Faculty of social studies department of economics supply response of tobacco output to price changes in
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- 2.1.2 The Nerlove (1958) Theory of Supply Response
| CHAPTER TWO LITERATURE REVIEW 2.0 Introduction This chapter reviews underlying theories and also some previous empirical findings in the field of agricultural supply response to changes in producer prices and other non-price factors. 2.1 Theoretical Literature 2.1.1 Basic Theory of Supply and Supply Response In this study the general micro-economic theory of supply, the Nerlove (1958) theory of supply response and the Cobweb theory are used to examine the responsiveness of tobacco output to price changes in Zimbabwe. Generally, the supply of a product is a function of its price assuming that other factors are held constant. Changes in the major determinants of supply either result in the movement along or a shift of the supply curve. The major shifters of supply are the state of technology, the natural environment, institutional settings, input prices, prices of competing products and joint products. The basic supply function is a static model implying that a change in exogenous factors induce an instantaneous response in supply that is there are no delays in adjustment. However, delayed adjustments exist in agricultural markets therefore there is need to incorporate adjusted quantity supplied and prices in order to differentiate between the short-run and long-run responses. The supply response concept is based on the assumption that a price change is likely to result in changes in other factors that influence supply for example arise in price may induce the adoption of new technology. The theory of supply has been used inmost agricultural supply response studies and it will also be used in this study. 2.1.2 The Nerlove (1958) Theory of Supply Response The supply response model developed by Nerlove (1958) is a dynamic model which states that current output is a function of expected price, lagged output and other exogenous variables. It is a dynamic partial adjustment model based on the concept of adaptive expectations which assumes farmers keep adjusting their output overtime towards along run desired level of output 6 on the basis of expected future prices. Assume farmers' production decisions are based on informal decisions without assigning any formal decision making mechanism. Nerlove (1958) also stated that acreage planted under a certain crop in the current period is a function of area planted in the previous period and the price of the crop in the previous period assuming a log- linear relationship between variables as represented by equation (2.1). Log(A t ) = α + alog(A t-1 ) + blog(P t-1 ) + cZ t + µ t …………………………………….............…(2.1) Where; At acreage used at time t At acreage used at time t P t-1 =crop price at time t Z t = other exogenous factors affecting agricultural supply. This study is based on further extensions rather than direct application of the model since direct estimation of the model may yield biased and inconsistent estimates since supply of output is determined simultaneously with input demand equations (Askari and Cummings, 1977). Download 1.11 Mb. Share with your friends:
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