝𝐸𝑈 : EU price in 1,000 euros per 1,000 tonnes; 𝑝𝑤 : world market
price in 1,000 euros per 1,000 tonnes.

Questions:
a) Calculate the market equilibrium of the following model (=autarky):
𝑦 𝑠 = 200 + 2𝑝𝐸𝑈 𝑦 𝑑 = 250 − 3𝑝𝐸𝑈 𝑦 𝑠 = 𝑦 𝑑

b) Calculate the market equilibrium of the following model (= a model for which the small
country assumption applies).
𝑦 = 200 + 2𝑝𝐸𝑈
𝑠
𝑦 𝑑 = 250 − 3𝑝𝐸𝑈 𝑝𝐸𝑈 = 𝑝𝑤 = 12

c) Calculate the market equilibrium of the of the following model (= a model for which the
large country assumption applies).
𝑦 = 200 + 2𝑝𝐸𝑈
𝑠
𝑦 𝑑 = 250 − 3𝑝𝐸𝑈 𝑦𝑟𝑑 = 16 − 𝑝𝑤 𝑦 𝑠 = 𝑦 𝑑 + 𝑦𝑟𝑑

38
8. Spatial equilibrium model
Suppose the following demand and supply functions of apples for two countries:

𝑦1𝑠 = 10 + 2𝑝1 𝑦2𝑠 = 4 + 𝑝2

𝑦1𝑑 = 20 − 2𝑝1 𝑦2𝑑 = 30 − 𝑝2

With:
𝑦𝑖𝑠 : supply of apples in 1000s of tonnes in country i, i=1,2, 𝑝𝑖 : price of apples in million euros
per 1000 tonne, 𝑦𝑖𝑑 : demand for apples in 1000s of tonnes in country i, i=1,2.

Questions:
a) Calculate the equilibrium price and produced and demanded quantities of apples in a
situation of autarky (no trade) for both countries.
b) Calculate the equilibrium price in a situation of free trade neglecting trade and transportation
costs. Calculate demand, supply and the quantity traded in both countries.
c) Calculate the changes in welfare (changes in producer surplus, consumer surplus and budget
costs) if both countries move form a situation of autarky to a situation of free trade. How
large is the increase in total welfare in both countries?
d) Suppose trade and transportation costs between both countries equal 1.5 million euro per
1000 tonnes. Calculate now price, demand, supply and the quantity traded in both countries
in case of free trade.
e) Suppose that country 2 is introducing an import tax / export subsidy of 1.0 million euro per
1000 tonne. Given this information, calculate price, demand, supply and quantity traded in
both countries (trade costs and transportation costs equal 0).

9. Trade
Suppose the following demand and supply functions for a product in the EU:
𝑦 𝑑 = 50 − 3𝑝𝑒𝑢 , 𝑦 𝑠 = 10 + 𝑝𝑒𝑢

Supply by the rest of the world is given by:

𝑠
𝑦𝑟𝑜𝑤 = 4 + 2𝑝𝑤

Market equilibrium is given by:

𝑦 𝑑 = 𝑦𝑟𝑜𝑤
𝑠
+ 𝑦𝑠

With:
𝑦 𝑑 : demand; 𝑦 𝑠 : supply; 𝑝𝑒𝑢 : domestic price in the EU, 𝑦𝑟𝑜𝑤
𝑠
: supply by the rest of the world;
𝑤
𝑝 : world market price.

Questions:
a) Calculate demand and supply in the case of free trade (𝑝𝑒𝑢 = 𝑝𝑤 ) for both the EU and rest
of the world.
b) Calculate the market equilibrium when the EU government introduces an import tariff of
1.5 (𝑝𝑒𝑢 = 𝑝𝑤 + 𝑡𝑎𝑟𝑖𝑓𝑓).
c) Show in a figure the old and new market equilibrium (prices and quantities) for the EU.
d) Calculate the welfare effects (change in producer surplus, consumer surplus and
government budget costs and total welfare effect) of introducing the import tariff of 1.5 for
both the EU and the rest of the world.

39
e) Give a definition of allocation losses and terms of trade losses. How large are they in this
example for the EU and the rest of the world?
f) Calculate the Nominal Protection Coefficient Degree after the introduction of the import
tariff.
g) What is the advantage of the percentage PSE (Producer Subsidy Equivalent) compared to
the Nominal Protection Coefficient?

10. True or false, please mark the correct statements

□ An appreciation of the euro implies a lower exchange rate (euro/dollar).
□ A depreciation stimulates exports.
□ In the case of the small country assumption trade liberalisation leads to terms of trade
gains.
□ In a customs union goods can be traded freely and there is a common external import
tariff. Labour and capital cannot be freely traded.
□ In an Armington model it is possible that a good is both imported and exported.

40