Annex I


While income determines the amount of money that can be spent on food (and/or other
commodities), prices determine how much the money can buy in real terms. Nominal or
monetary income has, therefore, to be related to the prices of the good purchased, in order to
arrive at what is called "real income". This can be expressed by the simple formula:

 Yr= f (Ym, P)
 Yr stands for real income, Ym for the monetary income from various sources, and p for the
 weighed average of the prices of all products forming part of the household budget. The latter
 is commonly referred to as 'cost of living price index'. The formula applies to the
 determination of real income of the individual household as well as to aggregate national
 income (real versus nominal national income).

 Any change in the price of a consumer good has a real income effect: The larger the share
 of a consumer good in the household budget, the stronger is the impact of price changes on
 real income. This is a highly important issue for food price/food security policy: As food
 insecure low-income households usually devote a larger share of their income to food than
 higher income classes (Engel's law), they are more severely affected by food price changes
 than higher income households. If, for example, a poor household spends 80 per cent of its
 income on food (a quite realistic assumption according to empirical evidence), a food price
 rise of 10 per cent will reduce the real income (hence the purchasing power) of the household
 by 8 per cent, while a high-income household spending 20 per cent of the income on food
 will only suffer a 2 per cent real income decline.

 In order to demonstrate the interaction between income, food prices and food demand, we
 complement our hitherto highly aggregated approach with a breakdown of the demand
 function into different income classes. This is done in Figures A-7 a) and b).

 Figure A-7 a) demonstrates what is called the Engel's law: food demand increases with
 increased incomes, but at an increasingly lower rate (lower elasticity). The income level 'i
 indicates the minimum income which, at the given food prices, a household (fully depending
 on the market as source of food supply) has to achieve in order to be able to express its food
 needs as effective demand.

 Figure A-7 b) presents a stylistic view of household food demand (in relation to varying food
 prices) of different income classes. High income households are able to purchase all the food
they need at higher price levels (up to p') than lower income classes, and show altogether a
lower response of demand to food price changes than the other income groups (lower demand
elasticity). At the price p, a household belonging to the medium income range (corresponding
to the income level 'i' in figure a) would be just able to satisfy its food needs, but a low
income class household would still suffer a food (demand) deficit of A-C. At the higher price
level p', the food deficit of medium income class households would amount to A-B, the
deficit of a low income household to A-D.


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