Price control in Chinese rice market

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Content page

List of figures………………………………………………………………………………………………….. 2

1.     Background of price control in Chinese rice market……………………………………….. 3

2.     Free market price and quantity determination process……………………………………. 4

3.     Quantity determination by suppliers…………………………………………………………….. 6

4.     Rationale of governmental intervention………………………………………………………… 7

5.     Expected and actual results from the government’s intervention……………………… 8

5.1      Expected consequences…………………………………………………………………….. 8

5.2      Actual consequences………………………………………………………………………… 9

6.     Recommendations……………………………………………………………………………………. 10

Reference list…………………………………………………………………………………………………. 11

 

 

List of figures

 

Figure 1 Historical data of international cereal prices (Source: FAO)…………………3

Figure 2 The demand curve (source: Tutor2u.net 2010)………………………………4

Figure 3 The supply curve (source: Tutor2u.net 2010)………………………………..4

Figure 4 Market equilibrium (source: manipulative-people.com 2010)………………5

Figure 5 Shift of equilibrium after movement of demand curve and supply curve……6

Figure 6 Profit maximization in perfect competition (source: Maclachlan 2010)…….6

Figure 7 Competition caused supply curve shift and quantity supplied change………7

Figure 8 Rice shortage under price ceiling policy…………………………………..…9

Figure 9 Rice output in China (source:Thebioenergysite.com 2009)………………..10

 

 

 

1.        Background of price control in Chinese rice market

 

During the 2008 to 2009 years term, the Chinese domestic rice price had been pushed up by both domestic and international factors that included fast growing rice demand due to economic development, rapid urbanization caused farm land transition to industrial usage and even bad weather had contributed to the poor harvest. And these complicated factors together with consumers’ expect of rice shortage in total added up the pressure for the surge of rice price in China. And the global cereal market even witnessed a more volatile rice price due to the major rice production countries had adopted rice export restrictions, the global rice price and other cereal prices are illustrated in the figure below. As the figure shows, according to the statistics released by Food and Agriculture Organization of the United Nations the global rice price index had increased dramatically since the mid 2007 and peak in the first quarter of year 2008 (FAO 2010). As for China, a country with 1.3 billion (World Bank 2008) people to feed, the problem was more serious. Under pressures from the society and in order to tackle the high food price led inflation, the Chinese government had frozen the major essential food prices including the rice price in March of 2008 (Nytimes.com 2008). Below let’s focus on how the price and quantity will be determined in a free and perfectly competitive market and see the rationale and influences of such price control policy.

 

 

Figure 1 Historical data of international cereal prices (Source: FAO)

 

2.        Free market price and quantity determination process

 

In a free market where there is no governmental interference and regulations that influence the suppliers and consumers’ decision to provide or purchase certain products. So two major powers, demand from the consumers and bargaining power from the suppliers, will jointly determine the price and quantity supplied. And these two forces theoretically could be understood in demand curve and supply curve.

 

Figure 2 The demand curve (source: Tutor2u.net 2010)

 

There is a simple and common sense principle depicting the demand curve: consumers will be likely to purchase more products when the price goes down which happen a lot around our life in term of seasonal or promotional discount provided by the retailers.  As seen in the figure above demand will increase from Q1 to Q2 when price of the product drop from P1 to P2 meanwhile.

 

Figure 3 The supply curve (source: Tutor2u.net 2010)

Similar common sense principle could also be found in the supply curve that describe the number of products the suppliers are willing to offer to the market for trading: suppliers will be encouraged to increase the supply while the price of the product increases. As the figure above tells, when the price soars from P1 to P2, the suppliers are willing the provide an increased quantity of Q2 rather than Q1 as stimulated by the higher price. Please notice that such supply increases may not increase immediately, usually there will be a time delay  because producers need to expand their business to produce more products or wait for the potential producers to joint the industry which later lead to a increase of total output.

 

Figure 4 Market equilibrium (source: manipulative-people.com 2010)

 

As the figure above shows, as the bargaining power from the suppliers meet that of the consumers in a free market, there will be equilibrium point where under the price level P1, the demand equals the amount the suppliers are willing to provide. Even in a free market, equilibrium point may change with the changes of demand curve or supply curve. Take the Chinese rice industry as an example, assume that the original equilibrium point is (q1, p1) determined by S1 and D1, but S1 could move to S2 when natural disaster happen and the cost has been forced to go up and supply thus shrinks and on the other hand demand curve could also move to D3 when there is a panic in the market anticipating a shortage in rice supply and people want to store more rice for safety’s sake. So under such situation, equilibrium point will surge to (q1, p3) in the free market.

 

Figure 5 Shift of equilibrium after movement of demand curve and supply curve

 

3.        Quantity determination by suppliers

 

MR=P=D

 

S

 

AC

 

MC

 

Figure 6 Profit maximization in perfect competition (source: Maclachlan 2010)

 

The rice production industry is very closed to a perfectly competitive market which is characterized with large number of relatively small suppliers, identical products, perfect resource mobility and perfect knowledge by the buyers (Duffy 1993), and because corn producers are majorly small farmers and companies and the rice generally share similar quality and farmers could swift to grow other plants instead of growing corn only, so we can see how the quantity that the suppliers want to provide is determined in a perfectly competitive market.

O

 

MR=P=D=AR

 

S

 

AVC

 

AC

 

MC

 

D

 

S1

As shown in figure 6, in the left chart as mentioned above and complied with the discussion we have earlier, the market price has been set by the intersection of demand and supply curve in term of market equilibrium with the same demanded and supplied quantity of Qmarket. But in the suppliers’ perspective, they would be willing to produce Qmax because they will pursuit maximized profit by adhering the principle of making marginal cost (MC) equal to marginal revenue (MR). As in the situation above, at the market equilibrium price level when producers would like to produce Qmax to maximize their profit, MC is more than AC which means that producers are gaining premium revenue in such price level as depicted by the shaded rectangle. But such high price could attract more fierce competition because the quantity Qmax is much more than Qmarket which means that supplier are willing to produce more than the market demand in that price level and so this trend later will move the demand curve from Sm to S1 as shown in the figure below making equilibrium demand go up and price go down gradually to P1 then suppliers would want to produce a decreased amount of Q2 rather than Qmarket in the new price level.

 

 

 

 

 

 

 

 

 

Figure 7 Competition caused supply curve shift and quantity supplied change

 

4.        Rationale of governmental intervention

 

Though there will be consequences coming together with government’s price restriction policy to set a ceiling for the retail price of rice, there could be more serious consequences if the government chose not to intervene the market. According to Industrial and Commercial Bank of China (ICBC), the Consumer Price Index (CPI) had increased by 8% in the first quarter which was largely contributed by the raise of food price in term of a 23.3% surge compared to the food price during the same period in 2007. The rapid growth of CPI also lead to the inflation issue as inflation rate grew by a 12 years term high 8.7% in February (Chinadaily.com 2008). The high inflation rate and CPI had brought substantial influences to millions of families. According to a social investigation, a record high 49 percent of respondents had expressed dissatisfaction about the high price in the first quarter (Economist.com 2008). With the increasing trend of social unrest, in order to contain the inflation and keep the essential food product affordable to the poor people, it was reasonable for the Chinese government to control certain food prices and obviously rice is one of the most significant product in the list.

 

5.        Expected and actual results from the government’s intervention

 

5.1    Expected consequences

 

The most desired result the government wanted to see is to remove the panic atmosphere in the rice retailing industry and rice price would go down again to make the rice and rice relative products affordable and accessible to most of the people. In another world, social stability was and is still the top priority in the government’s perspective. But another expected result is a bad consequence which is a theritical rice shortage caused by a price ceiling policy as shown in the figure below. When the government froze the price in Pc, lower than the market equilirium price Pe, suppliers would only want to supply A1 as discouraged by the price control and the quantity consumers could consume under such Pc would be A2, so a shortage would appear.

 

Figure 8 Rice shortage under price ceiling policy

 

5.2    Actual consequences

 

The government’s price control together with other policies had taken significant effect on stabilizing the rice price in the short term and even in the long term’s perspective as indicated by the various data. Firstly, in the short term, the government had enforced an export restriction policy and increase the market supply with the national grain reserve and increased the import of rice. Such actions had played important role in avoiding the shortage due to the price ceiling. And in the long run, the anticipated rice output decreases due to the discouraging control price again had not shown up either. As shown in the figure below, the rice output kept growing since for six year in a line since 2005, and according to the most recent forecast this recovering trend will continue and refresh the exciting record to seven straight years’ increases (Grain.gov.cn 2010). This unreliable achievement has been made not only by the price ceiling restriction but also by the followed up policies. For example, though the government restrict the retail price of rice, but farmers were still encouraged to produce more rice by the increased rice growing subsidy and governmental procurement prices (China.org.cn 2009).

Figure 9 Rice output in China (source:Thebioenergysite.com 2009)

 

6.        Recommendations

 

With the analysis above, it is safe to conclude that the Chinese rice market is not a free market and the government does play a critical role in influencing the market behaviors in this industry. But it is reasonable for the government to froze the rice price for consumers’ sake and economic and social stability. Under such circumstances, there is two recommendations for the government’s further economic plan. Firstly, the government should input more administration effort to enforce the price control policy domestically and ensure that the market is running according to the price control policy and eliminate the black market transactions which will undermine the effectiveness of the policy. Secondly, in the long term’s perspective, the government should gradually relieve the market interference from the government when the rice market is back to normal again because currently the subsidy or increased procurement policies could not really replace the market functions by normal market equilibrium.

Reference list

 

China.org.cn 2009, China raises rice price, accessed on 13 Nov 2010 [online] available: http://www.china.org.cn/business/news/2009-01/24/content_17182131.htm

 

Chinadaily.com 2008, ICBC: China’s inflation rate to hit 8% in Q1, accessed on 13 Nov 2010 [online] available: http://www.chinadaily.com.cn/china/2008-04/04/content_6592032.htm

 

Duffy, J. 1993, Economics, Wiley Publishing, Inc: New York

 

Economist.com 2008, China’s inflation worries: High prices for food, fuel and other goods are troubling, accessed on 13 Nov 2010 [online] available: http://www.economist.com/node/11114381?story_id=11114381

 

FAO (Food and Agriculture Organization of the United Nations) 2010, Statistics, accessed on 12 Nov 2010 [online] available from http://www.fao.org/corp/statistics/en/

 

Grain.gov.cn 2010, 粮食产量有望实现”七连增” 连续四年1万亿斤 (Grain output hopefully will increase for seven consecutive years, and four years’ output are over 500 billion kilo), accessed on 12 Nov 2010 [online] available from http://www.grain.gov.cn/Grain/Login.aspx?newsid=10564

 

World Bank 2008, Midyear estimates of the resident population in China,]accessed on 12 Nov 2010 [online] available from:http://data.worldbank.org/data-catalog/world-development-indicators?cid=GPD_WDI

 

Manipulative-people.com 2010, Nothing found for on acceptable-macro-equilibrium-point, accessed on 12 Nov 2010 [online] available from: http://www.manipulative-people.com/on/acceptable-macro-equilibrium-point.html

 

Maclachlan, F. 2010, Profit Maximization in Perfect Competition, accessed on 12 Nov 2010 [online] available from: http://demonstrations.wolfram.com/ProfitMaximizationInPerfectCompetition/

 

Nytimes.com 2008, China raises prices paid to farmers for rice and wheat, accessed on 12 Nov 2010 [online] available from: http://www.nytimes.com/2008/03/28/business/worldbusiness/28iht-28chinarice.11492395.html

 

Tutor2u.net 2010, AS Markets & Market Systems, accessed on 12 Nov 2010 [online] available from: http://tutor2u.net/economics/revision-notes/as-markets-supply.html.

 

Thebioenergysite.com 2009, World Agricultural Production, accessed on 13 Nov 2010 [online] available: http://www.thebioenergysite.com/articles/385/world-agricultural-production-july-2009