###### Glossary: Definition of Key Terms

Coefficient of variation: The coefficient of variation is a measure of the variation in a variable. It is calculated as the standard deviation of the variable divided by the mean of the variable. If the coefficient of variation is zero, there is no variation in the variable and all values are the same.

Consumer price index: The consumer price index (CPI) is a ratio of the general level of prices in a given period and the level of prices in the base period. It is usually expressed as a percentage. For example, if the base period for a CPI is January 2005 and the CPI for June 2008 is 165, this implies that prices in June 2008 are 65% above what they were in January 2005. The CPI is used to deflate prices, that is to calculate real prices from nominal prices. It is also used to calculate the rate of inflation. See nominal price and real price.

Consumer surplus: Consumer surplus is an estimate of the benefit to consumers from paying a fixed price rather than each consumer paying the maximum he or she is willing to pay. The level of consumer surplus is rarely calculated, but the change in consumer surplus is a common measure of the benefit (or cost) to consumers of a change in markets. The simplest case is that of a change in price due to a change in world prices or a shift in the supply curve. In this case, the change in consumer surplus is equal to -ΔP(Q1+Q2)/2, where ΔP is the change in price, Q1 is the quantity consumed before the price change and Q2 is the quantity consumed after. In the short term, before consumers have an opportunity to respond to the price change, Q1 = Q2 and the expression becomes -ΔP(Q1).

Demand curve: The demand curve describes the relationship between the price of a commodity and the level of consumption (or demand) of the commodity. Typically, the demand curve is graphed with the price on the vertical axis and production on the horizontal axis. As the price rises, consumers decrease their consumption of the good so the demand curve slopes downward. The steepness of this line depends on the price elasticity of demand. A large price elasticity of demand (meaning a large negative number) implies a flat slope, while a low elasticity (meaning a negative number close to zero) implies a steep slope.

Elastic demand: A good has an elastic demand when a price change results in a large decrease in the quantity consumed. More specifically, it refers to the situation when a one percent increase in price causes a decrease in the quantity demanded of more than one percent. In other words, the price elasticity of demand is more negative than -1. See inelastic demand.

Elastic supply: A good has an elastic supply when a price change results in large increase in the quantity of production. More specifically, it refers to the situation when a one percent increase in the price causes an increase in the quantity supplied of more than one percent. In other words, the supply elasticity is greater than 1.0. See inelastic supply.

Elasticity of supply: The percentage change in production in response to a 1% increase in the price. Because it takes time for producers to respond to higher prices, supply elasticities are smaller in the short term (within a year) than in the long-term (1-3 years). For agricultural commodities with one harvest per year, economists often assume that the short-term supply elasticity is zero. Long-term supply agricultural elasticities tend to range from 0.2 to 1.5. See elastic supply and inelastic supply.

Exchange rate: The number of units of one currency needed to purchase one unit in another currency. In other words, it is the “price” of one currency expressed in terms of another currency. For example, the US dollar-euro exchange rate can be expressed as 1.33 dollars/euro or 0.75 euros/dollar. See undervalued exchange rate and overvalued exchange rate.

Export parity price: The export parity price is the price one could get for exporting it from a given location, given the world price and the cost of delivering it to international markets. It is calculated as the world price minus the costs of transportation, handling, export taxes, insurance, and sea-freight. The export parity price is always less than the import parity price, and it is less than the world price. For interior locations far from ports, the export parity price may be negative. See import parity price.

General equilibrium model: A general equilibrium model is a mathematical representation of an economy that includes all sectors and that makes income endogenous (determined within the model). It typically represents households that earn money by selling factors of production (e.g. labor and capital) to firms and firms that use factors for production to produce goods, which are sold to households. See single-commodity model, multimarket model, spatial equilibrium model, and partial-equilibrium model.

Imperfect substitute: If two commodities are imperfect substitutes, then there is some switching between the two, but consumers do not consider them identical. The two prices will tend to move together, but they will not be identical. The higher price of one of the commodities indicates that it is preferred to the other. In international trade, local and imported versions of a commodity may be modeled as perfect substitutes or as imperfect substitutes. The latter case is often referred to as the Armington assumption, based on the economist who developed the equation used to describe it.

Import parity price: The import parity price is the cost of purchasing it on the international market and transporting it to a particular location. This includes the cost of purchasing it on the world market, sea-freight, insurance, port charges, overland transportation, handling, tariffs, and other taxes. The import parity price is always greater than the world price and the export parity price. See export parity price.

Income-elastic demand: A good has an income-elastic demand when a price change results in a large increase in demand. More specifically, it refers to the situation when a one percent increase in income results in an increase in demand of more than one percent. Non-food items in general and luxury good in particular have an income-elastic demand. See income-inelastic demand.

Income-inelastic demand: A good has an income-inelastic demand when the quantity consumed is not very sensitive to changes in income. More specifically, it refers to the situation where a one percent increase in income causes an increase in the quantity demanded of less than one percent. In other words, the income elasticity of demand is less than 1.0. Food in general and staple foods in particular generally have an income-inelastic demand. See income-elastic demand.

Inelastic demand: A good has an inelastic demand when a price change results in only a small reduction in the quantity consumed. More specifically, it refers to the situation when a one percent increase in price causes a reduction in the quantity demanded of less than one percent. In other words, the price elasticity of demand is between 0 and -1. As a result, a higher price actually increases the total expenditure on the good. Staple foods and fuel are often said to have an inelastic demand. See elastic demand.

Inelastic supply: A good has an inelastic supply when a price change results in only a small increase in the quantity produced. More specifically, it refers to the situation when a one percent increase in price causes an increase in the quantity supplied of less than one percent. In other words, the supply elasticity is between 0 and 1. Crop production is often characterized by inelastic supply, particularly in the short run and particularly crops grown partly for subsistence. See elastic supply.

Large-country assumption: In international trade, the large-country assumption is the assumption that the imports and exports of a given commodity of a given country are large enough to have a noticeable effect on world prices. This is in contrast to the small-country assumption, in which a countries imports and exports of a commodity have negligible effects on world markets.

Multi-market model: A multi-market model is a mathematical representation of markets for a number of inter-related goods, with supply and demand equations for each good. The goods may be related by being substitutes in consumption (such as sorghum and wheat), they may be substitutes in production (such as maize and soybeans), or one may be an input into the production of another (such as maize and livestock). These models are partial equilibrium models in that they do not represent all sectors in the economy and income is not fully endogenous (determined by the model). Agricultural multi-market models typically represent three to ten commodities. They are appropriate for simulations that focus on interactions within the agricultural sector but do not have significant economy-wide implications. See single-commodity model, spatial equilibrium model, partial-equilibrium model, and general equilibrium model.

Nominal price: The nominal price of a good is the price observed in the market place, before any adjustments for inflation. See real price.

Non-tradable good: A non-tradable good is one that cannot be imported or exported. The price of a non-tradable good is largely determined by domestic supply and demand factors. The price of a non-tradable good is generally above the export parity price and below the import parity price. See import parity price, export parity price, and non-tradable good.

Overvalued exchange rate: An exchange rate is overvalued when it implies that the currency is stronger(worth more) than it is according to a long-run market-determined rate. For example, if a government sets its exchange rate as 20 shillings/dollar but the market rate is 40 shillings/dollar, then the currency is overvalued. This typically occurs when the government sets an official exchange rate and wants to reduce the local-currency cost of imports, though it must usually ration foreign exchange to implement this policy. See undervalued exchange rate.

Partial equilibrium model: A partial equilibrium model is a mathematical representation of an economy that does not include all sectors and does not make income fully endogenous (determined by the model). A single-commodity model and multimarket models are types of partial equilibrium models. In addition, most spatial equilibrium models are partial equilibrium models. See single-commodity model, multimarket model, spatial equilibrium model, and general equilibrium model.

Perfect substitutes: Two commodities are perfect substitutes if consumers consider them to be equivalent to each other, showing no preference for one over the other. If two commodities are perfect substitutes, then there will be no difference in price between them. This is because any price difference will cause consumers to switch to the less expensive version, thus increasing the demand and raising its price. For example, if locally produced rice is a perfect substitute for imported rice (there is no difference in taste, aroma, or cooking qualities), then the prices of both in the market will be identical. Likewise, any consistent price difference between two commodities implies that they are not perfect substitutes. See substitution in consumption.

Price elasticity of demand: The percentage change in demand in response to a 1% increase in price. Price elasticities of demand are negative because high prices induce consumers to reduce demand and switch to substitute goods. Price elasticities of demand usually fall in the range of -0.1 to -3.0. The price elasticity of demand depends partly on the number of close substitutes in consumption. For example, the price elasticity of oranges is likely to be large (e.g. -2.5) because if orange prices rise, consumers can simply switch to other fruit. However, the price elasticity of rice in a country like Bangladesh where rice is the dominant staple is small (e.g. -0.5).

Producer surplus: Producer surplus is an estimate of the benefit to producers from being paid a fixed price rather than each producer being paid the minimum that he or she would be willing to accept. The level of producer surplus is rarely calculated, but the change in producer surplus is a common measure of the benefit (or cost) to producers of a change in markets. The simplest case is that of a change in price due to a change in world prices or a shift in the demand curve. In this case, the change in producer surplus is equal to ΔP(Q1+Q2)/2, where ΔP is the change in price, Q1 is the quantity produced before the price change, and Q2 is the quantity produced after. In the short term, before producers have an opportunity to respond to the price change, Q1 = Q2 and the expression becomes ΔP(Q1).

Real price: The real price of a good is the price after adjusting for inflation. It is calculated as the nominal price divided by the consumer price index, where the latter is expressed as a ratio, not a percentage. See nominal price and consumer price index.

Regression analysis: Regression analysis is a statistical procedure that examines the effect of one or more explanatory variables on one or more dependent variables . In the simple case of a single-equation linear multiple regression, there is one dependent variable (y) with a linear relationship to the explanatory variables (Xi). The relationship is describes as follows: y = α+β1X1+β2X2…βnXn. The main output of the analysis is a set of coefficients (α and the β’s) that best describe the data. The output also includes measures of the statistical significance of the coefficients (the probability that each one is actually different from zero) and measures of how close the equation describes the data. Regression analysis is used to describe a wide variety of patterns in economics, including the effect of prices and income on consumer demand, the determinants of farmer use of agricultural technology, and the relationship among commodity prices.

Single-commodity model: A single-commodity model is a simple mathematical representation of supply and demand for one good. For nontradable good, it usually consists of two equations, one for supply and one for demand. For tradable goods, a third equation determines the price. This type of model is appropriate for analyses where simplicity and speed are more important than precise estimates. See multimarket model, spatial equilibrium model, partial-equilibrium model, and general equilibrium model.

Small-country assumption: In international trade, the small-country assumption is the assumption that the imports and exports of a given commodity of a given country have a negligible effect on world prices. Thus, on a graph of the domestic supply and demand for the commodity, the world price can be represented as a horizontal line. If exports or imports of a commodity in a country are large enough to significantly influence world prices, it is necessary to adopt the large-country assumption. A country can be “small” with respect to one commodity but “large” with respect to another. For example, Vietnam is a “large” country in rice markets, but a “small” one in maize markets.

Spatial arbitrage: Spatial arbitrage refers to the tendency of traders to ship goods from one location to another whenever the price difference between the two locations is large enough to cover the cost of transportation. In mathematical terms, traders will ship good from location A to location B whenever PB – PA > Ct, where PA is the price in location A, PB is the price in location B, and Ct is the full cost of transporting goods from A to B (including normal profit and risk premium). The act of transporting goods from A to B will raise the price in A and reduce the price in B until the price difference no longer covers the cost of transportation. Thus, in a competitive market, the difference in prices between two locations will not be consistently greater than the cost of transportation between them. Furthermore, if the price difference is less than the cost of transportation, there will be no trade, and if there is trade, the price difference will be approximately equal to the cost of transportation. If the price difference between two locations is consistently greater than the full cost of transportation, this implies that markets are not working well. This may be due to government restrictions on trade, collusive behavior among traders, lack of credit, lack of market information, or other factors.

Spatial equilibrium model: A spatial-equilibrium model is a mathematical representation of markets for one or more commodity in several locations, taking into account the cost of transporting goods between locations and allowing trade to flow in either direction. It is possible to construct a spatial general equilibrium model, but spatial models are usually partial-equilibrium models. This type of model is appropriate when the commodities being represented have a low value/bulk ratio and one is interested in the effects on different regions within a country. See single-commodity model, multimarket model, partial-equilibrium model, and general equilibrium model.

Substitution in consumption: Substitution in consumption refers to the tendency of consumers to switch from one commodity to another depending on the relative prices. Food that play the same role in the diet, such as cereals or meat, are usually substitutes for each other, meaning that consumers can switch from one to the other if prices change. This implies that each has a relatively price-elastic demand. It also means that their prices tend to move together. This is because if the price of one food rises, consumers switch from that food to a close substitute, which increases the demand for the second food and raises its price as well.

Substitution in production: Substitution in production refers to the tendency of producers to switch from one commodity to another depending on the relative profitability. Annual crops grown in the same agro-ecological zone are usually substitutes for each other, meaning that farmers can switch easily from one to the other. This implies that each has a relatively elastic supply. It also means that their prices tend to move together. This is because if the price of one crop rises, farmers switch land from the second crop to the first, which reduces the supply of the second crop and raises its price as well.

Supply curve: A supply curve describes the relationship between the price of a commodity and the level of production (or supply) of the commodity. Typically, the supply curve is graphed with the price on the vertical axis and production on the horizontal axis. As the price rises, farmers are willing to increase production by using more inputs and/or by expanding area. Thus, the supply curve slopes upward. The steepness of this line depends on the elasticity of supply: a high supply elasticity implies a flat slope, while a low elasticity implies a steep slope. See elasticity of supply.

Temporal arbitrage: Temporal arbitrage refers to the tendency of traders to store goods from one time period to a later period whenever the expected increase in price between the two time periods is large enough to cover the full cost of storage, including a normal profit and risk premium. In mathematical terms, traders will store goods whenever P2 – P1 > Cs, where P1 is the current price, P2 is the expected price at a later time, and Cs is the full cost of storing the good until the later period. The act of storing goods raises the current price and lowers the expected future price until the difference between the two prices no longer covers the cost of storage. Thus, in a competitive market, the price difference between two time periods will not be consistently greater than the cost of storage between the two time periods. Furthermore, if the expected price difference is less than the cost of storage, no additional quantities will be put into storage, and if there is storage, the expected price difference will be approximately equal to the cost of storage. One implication is that commodities with higher costs of storage will have stronger seasonal variation in prices. Another implication is that if seasonal variation in prices is greater than the cost of storage (including normal profit and risk premium), then markets are not working well. This may be due to government restrictions on storage (“hoarding”), collusive behavior among traders, lack of credit, lack of market information, or other factors.

Tradable good: A tradable good is one that can be imported or exported. The price of tradable goods is largely determined by world prices and trade policy. A tradable good may be importable or exportable. The price of an importable good is usually set by the import parity price, and the price of an exportable is set by the export parity price. This relationship does not hold, however, if there are quantitative restrictions on trade such as a ban or quota, or if there are other constraints on trade such as unavailability of foreign exchange. See import parity price, export parity price, and non-tradable good.

Undervalued exchange rate: An exchange rate is undervalued when it implies that the currency is weaker (worth less) than it is according to a long-run market-determined rate. For example, if a government sets its exchange rate as 40 shillings/dollar but the market rate is 20 shillings/dollar, then the currency is undervalued. This typically occurs when the government sets an official exchange rate and wants to stimulate exports. See overvalued exchange rate.