Chapter 4. Farm Budgets at Social Prices: The PAM’s Second Row

The preceding commodity budget was based on private prices, those that farmers face in the market place. As the PAM manual notes, in many instances, private prices do not reflect the true scarcity value of a good to the economy. Market failures and policy interventions may drive a wedge between the true opportunity cost, or social price of a good, and the observed market price.

Because they are not directly observed, social prices must be estimated from other economic data. The process can be quite elaborate, depending on the extent to which a good is traded. To simplify the initial calculations, this chapter provides social prices for the tradables and nontradables needed to set up the basic PAM discussed in Chapter 2 of Monk and Pearson).The process of calculating those social prices and the sensitivity of those prices to economic policies are discussed in M-P’s Chapter 6.

Adding Social Prices

The first step in adding social prices is to retrieve the workbook saved at the end of the last chapter (PAMTutorial). Insert a new worksheet and rename the tab Chapter 4. Select the worksheet under the Chapter 3 tab and copy it into the newly created Chapter 4 worksheet. This new worksheet will be devoted to computing the rice budget at social prices. (In the interest of clarity, rename Table 3.1. Physical Input-Output Data to Table 4.1. Phystical Input-Output Data. As in all PAM analyses at this level, the basic underlying production data are the same for both the first and second rows of the PAM matrix. (Recall that these figures reflect high-yielding paddy grown on land assumed to have good water control.)

Rename Table 3.2. Private Prices to Table 4.2. Social Prices. For several reasons, this is the most difficult table to construct in the PAM analysis. Tradable commodities are hard to estimate because, not only does the export or import parity price involve getting international prices that may be difficult to find, but conversion to farmgate prices requires obtaining prices for such items as transportation, marketing, processing, etc. These may also be hard to obtain.

Estimating prices for fixed factors such as land, labor, and capital is no easier. There are no “social” prices for factors that can be observed directly, and the estimation procedure depends heavily on identifying institutional and market conditions that might produce distortions from observed private prices. (E.g., monopolies, monopsonies, and, in the case of land, the lack of markets that incorporate environmental degradation.)

The details of computing the figures shown in Table 4.2 are developed in a series of appendices to Chapter 4. Appendix 4.1 deals with the estimation of export and import parity prices. Examples are given for rice imported from Bangkok and corn exported from Padang.

Appendix 4.2 takes up the question of how analysts should go about decomposing goods and services that are a combination of traded and non-traded commodities.

Note that the Land price is 0. In the absence of clearly specified cropping alternatives, imputing social opportunity costs to fixed factors within a single commodity budgeting framework is arbitrary. Consequently, the land price, and thus cost, equals 0 and all returns to land are included in the Profits residual, i.e., Profits and Net Profits are the same. Social profits thus measure the returns to land and management when all commodities are priced at their efficiency prices. The rationale for this approach will be examined in greater detail in a future chapter.

Constructing Farm Budgets at Social Prices.

Rename Table 3.3. Private Prices Budget to Table 4.3. Social Prices Budget. The formulas that multiply the Input-Output table and the Prices table should have been copied automatically and the Social Prices budget should be ready for the computation of the PAM’s middle row.

Appendix 4.1. Determining Export and Import Parity Prices

The social price of a tradable output or input at the wholesale market nearest to the farm gate equals the international or border price adjusted for exchange rates and domestic transportation, processing, and marketing costs. The resulting farm gate prices are called import and export parity prices or sometimes _border price equivalents. The general concepts for developing export and import parity prices are shown in Table 4.1.1.

Appendix Table 4.1.1. Determining Import and Export Parity Prices

Step	Import Parity Prices		Export Parity Prices
STEP	DATA	PROCESS	DATA	PROCESS
International Prices	F.o.b. price at point of export	Given	C.i.f. price at point of import	Given
	Freight to point of import	Given	Freight to point of export	Given
	Insurance	Given	Insurance	Given
	C.i.f. at point of import	F.o.b + Freight + Insurance.	F.o.b. at point of export	C.i.f - Freight - Insurance
Currency Conversions	Foreign exchange rate	Given	Foreign exchange rate	Given
	Foreign exchange premium	Given	Foreign exchange premium	Given
	Equilibrium exchange rate	ER * (1 + ERP)	Equilibrium exchange rate	ER * (1 + ERP)
	C.i.f. in domestic currency	EER * C.i.f at point of import	F.o.b in domestic currency	EER * F.o.b. at point of export
Weight Conversions	Weight conversion factor	Given	Weight conv. factor	Given
	C.i.f. in dom. curr. and weight	C.i.f. in dom. curr. / Weight conversion factor	F.o.b. in dom. curr. and weight	F.o.b. in dom. curr. / Weight conversion factor
Distribution between port & wholesale market.	Local transport & mkting costs to wholesale mkt, in social prices	Given	Local transport & mkting costs to wholesale mkt, in social prices	Given
	Value before processing	C.i.f. in dom. curr. and weight + distrib. costs.	Value before processing	F.o.b. in dom. curr. and weight - distrib. costs.
	Processing conv. factor	Given	Processing conv. factor	Given
	Import parity value at wholesale market	Value before processing * conversion factor	Export parity value at wholesale market	Value before processing * conversion factor
Distribution between wholesale & farm gate	Transport, marketing, & storage costs to farm, in social prices	Given	Transport, marketing, & storage costs to farm, in social prices	Given
Result	Import parity value at farm gate	Import parity value at wholesale market +/- distr. costs to farm gate (Deduct if output; Add if input)	Export parity value at farm gate	Export parity value at wholesale market - distr. costs to farm gate

Preparing an Import Parity Price Table.

Create a table to the right of the Table 4.1 on the Chapter 4 worksheet and label it Appendix Table 4.1.2. The data to be used, and the required intermediate calculations, are shown in the table below.

Formulas for Determining Import Parity Price of Rice

The price of imported rice from Bangkok will serve as a starting point for deriving the import parity price for paddy in Indonesia.

To calculate the C.i.f. price for rice at the Indonesian port:


Calculate the Equilibrium exchange rate:

Convert international prices in dollars ($) to local currency (Rupiah).

Convert the unit of measure from tons, the usual international price unit, to kilograms.

Add distribution costs between the port and the wholesale market to the weight-adjusted c.i.f.price

Multiply "before processing" cost by the processing conversion factor.

Adjust for the cost of distributing the commodity from the wholesale market to the farm gate. Because paddy is an output, the costs of distribution between the wholesale market and farm gate are deducted from the import parity value at the wholesale market.

Determining Export Parity Price of Corn

The social export parity price is the border price of an exportable good adjusted for transport and handling costs and revalued by the EER. The calculations for the export parity price resemble those for the import parity price, but generally work in the opposite direction. Follow the steps outlined in Table 4.1.2 to calculate Table 4.1.3, the social price of corn in Padang, assuming that corn is an exportable good.

Create a new table under Appendix Table 4.1.2 and label it Table 4.1.3. Social Export Parity Price of Corn. It can be created most easily by copying Table 4.1.2 and changing the labels and computations where necessary.

Data and Assumptions for Appendix Table 4.1.3.

C.i.f. U.S. Gulf price for no. 2 yellow corn = $115/ton
Costs of insurance and freight between the U.S. and Jakarta = $17.50/ton
Official exchange rate: $1 = Rp1644
Foreign exchange premium = 10%
Transportation costs from port of Jakarta to wholesale market = Rp7/kg.
Handling costs from port to wholesale market = Rp8/kg.
Conversion of weights: 1000 kilograms = 1 ton
Farm to wholesale distribution costs= Rp10/kg

A conversion factor is not necessary for processing corn because the commodity is sold on international markets in an unprocessed form.

Deriving the Export Parity Price for Corn in Padang.

Derive the intermediate values based on the assumptions given above and the steps described in Table 4.1.2. Several of the cell formulas must be modified to account for the difference between an imported output and an exported output.

Linking Tables in the Spreadsheet

Link the results of the import parity price calculations for rice directly into the Social Prices table, overwriting the preliminary values entered in Chapter 4.

To link the relevant cells, move to the Social Prices Table, delete the existing entry, and click on =. Then select the appropriate (final price) entry from the parity price calculation table. Click OK.

Sensitivity Analysis

The spreadsheet is now integrated so that sensitivity analysis on international prices and exchange rates can be reflected in the social budgets. How does the social profitability for the paddy system change when:

1) The exchange rate premium rises to 30%?

2) The international price of rice rises by 25%?

The Import and Export Parity Prices tables assume an exchange rate premium of 0 percent, which means that the exchange rate is not overvalued. Although many developing countries experience overvalued exchange rates, it is often difficult to ascertain the exact amount of the premium. Hence, it is desirable to test the results of different EER assumptions.

Summary

This appendix reviewed the process for calculating the social prices of tradable commodities. Data are required for international commodity prices, distribution costs between various stages of the marketing chain, exchange rates, weight conversions and processing factors. The steps involved in transforming these data into parity prices were outlined in Table 4.1.1. Distinctions were drawn between the calculations for imported outputs, imported inputs, and exports of both outputs and inputs. For purposes of illustration, sample data were provided for only two of these categories, permitting the construction of tables for paddy (occasionally an imported output) and corn (occasionally an exported output). The import and export parity prices so derived are the social prices faced by farmers. To test the effects of changes in international prices and exchange rates on social profitability, these results were linked to the original Social Prices table constructed in Chapter 4.

Although the computations are straightforward, data requirements are often formidable. For example, in identifying the f.o.b. and c.i.f. prices in international markets, it is usually difficult to ensure equivalence in specifications (e.g., quality) between the traded product and the domestically available product. Even small mistakes in establishing the comparability of products can swamp large errors in input-output coefficients.

Appendix 4.2. Nontradable Good Prices

Analysis of Non-Tradable Services

Previous chapters have ignored the issue of nontradable services such as machine rentals, transportation, processing, and handling. Collecting data for these nontradable services is one of the most challenging, and often frustrating, exercises in agricultural policy analysis. Because the information is difficult to collect and, once gathered, may only have a marginal impact on the results, analysts frequently resort to broad assumptions about the data, using sensitivity analysis to verify that these assumptions would not do violence to their conclusions.

But as Monke and Pearson point out in their Chapter 10 ("Postfarm Budgets and Analysis"), market imperfections or policy divergences in nontradable goods and services should not be treated in a cavalier fashion. In theory, the costs of all nontradable inputs (goods and services) should be decomposed into their tradable inputs and domestic factor cost components. These costs, standardized on units such as hours or measures of volume or weight, then can be substituted into the appropriate cells of the Private and Social prices tables. The current chapter focuses on policy divergences in the tradable component of tractor services and illustrates how these divergences affect private and social budgets.

Decomposing Tractor Costs

In Chapter 1, tractor services were considered domestic factors rather than tradable components of the farm budget. As such, the labor associated with tractor services was included in various farming operations; the capital cost associated with these services was included in the capital account. A certain amount of domestic labor and capital is needed to operate and maintain tractors. But the rental price of these machines masks a significant tradable component in the form of machine depreciation, fuel, and grease and oil.

This exercise decomposes tractor services and assigns the tradable, labor, and capital components to their respective accounts in the private and social budgets. As with the linking of import and export parity prices to the Social Prices table (last chapter), the steps involved in identifying the tradable portion of nontradable services are not conceptually difficult. The process of modifying the spreadsheet, however, requires several calculations and careful adjustments to early tables.

he first step is to identify the aspects of tractor services that are tradable. In this example, the tradable component consists of three parts -- the tractor itself, fuel, and grease and oil. The nontradable component consists of two parts -- the use of labor for repairs, maintenance, and management operations, and the working capital required to finance operational expenses.

Second, one needs to determine a meaningful unit of tractor use (usually taken as the tractor service hour) and the quantity of each tradable and nontradable component used during that time. For example, how much tractor capital is used up during one hour of tractor use (depreciation)? How much fuel is used? Grease and oil? Labor? Capital?

Third, appropriate private and social prices for these quantities must be found. For tradables, social prices are derived in a manner similar to that used to calculate import and export parity prices in the last chapter. In this particular example, tractors, fuel, and grease/oil are imported and thus the calculations follow the steps used to derive import parity prices. In general, private prices for both tradables and nontradables are those observed in the market place. In this example, the private prices for tradable goods have been further decomposed to highlight the effect of government interventions and the assumptions concerning depreciation. For nontradables, private prices are observed in the market and thus are taken as given. In both cases, private prices are presented on a per tractor hour basis.

Once the quantities and prices for the newly defined components of tractor services have been determined, they must be linked back into the initial budgetary calculations. The Input-Output table must be expanded to incorporate rows for tradable tractor services, tractor labor, and tractor capital. The original figures for hours of tractor services (previously lumped under the capital account of the I-O table) must be moved to the tradables portion of the table. There they serve as the base for calculating the hours of repair and maintenance labor (R & M) used per hectare and working capital required for tractor services per hectare.

Next, similar rows are inserted in the Private Prices and Social Prices tables. Private and social price data must be linked from the table containing the various "tractor services" calculations. Once the appropriate lines and formulas are inserted, the Private Budget and Social Budget tables recalculate automatically. Sensitivity analysis can be undertaken to evaluate the importance of decomposing the tradable components of domestic services.

Modifications to the Spreadsheet

Step 1: Creating the Tractor Inputs Table.

Retrieve PAMTutorial. Insert a new worksheet, rename it Nontradables. Create a data Table 4.2.1 called Tractor Inputs_. Enter the quantity of each of the tradable components (tractors, fuel, grease/oil, and nontradable components (R&M labor, working capital)) used per tractor hour. The R&M coefficient describes the amount of repair, maintenance, and administrative labor used by the vendor to deliver one hour of tractor services. The working capital coefficient describes the amount of working capital used by the vendor to deliver one hour of tractor services.

Step 2: Creating the Tractor Prices Table

Create the Tractor Prices table below the Tractor Inputs table. It resembles the Import Parity table in structure and in arithmetic logic (i.e_., the calculations are very similar). The necessary additional labels and formulas to incorporate duties, subsidies, time conversions, and depreciation can then be added. (The labels in the social price portion of the Tractor table are identical to those in the private portion.)

The costs of tradable tractor services are constructed along the same lines as the commodity import parity prices. F.o.b. prices obtained from exporting countries are the point of departure if local estimates of the c.i.f. prices in foreign currency are unavailable. The likelihood that the latter can be found is very high since local importers will know what their landed costs are.

Calculate the Import value at border as the c.i.f. price plus the Rupiah value of domestic duties less the Rupiah value of domestic subsidies. Because duties and subsidies are proportions, the formula is:

Prorate the total capital cost of the tractor over its useful life:

Calculate the Total cost per tractor service hour for each of the tradable components as the product of its Farm gate value and the # of units per tractor service hour (found in the Tractor Inputs table).

The social price formulas are identical to those for private prices. So too are the data, with the exception of the Domestic duties and Equilibrium exchange rate.

The differences between private and social costs in tractor services originate from the same sources as the divergences in the agricultural sector. For example, many governments subsidize tractor services by permitting tractor dealers to import tractors and spare parts using foreign exchange obtained at an overvalued exchange rate. Gasoline and diesel fuel are also frequently subsidized. (No subsidies are shown in the current example.) Conversely, imports of machines are heavily taxed to encourage and protect domestic production, especially of smaller machines like two-wheeled tractors. Imports of oil are also significantly taxed instead of subsidized. For both machines and production inputs such as fuel, the degree of taxation is somewhat offset by granting foreign exchange allocations at a cost below the equilibrium exchange rate. The offsetting effects of an overvalued currency and import duties can be seen from the private and social price calculations in Table 4.2.2.

Step 3: Modifying the Input-Output, Prices, and Budget Tables

The structure of the Input-Output, Private Prices, Private Budget, Social Prices, and Social Budget tables are each modified in an identical fashion, by inserting a new row in the tradables and labor sections. (The capital section already includes tractor services). It is easiest to complete all structural changes on each table before progressing to the next. A sample drawn from the I-O table is shown in Table 4.2.3. Consistent with the original design of these tables, the units of measure depend on the table, and in some cases, on the nature of the input. Apply the following steps to each of the five tables cited.

Modify the tradables section by inserting a row entitled Tractor Services (hr/ha).

Modify the labor section by inserting a row entitled Tractor R&M.

In the I-O table only, move the hours from the Tractor services row currently in the capital section to the new tradables row for these same services. These coefficients describe the number of tractors hours used by each commodity. The Tractor Services row in the capital section and the Tractor R&M row in the labor section should be devoid of data. New data will be written in later.

Repeat the first 2 steps for the Private Prices, Private Budget, Social Prices, and Social Budget tables. Adjust units according to the nature of the table (_e.g., hr/ha for the I-O table, Rp/hr for the Prices tables, and Rp/ha for the Budget tables.) Note that Tractor Services Capital is now on a percent basis in the Prices tables (rather than Rp/hr).

Step 4: Linking the Tractor Tables to the Input-Output and Prices Tables

The Tractor Inputs table contains information on the quantities of tradables and nontradables used per tractor service hour. The Tractor Prices table contains the private and social prices of the tradable components (the tractor, fuel, and grease/oil) per tractor service hour. These must be converted to the unit used throughout this analysis -- hectares -- and linked to the appropriate tables. The prices of labor and capital have not changed and are already included in the prices tables.

In the labor section of the I-O table, calculate Tractor R&M labor per hectare by multiplying the number of hours of Tractor Services per hectare (in the tradables section of the I-O table) by R&M labor per tractor service hour (on the Tractor Inputs table).

In the capital section of the I-O table, calculate Tractor Services capital per hectare by multiplying the hours of Tractor Services per hectare (in the tradables section of the I-O table) by Working Capital per tractor service hour (on the Tractor Inputs table).
Format the new rows to be consistent with other data presented in the I-0 table.

In the tradables section of the Private Prices table, calculate the private price of Tractor Services per hectare as total Cost per Tractor Service Hour, aggregated across Tractor Services, Fuel, and Grease/Oil (on the Tractor Prices table).

In the labor section of the Private Prices table, copy the private price of Tractor R&M per hectare directly down from the wages figure in the preceding row.

In the capital section of the Private Prices table, copy the private price of Tractor Capital per hectare directly down from the season interest rate in the preceding row.

Format the new rows to be consistent with other data presented in the table.

Calculate the social price of tradable Tractor Services, Tractor R&M labor, and Tractor Services capital in the same manner as that used for the private price, referencing data in the Social Prices section of the Tractor Services table.

Update the Private and Social Budget tables by copying the formula in adjacent rows to those for the tradable component of tractor services and the labor component of tractor services. The capital component of tractor services should have adjusted automatically.

Save the spreadsheet as PAMTutorial

Sensitivity Analysis

Integrating the results of the decomposition into the existing tables is the most time-consuming part of the exercise. However, such integration is highly desirable because it simplifies the sensitivity analysis of various types of policy proposals. Once the template has been properly implemented, it will be easy to see if significant changes in the international price of tractors has an impact on commodity PAMs.

If the PAMs have been done correctly in the earlier exercises, changes in the Tractor Decomposition table should be automatically reflected in the PAMs. To gain a better understanding of the relative importance of nontradable service decomposition, perform the following sensitivity analysis.

1) Tractor prices double.

2) Fuel prices triple.

Do the PAM results change much? What do the results of this sensitivity analysis imply for data collection priorities?

Summary

This appendix has shown how to decompose nontradable services into their tradable and domestic factor components. The illustration was simplified for ease of presentation, but the difficulty in computing costs of nontradable services should not be underestimated. Due to the inherent problems of estimating the social costs of services, it is often useful to assess their importance in the budget of individual commodities before embarking on a complete analysis. This can be done by computing the value of nontradable services as a share of total costs and by performing sensitivity analyses.