A item in the Times of India reports on “Retail loot: Mandi prices are a fraction of retail prices. What explains the wedge in prices?
The report reads:
The potatoes you bought yesterday for anything between Rs 8 and Rs 12 per kg depending on which part of the city you live in, cost your retailer just Rs 3 per kg at the mandi. And the cauliflower he is selling for Rs 12 to Rs 16 per kg costs him only Rs 2 per kg.
It is natural to feel that prices should reflect costs. But in reality, prices often diverge very drastically from costs. Imagine a hypothetical situation where it costs Rs 2 to produce a kilo of potatoes. What’s the proper price of potatoes? That depends. It can be anything from zero to a very large positive number. It is not even guaranteed that the price cannot be a negative number also.
Let’s for the moment forget that the price can be a negative. What positive non-zero price can it be? Assuming that the supply of potatoes for a given period is fixed (which means that it takes time to increase the supply of potatoes by planting and harvesting them), then the market-clearing price is strictly determined by demand. If the demand for potatoes is high, the price goes up. A medical journal report says, “A few potatoes a day keeps cancer away,” and suddenly everyone is eating potatoes. The price goes up.
The next week a report clearly indicates that potatoes are the chief cause of dementia. Down goes the demand and you cannot even give those potatoes away. People refuse to eat potatoes. Prices crash. The potatoes rot in the heaps and someone has to be paid to haul the stuff away for disposal.
Bottom line: in the short run, the supply is fixed. Short run is actually defined as the period in which you cannot change the supply. In the long run, the supply of everything is flexible — you can produce more or less of something. In the short run, the price is determined by the demand.
Now back to the specific case of vegetable prices. The wedge between farm gate prices (the price that the farmer receives for the produce) and the price that the consumer pays at the retail store is a reality. The intermediary buys at mandi or farm gate prices and sells it at the retail price.
The price of Rs 20 a kilo is justified given the fixed supply and the prevalent demand. There is no link between the cost to the buyer at the farm gate (Rs 2 per kilo) and the price that customers pay at retail. Can the retailer charge Rs 100 per kilo? Not realistically. At Rs 100 per kilo, he will have lots of unsold potatoes. For profit maximizing, the price has to be set so that the quantity at hand is bought by the customers.
Should the government intervene and force the sellers to sell the potatoes at Rs 3? At Rs 3, the quantity demanded will be more than what is at hand to be sold. Early shoppers will buy a lot and the later shoppers will find the market devoid of potatoes.
Will this be good for you? Depends on whether you are among the lucky few who got to the market early. Overall, the government mandating a below market-clearing price is not a good idea. It is in fact a very bad idea.
Here’s how. Imagine that the intermediary between the farmer and the consumer is a good guy and does not rip off neither the farmer nor the consumer. The farmer produces stuff and the intermediary brings it to the market. The price is determined by the interaction of the fixed supply and the market demand. Suppose the price is Rs 20. Given that price, suppose the farmer receives Rs 18, and the intermediary keeps Rs 2. Assume that the cost of production was Rs 4. The farmer therefore makes a profit of Rs 14 per kilo. Other farmers notice that. Onion farmers who were making only Rs 5 per kilo decide to plant potatoes. So in a short time (the time it takes to grow potatoes), the supply of potatoes goes up. The retail price drops as a result and with it the profits of potato farmers. In a while, the profits drop sufficiently that farmers don’t find it profitable to switch to potato farming.
Imagine if the government has mandated that while the market-clearing price was Rs 20, that retailers must sell potatoes at Rs 7. Now if that intermediary kept his Rs 2, the farmer receives Rs 5. His cost of production is Rs 4. His profit is Rs 1. No great profit. The production of potatoes does not increase. At Rs 7 a kilo, there is a perpetual shortage of potatoes. People who have connections, actually get to eat potatoes and pay a black market rate. The poor don’t get any potatoes at all.
That’s what happens when price ceilings are mandated by the government. The producer does not have the incentive to increase production. The poor consumers get rationed out of the market.
What’s going on in the vegetable market in India? The demand is high and the supply is limited. That explains the high prices. If the intermediary pays the producer Rs 2 and is able to sell the production at Rs 20, then the farmer is not getting the signal to increase production and the consumer suffers high prices. The only winner is the intermediary. So what is the answer? The answer is to get other intermediaries. Suppose another intermediary B enters the market and offers the farmer Rs 5 for his potatoes, thus outbidding intermediary A. The farmer will sell it to B. Healthy competition among intermediaries will ensure that the intermediary will make a fair profit and that the bulk of the gains will reach the farmer. Seeing that some farmers are making a lot of profit, other farmers will enter into production. And so on.
The fact that there is a huge wedge between farm gate prices and retail prices has to do with an inefficient supply chain. The intermediation has to be looked at. But to maximize loot, the government can limit the number of intermediaries. The intermediaries make a killing and they pay the government for the license to operate their killing machines.
Isn’t socialism wonderful?
{Thanks to Barbarindian for the question.}
Atanu Dey : Life is a Random Draw 
I was searching answer to this very question for a very long time.
I come from a family that relies on Coconuts to make a living. 10 years back we sold coconuts for a price range between 2-5 and today too the price range is exactly the same. In fact in last 10 years we have seen that most of the intermediaries have become extinct. Only 2-3 dalals are left in the business and they dictate the prices.
When I go to city and buy a coconut it costs me nothing less that Rs.10. The exact same one we sold for Rs 3-4. I dont see any value addition being done to it except that it is being transported to a distance of say 50-70km.
The reason I feel is that lack of intermediaries. And in case of coconuts we simply cant change the crop.
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Akshar:
Your case is an illustrative example of what happens when there is lack of competition in the intermediation stage. An intermediary that gives you Rs 6 for a coconut can outbid one that gives you Rs 2 to 5. At a market price of Rs 10, that new intermediary still makes Rs 4 per coconut. With proper competition in intermediation (which has to not only be allowed but has to be encouraged), the supernormal profits that intermediaries make will disappear and in the end the market price will be close to what the producer receives. This means that the price signals will reach producers more efficiently — which means that the market will become more efficient, thus improving both producer and consumer welfare.
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I wish we had people like you writing well thought-out and deeply analyzed articles like this in our newspapers. Of course I am lucky enough to know the existence of your blog but can’t say the same for millions reading TOI and other junk papers.
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market efficiency is what i have been trying to understand.
Is the paucity of many intermediaries incidental? or *designed* by some conspirators as a natural law (tiresome, Survival of the fittest)
Are there any *possible* levelers we could conjure up? Or, Could this be due to *consolidation* of many intermediaries over a period of time? Ifso, its more like a *natural process* and then any corrective action could be akin to straightening a hair strand. Doesn’t seem so, at least on the surface, giving rise to some *hope*. but it could be an easy trap to get cannibalized (momentary drop in prices is cheap, if pockets are deep) by the incumbents
One could soon arrive at the crossroads: Ride the wave or change the course of the nature?
-Sriram
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Sriram, you wrote:
I would like to address the points you raise. But could you explain a bit more what your points are? I am not sure that I understand them very well. I don’t want to be talking at cross purposes and reduce this to a semantic debate.
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I wrote, “For profit maximizing, the price has to be set so that the quantity at hand is bought by the customers.” This is not strictly true because monopolists maximize profits by restricting quantities — which could mean unsold product. But I don’t want to complicate matters by getting into details of when profit maximizing coincides with revenue maximizing.
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As always, a pleasure to read your concise and lucid analysis, Atanu.
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just checking if it was a rejoinder? if so, i couldn’t get it. we could take it offline if you wish. I wanted to know if there is a punitive/corrective action to bring efficiency. I don’t think (by experience of my friend who is into vegetable trade) it was licence issue but more of big guys pooling up to stop new entrants by setting up some barriers. Correct me.
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Sriram wrote: “just checking if it was a rejoinder?”
What does “it” refer to?
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Atanu wrote:
“With proper competition in intermediation (which has to not only be allowed but has to be encouraged), the supernormal profits that intermediaries make will disappear and in the end the market price will be close to what the producer receives.”
The entry of retail houses in the market has been opposed by many political parties but there are signs that farmers have benifitted to some extent.Retailers have started linking their operations directly to the farmer.They buy the produce from the farm & there is no transport cost for the farmer.This takes out middlemen.There are many Corporates who have entered the retail space and this will ensure competition & more choice for the farmer.
Additionally,many of these retailers have in-house brands & there is a market for them due to their low price.The recession has actually led to an increase in the marketshare of such brands.
So,the farmer has the option of entering into an exclusive agreement with a particular retailer to supply his produce at a mutually agreed upon price or he can decide to sell the produce every day in the mandi or to the retailers depending on price offered to him.
The farmer has choice,gets a better price for his produce & there is a sense of empowerment.
Some old reports related to this:
Birla Retail in talks with farmers’ co-ops for direct procurement. http://bit.ly/cvdo0Z
Modern retail offers wide choice. http://bit.ly/djgGrU
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I think to somewhat fix this, CB Naidu in Andhra implemented a “Raitu Bazaar” (farmer’s market) scheme. It was more like a provision for farmers to sell their produce directly without middle men. This seems to make sense but on a larger scale farmer’s opportunity costs may outweigh the profits got by selling those themselves. I noticed when this was introduced, the mandis (via middlemen) got more professional, neat and organized as well (an observation in hindsight).
So, in a way farmers themselves were the competing middle men.
Since I don’t live in India, my observations could be subject to judgemental errors. At the moment though am not sure how its faring out – the farmer’s market scheme. Next time when I go, I’ll probably pay more attention and study it.
That said, I am also wondering if there could be any other strategy (thinking out of conventional norms) than encouraging middle men competition. I mean, something like a game changing strategy…that can out play Govt interference…Don’t say black market :-).
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@Yoga, http://www.leverduredelmioorto.it/ this idea can be disruptive and overhaul the whole supply chain as we currently see..
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Reliance Fresh was such an intermediary. It bought potatoes, onions and other vegetables directly from farmers at higher rates, provided transportation directly to the farm and sold it at their shops.
Then a few years ago, the APMC (Agricultural Produce Marketing Committee) protested against this. They burnt a few shops and got this policy changed. Nowadays Reliance fresh and all other retail shops have to buy vegetables from them, while the farmer is paid a pittance.
The sad thing is that this is the law.
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Excellent example and as usual, enjoyed a lot reading the post Atanu sir!
If only our textbooks had such real-time examples!!!
Why is this SO TOUGH for our socialist leaders to understand is my crib!!
TN is experimenting a form of farmer’s market where farmers directly can market their produce. Would this help, since the intermediaries are eliminated completely or are the intermediaries needed for sure? I agree farmers can’t travel all across the country to market their produce, but wherever possible, if they market it directly, will that bring in more efficiency to the whole process or reduce it?
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Profit (or abnormal profit) is every where. We are purchasing a toothpaste which cost the manufacturer some Rs.5 per 200gms(I think it wont cost that much also) for Rs.40. & a soap whose manufacturing cost is less then or equal to Rs.1 for 15 rupees. There are vast number of suppliers/brands in the market for this. But they are selling it for abnormal prices. Even when you purchase a litre of mineral water of some MNC brand you pay Rs.12-14 per bottle (but the retailer too wont get more than 1-2 rs of profit here), but when you go for a 25 litre water can it is Rs 35-50.
In some business regarding essential goods (like vegetables/pulses/rice etc) even the intermediaries go by wholesale Market price which varies daily. Intermediaries are not some outside persons but they are also farmers (or the person who left the farming). The farmers are also not that much innocent (like we see in movies) now-a-days, if they feel they can do it, they are going to the end-retailer and selling them directly. Every thing depends on DEMAND & SUPPLY.
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@rishi
Reliance purchased goods directly from farmers at a higher price. Yes its true. But in some cases what it do is it will grade the goods and will only take the best grade and give back the remaining to the farmer. Again the farmer must go back to the local market/intermediary to sell the intermediary. It paid a higher price for the good grade product. Thats all, it didn’t done any favour to the farmer.
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For the past 2 months I have been part of many discussions among friends and relatives, about the price-rise. I took the market-is-best-for-rationalizing-prices-line-of-thought. I tried quoting what Ashok Desai wrote in his book “The price of Onions”. He wrote “Prices increased not because there was hoarding, it increased because there was less hoarding. If more hoarders were there, there would have been competition among the hoarders and prices would have dropped” (may not be the exact wording).
I failed to communicate my point across in almost all the discussions. Other party could not let go of the hang-the-evil-hoarders line of thought. I understand that hang-the-hoarders is an easy logic. But market-is-best-for-rationalizing-prices is an easy logic too. How government intervention distorts price-rationalization is an easy logic too. Why does it not capture imagination? Is it because hang-the-hoarders allows me to pin the blame easily and get me more angry? Getting angry is delicious and easy.
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@praveen
There is nothing wrong with paying a better price for a better product. In fact Reliance did away with a major bottleneck by providing transport to the farmers through its own network.
The sticking point that I have is that what Reliance did is against the law, while it was actually helping both the farmers and consumers.
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Green Revolution in India Wilts as Subsidies Backfire
WSJ – http://online.wsj.com/article/SB10001424052748703615904575052921612723844.html?mod=WSJ_hpp_RIGHTInDepthCarousel
“Behind the worsening picture is the government’s agricultural policy. In an effort to boost food production, win farmer votes and encourage the domestic fertilizer industry, the government has increased its subsidy of urea over the years, and now pays about half of the domestic industry’s cost of production.”
That’s another area government is involved in, costing lot of money to tax payers, allowing fertilizer companies to make lot of money based on subsidies, and now spoiling the farm lands….it’s all about votes and money…
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Hi Atanu
My suspicions about the incumbents playing the role of the *survival of the fittest* (in a cynical way) is already mentioned by Rishi’s post:
Rishi wrote:
>>Then a few years ago, the APMC (Agricultural Produce Marketing Committee) protested against this. They burnt a few shops and got this policy changed. Nowadays Reliance fresh and all other retail shops have to buy vegetables from them, while the farmer is paid a pittance.
A very good approach of Reliance Fresh (a new player at that time) did not become reality. This is clearly less of a government problem but a few intermediaries blocking (in USA they do it in a more suave manner, by temporary pricing mechanisms) new entrants. Even the intermediaries could have approached government to make a rule as well, then it will be a government problem. An instance of this was there too: When CB Naidu was overtrhown, Rajasekhar Reddy brought back the older *intermediary system* prompty (very likely a result of intermediary lobby) back and farmers were sent to where they *should* belong, getting pittance for their work.
I mean *natural laws* can have a cynical look and the phrase *survival of the fittest* can mean survival of the powerful intermediaries, even in market economy.
-Sriram
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I know this is a simplistic explanation of the price gap, but how do you think the export policy of government (incentive for exports when we have surplus produce)and the speculative trading of these commodities plays into the picture..
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I think Chandrababu Naidu started a concept of Raitu Bazar (Farmer market) in Andhra Pradesh. Wonder what happened to them now. My wild guess (I am not in India, hence do not know): middle men who have paid sufficient money to congress guys are controlling the prices over there arbitrarily.
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A very timely article on this topic when food inflation is raging through out the country and the mainstream media has little or nothing to say about it.
I agree that namely eliminating government mandated trading and pricing bottlenecks would benefit. This article also provides a list of suggestions to that effect – http://www.ccsindia.org/ccsindia/dh_pdf/ch_19damb.pdf
Actually, there seems to be some movement in this direction with even the State APMC laws seeing some tentative liberalization, if the following stories are to be believed –
http://www.businessworld.in/bw/2010_01_09_Land_Of_Plenty.html
http://www.thehindubusinessline.com/2009/10/05/stories/2009100551001300.htm
I was also pleasantly surprised to note that the latest wholesale prices are now available on the internet. Here are some links that might be of interest –
http://www.delagrimarket.org/dambcrateb.asp?comName=4&submit=Select
for Delhi
http://www.msamb.com/
for Maharashtra
http://www.msamb.com/english/apmcpri.asp
http://www.agmarknet.nic.in/arrivals1.htm
for states across India
http://krishimaratavahini.kar.nic.in/department.aspx
for Karnataka
Raising public awareness about these prices would keep a lid on the price differential between wholesale and retail pricing. Too large a differential would incentivize the customer to make the trip to mandi (see – http://mumbai-magic.blogspot.com/2009/06/wholesale-market-at-vashi-asias-largest.html)
Cell phone providers could provide value added service to their customers by informing them of the latest news at the local mandi.
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Until a year ago, i was not even aware that Government controlled who could run a Sugar Mill or Rice Mill.
When i digged further i found that, most Sugar Mills in Maharashtra are owned indirectly by a Mahrashatra Politician with interest in Cricket.
And almost all Rice Mills in Madhya Pradesh are run by Politicians or their henchmen.
And both these run in controlled environments, others are simply not allowed by means of Licensing mechanism.
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