Annex 1


Box A-2: Response of Food Demand to Price and Income Variations

The econometric expression of the response of demand to price and income changes are price and income
elasticities of demand. The elasticities are calculated on the basis of the following formula:
 Price elasticity of demand: Income elasticity of demand
 Ad Ad
 P d = d- ICa=
 &p d
 P
While the price elasticity of demand has usually a negative value (the volume of demand goes down when
prices go up and vice versa), the income elasticity of demand is usually positive (demand increases with rising
incomes and vice versa). As to the degree of demand response (the absolute value of the price and income
elasticities), the following distinctions need to be made:
Demand elasticities at different income levels: the response of food demand to changing prices and incomes
varies with different income levels. While the volume of food demand of high-income households responds
only slightly to price and income variations (ped and i d close to zero), poorer households usually have a highly
elastic response (ped and led close to 1). According to the author who first described this phenomenon it is
commonly referred to as 'Engel's law'.
Differentiation by type and quality of food commodities: The price elasticities of demand vary significantly
as to type and quality of different food commodities. Poor households with insufficient income to cover their
basic food needs will respond significantly to changing prices of staple food commodities but hardly at all to
price changes of expensive food items which, anyway, are out of their reach. Households belonging to the
medium and high income range respond less to price changes of staple food commodities but more to price
changes of expensive high quality food. This issue is of high relevance for price and market interventions
concerning selected food items.
Income and substitution effects: If the price of a consumer commodity changes in relation to other
commodities, demand response is the result of a combined income and substitution effect. Both effects normally
work in the same direction: Demand increases with decreasing prices as real income rises (income effect) and
demand switches from more expensive to cheaper commodities (substitution effect) or vice versa. If food is
treated as one single commodity group as in our aggregate model, substitution effects are ruled out and the price
elasticities of demand are approximately equal to the income effect (there is little substitution of food by non-
food items, at least as far as staple food commodities are concerned).
Direct versus cross-price elasticities: The demand for a certain food commodity is influenced not only by
price changes of the same product (direct price elasticity) but also by price changes of other products purchased
by the households (cross-price elasticity). While the direct price elasticity of demand usually has a negative
value (due a negative income and substitution effect), the cross-price elasticities are mostly positive, as higher
priced products are substituted by relatively cheaper ones (and if the negative income effect is outweighed by a
positive substitution effect). There are exceptions to this general rule, e.g. in the case of complementary
products (negative cross-price elasticity) or inferior commodities (with increased real income, demand switches
to higher quality food, i.e. if a negative substitution effect is outweighed by a positive income effect, or vice
versa).
Demand response at different levels of consumer prices: As in the case of supply elasticities (see Box A-1)
price elasticities of demand also are not constant but vary with different levels of market prices. The typical
shape of the demand curve as presented in this Annex implies:
* low but increasing pEd in the range of high food prices (above p). Reason: weak demand response, as only
 high income households (who, furthermore, respond less to changing food prices) can afford to buy the
 food they need.
 medium and increasing ped in the medium price range (between p and p'), as an increasing number of
 medium and low income households (with higher demand response) are able to express their food needs as
 effective demand.
 high and further increasing ped at extremely low food prices (below p') as even the poorest households are
 able to express their food needs as effective demand. Further price decreases would induce food demand in
 excess of what is required to satisfy the basic needs (excess consumption, waste, food used as animal feed).


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