EQUILIBRIUM ANALYSIS OF RICE SUPPLY AND DEMAND SYSTEMS IN INDONESIA

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1 EQUILIBRIUM ANALYSIS OF RICE SUPPLY AND DEMAND SYSTEMS IN INDONESIA Sri Nuryanti Indonesian Center for Agriculture and Social Economic Policy Studies Jl. A. Yani 7 Bogor 66 ABSTRACT This study aims to analyze the stability of Indonesian rice supply and demand equilibrium system and to evaluate short-run and long-run impacts of price policy using Cobweb equilibrium model. The results show that in the short-run equilibrium of rice supply and demand deviates; however, in the long-run it is stable. These imply that price policy on agricultural inputs and output does not disturb Indonesian rice market. Therefore, the policy is still reasonable to implement. Key words: stability, market equilibrium, rice, rice supply, rice demand INTRODUCTION Dynamic model is one of tools used to evaluate short-term and longterm impacts of a policy (Swastika, 999). Impacts of government policies in agricultural sector are usually observed after several months or years later. It means that there is time lag between the period when the policy is implemented and the farmers response. There are two reasons, namely the farmers can not anticipate the policy directly and the desired impact is slowly observed. In addition, agricultural production could be monitored after several planting seasons. It indicates that time lag in agricultural activities takes place between the decision in growing the crops and harvest period. Government s policy on floor price of rice (HDPP) depicted in Inpres No. 9/22 on December 2, 22 (mid of planting season on wet season 22/3), stated that purchase price of rice was Rp,725/kg. Previously, Inpres No. 9/2 on December 3, 2 affirmed that purchase price of rice was Rp,5/kg. The rice price policy got positive response from the producers indicated by increased supply of rice in the domestic market from,48,3 tons in 22 to,624,6 tons in 23. It showed that the producers had time lag in responding to commodity market-shock. Increased supply of rice was due to increase in rice harvested area as the impact of improved selling-price of rice. Conversely, when fertilizer price subsidy was removed since December, 998 and fertilizer price was not controlled by the government anymore but it was determined by market mechanism, fertilizer price at farm level became higher. However, fertilizer ceiling price removal did not encourage farmers to ANALISA KESEIMBANGAN SISTEM PENAWARAN DAN PERMINTAAN BERAS DI INDONESIA Sri Nuryanti

2 apply fertilizers more efficiently (Sutrilah et al., 2). It was shown by fluctuating supply of rice from 998 to 22, namely,49, 2,73,,287,,9, and,48 thousand tons, respectively. Such a fluctuating supply is susceptible because of increased growth rate of population such that rice consumption keeps also expanding. This study analyzes stability of equilibrium system of rice supply and demand in Indonesia using Cobweb equilibrium model from dynamic supply and demand. It also analyzes short-run and long-run impacts of changes in the policies on rice and fertilizer prices, and stability of domestic rice market. Cobweb model is selected because it is suitable for analyzing price change impact on agricultural commodities supply and demand, especially in the short term (Widodo, 992). METHODOLOGY Conceptual Framework Supply is static correlation between quantity of commodity sold at a certain place and time with various levels of price, other factors are assumed to be constant (Tomek and Robinson, 99). Supply curve shows positive correlation between quantities of commodity to be sold with its price level (Lantican, 99). Increased price of a commodity when other factors are constant encourages the producers to supply more. Conversely, if the commodity price decreases the producers will reduce supply of the commodity. The supply curve is assumed that the producers act rationally, namely they try to maximize profits. Producers will apply inputs until marginal cost of input is equal to marginal value of output. Mathematically, principle of maximizing profit is formulated as follow: Px = Py * MPx... () where Px is price of per unit of input X, Py is price of per unit of output Y, and MPx is marginal product of input X. The equation above is static analysis. On the other hand, dynamic analysis is not only determined by economic variables at the same time, but also by previous variables. Such as mentioned above, in agriculture sector there is time lag between production decision making and realized production. Production decision is made one period before the product is sold. If production decision is made at time t based on the price at time t, namely P t, the product is not realized at time t. Thus, P t does not affect production at time t or Q t, but Q t+. The time lag response implies functional correlation in which mathematically is formulated as follows (Nerlove, 958): Qs t+ = f(p t ) or Qs t = f(p t- )... (2) Jurnal Agro Ekonomi, Volume 23 No., Mei 25 : 7-8 2

3 Actually, supply of the year is also affected by supply and input price in the previous year. Thus, supply function of equation (2) becomes: Qs t+ = f(qs t, P t, Pf t ) or Qs t = f(qs t-, P t-, Pf t- )... (3) On the other hand, consumer s demand is the quantities of a commodity which the consumer is willing and able to buy in a particular place and period as price varies, other factors are held constant. Market demand is an aggregate of individual demands (Tomek and Robinson, 99). Demand could be depicted as a curve showing a negative correlation between quantities of demanded commodity and various price levels. Such as supply, demand could be explained using a mathematical equation as a function of many factors, namely previous year s demand, price of the commodity, price of other commodities, per capita income, total population, among others. Model of Analysis Referring to the assumption of Cobweb system equilibrium, a function model of demand for rice in year t is defined as a function of demand for rice in year t-, rice price in year t, per capita income in year t, and total population in year t. Mathematically, demand for rice is formulated as follow: Qd t = a Qd t- + a 2 P t- + a 3 I t + a 4 Pop t + c... (4) Qd t = a Qd t- + a 2 P t- + a 3 + a c... (5) On the other hand, supply function is defined as a function of rice supply in year t-, rice price in year t-, and Urea fertilizer price in year t- which mathematically is formulated as follow: Qs t = b Qs t- + b 2 P t- + b 3 Pf t- + k... (6) Qs t = b Qs t- + b 2 P t- + b k... (7) Based on Cobweb model s assumption, then: where: Qd t = Qs t... (8) Qd t = quantity of rice demanded in year t Qd t- = quantity of rice demanded in year t- Qs t = quantity of rice supply in year t Qs t- = quantity of rice supply in year t- P t = rice price in year t P t- = rice price in year t- ANALISA KESEIMBANGAN SISTEM PENAWARAN DAN PERMINTAAN BERAS DI INDONESIA Sri Nuryanti 3

4 Pf t = Urea fertilizer price in year t I t = = per capita income in year t Pop t = 2 = total population in year t Pf t- = 3 = Urea fertilizer price in year t- a, b = estimated parameters c, k = first-stage regression constants Based on equations (5), (7), and (8) there are three stages of analysis. First stage, parameters of supply and demand functions were estimated separately. Estimation was done through Cobb-Douglas function using an ordinary least square (OLS) method. Cobb-Douglas equation is in natural logarithm transform of supply and demand functions. Cobb-Douglas is chosen because the coefficient of each variable indicates its elasticity. Second stage, Cobweb equilibrium (equation 8) was analyzed using supply and demand functions in which the parameters were estimated at the first stage based on market equilibrium principle. It implies that total supply is equal to total demand. Afterward, Cobweb equilibrium was formulated in a matrix. Third stage, price policy impact was done for short term and long term using Cobweb equilibrium matrix. Equilibrium stability analysis of rice supply and demand systems was done through finding the roots of Cobweb equilibrium characteristics equation resulted from statistical estimation transformed in a matrix (Simatupang, 995). The next was transforming equations (6) (8) in a matrix form: or a 2 Q P t t = b a b 2 Q P t- t- + k c b 3 a 3 a (9) H * Y t = H 2 * Y t- + H 3 *...() Short-run multiplier effects were notified as D and D 2, formulated as follows (Ruetlinger, 996): D = H - * H 2...() D 2 = H - * H 3...(2) Short-term shock was notified as D 3 and formulated as follows: Jurnal Agro Ekonomi, Volume 23 No., Mei 25 : 7-8 4

5 where: D 3 = (I D ) - * D 2...(3) H = parameters matrix of endogenous variables in year t Y t = parameters matrix of endogenous variables (quantity and price of rice) in year t H 2 = parameters matrix of endogenous variables in year t Y t- = parameters matrix of endogenous variables (quantity and price of rice) t H 3 = constants and parameters matrix of exogenous variable = exogenous variable matrix (,, 2, 3, with = ) D = short-term multiplier effect of rice price change D 2 = short-term multiplier effect of Urea fertilizer price change D 3 = long-term multiplier effect Data The study used annual time series data for 32 years, namely for the period of Sources of data were Indonesia Statistics, Food Balance, and SUSENAS. Types of data collected were net rice supply based on end-ofyear rice supply, floor price of rice as a proxy of farm-gate rice price, retail price of Urea as a proxy of farm-gate Urea price (for the period of used highest retail price), domestic rice consumption as a proxy of quantity of demand for price, per capita real income as a proxy of population income, and total midyear population as a proxy of total population. RESULTS AND DISCUSSION Estimated Parameters First-stage analysis was using OLS method and the supply and demand functions were formulated as follows: Qd t =,56 Qd t-,4 P t +, I t +,93 Pop t 9,83... (4) Qd t =,56 Qd t-,4 P t +, +,93 2 9,83... (5) Qs t =,9 Qs t- +,33 P t-,2 Pf t- + 2,5...(6) Qs t =,9 Qs t- +,33 P t-, ,5...(7) Using market equilibrium principle, equation (9) was transformed into: ANALISA KESEIMBANGAN SISTEM PENAWARAN DAN PERMINTAAN BERAS DI INDONESIA Sri Nuryanti 5

6 ,4 Q P t t,9,56,33 Short-Run Multiplier Effects = Q P t- t- + 2,5-9,83 -,2,, (8) Based on equation (8), the short-term effects were obtained in matrix forms of D and D 2 as follows: D = H - * H 2 = -,55,56,33,33...(9) D 2 = H - * H 3 =,32-9,83 -,5, -,, -,93,93...(2) Values of D in equation (9) indicate that increase in supply by percent in short term will result in price decrease by.56 percent, or increase in supply by percent will decrease rice price by 5.6 percent. Conversely, increase in rice price by percent will improve supply by.33 percent, or increase in rice price by percent will improve supply by 3.3 percent. Such as responses of other commodities supplies, the producers will increase supply if the price increases, other factors are held constant. It indicates that in short term the farmers respond to price increase by increasing supply of rice. It was shown by elasticity value of rice supply on rice price by.33 or more than one (elastic). Based on values of D 2 in equation (2), it was indicated that increase in Urea price by percent would reduce supply by.5 percent, or increase in Urea price by percent in short term would reduce rice supply by.5 percent. Trivial response to increase in Urea price indicates that subsidy decrease of Urea price will have little impact on reduced rice supply. It is most probably due to farmers risk averse. Some studies in Java showed that increase in fertilizers price did not encourage farmers to lower fertilizers application. Reducing fertilizers application would decrease rice yields (Swastika, 995). Because policies on increases in fertilizer price and floor price of rice did not reduce optimal fertilizer application, thus, rice farm business profit could be improved (Swastika and Fagi, 993). Other analysis result showed that increases in per capita income and population growth rate were not affected by rice supply, but both variables affected rice demand. Those two variables affected rice price hike. Specifically, increase in per capita income by percent in short term would improve demand Jurnal Agro Ekonomi, Volume 23 No., Mei 25 : 7-8 6

7 for rice by. percent. Increase in population growth rate by percent in short term would enhance demand for rice.93 percent. Population growth rate increase had greater impact on demand for rice than that of per capita income. Increased population will enhance demand for rice accordingly, thus in aggregate it will have great impact on rice demanded. Long-Term Multiplier Effect Change in one variable in the long term could be evaluated from D 3 matrix in equation (3) as follows: D 3 = (I D ) - * D 2 = - 8,9 -,54,2 -,7,,,82,2...(2) Equation (2) shows that increased price of Urea by percent in the long term will result in improved supply of rice by.2 percent. Long-run increase in Urea price is accumulation of short-run changes. Such as rice supply fluctuation after fertilizer price subsidy removal in 998, in the long term the farmers did not tend to reduce fertilizer application rates that the rice production was not affected. Even though insignificant, rice production improved. In addition, in the long term an increase in Urea price will result in rice price decrease by.7 percent. Because per unit of input price increase (especially that of Urea price), marginal income of increase in rice price received by farmers becomes lesser. It means that in the long term real price received by farmers decreases. In other words, ratio of rice price to fertilizer price gets smaller. Such as in the short term, the long term effect of increase in Urea price on rice supply and rice price is very small. The farmers did not response to Urea price increase which was controlled by the government, so far, and rice price fluctuation was still under control of government such that it was still affordable to the consumers. During minimal quantity of supply (off season), the government applied ceiling price to protect consumers and conducted market operation. On the other hand, during peak season in which the rice supply was abundant the government implemented rice floor price to sustain farm gate price. Equation (2) shows that an increase in per capita income by percent in the long term will not affect supply and price of rice. It indicates that elasticities of per capita income to rice demand and rice price are zero. In the long term, rice is still a primary product that it is inelastic to increases in per capita and rice price. Even though per capita income and rice price increase but quantity of rice consumed is constant and consumers will keep buying rice whatever its price. Population growth rate in the long term by percent will enhance demand for rice by.82 percent and increase rice price by.2 percent. In ANALISA KESEIMBANGAN SISTEM PENAWARAN DAN PERMINTAAN BERAS DI INDONESIA Sri Nuryanti 7

8 accordance with market law, rice price increases if its demand increases, other things are held constant. Such as in the short term, effects of population growth rate and rice price in the long term on are greater than that of per capita income. Thus, the short term effects are applicable with those in the long term. Stability of Supply and Demand Equilibrium Stability analysis of supply and demand system equilibrium was evaluated through findings the roots of characteristics equation (Simatupang, 995) from D matrix or multiplier effect of rice price change as follows:? +,55 -,33 I? - D = =...(22) -,56? -,33 The roots of equation matrix (22) were achieved by computing determinant values of the equation matrix, and the quadratic equation obtained is as follows: λ 2,78λ,48 =...(23) Values of λ and λ 2 are the roots of characteristics equation obtained using abc formula, and the values of λ and λ 2 are.67 and -.89, respectively. Equilibrium system is stable if and only if the real parts of all matrix values are less than zero (Simatupang, 995). Values of λ are both positive and negative indicating that one of real parts of the matrix has value less than zero and, thus, system equilibrium is stable. Even though in the short term, price policy has caused supply and demand system unstable (diverged), but in the long term the system returns to equilibrium and become stable (converged). In accordance with the analysis above, Adnyana and Julin (993) and Adnyana and akaria (993) found that policy on increase in fertilizer price lowered fertilizer demand and rice supply. The government avoided decreases rice production and farmers income through compensation of increased production costs through increasing rice price equal to percentage of output supply decrease to input demand decrease ratio. Therefore, if rice price to urea fertilizer price ratio increases, in the long term stability of rice supply and demand will be sustained. Implication of the study is that in the long term price policy will not affect market equilibrium and, thus, the policy is reliable to implement. Jurnal Agro Ekonomi, Volume 23 No., Mei 25 : 7-8 8

9 CONCLUSIONS AND POLICY IMPLICATIONS In the short term and long term an increase in rice price will improve rice supply. Urea fertilizer price increase in the short term will lower rice supply, but in the long term it will enhance rice supply and decrease rice price. Per capita income increase in the short term will improve demand for rice, but in the long term it will not affect rice supply and rice price. On the other hand, population growth rate both in the short and long terms have greater effect on increases in rice demand and rice price than that of per capita income increase on rice demand and price. Rice supply and demand system in the short term diverges from its equilibrium, but in the long term the system converges to equilibrium price and becomes stable. The study implies that price policy on urea fertilizer input and output (rice) does not affect market equilibrium, and demand for rice is relatively stable. Thus, the price policy on input and output is reliable to implement. The study using Cobweb dynamic equilibrium model for Indonesian rice supply and demand system was able to evaluate effects of agricultural input and output price policy both in the short and long terms. This model is applicable for similar studies on agricultural and non-agricultural commodities. REFERENCES Adnyana, M.O. and A. Julin Dampak Kebijaksanaan Penghapusan Subsidi pada Sarana Produksi Terhadap Keragaan Usahatani Padi di Jawa Tengah (Impacts of Input Subsidy Removal on Rice Farm Business Performance in Central Java). Risalah Hasil Penelitian Sosial Ekonomi dan Pengembangan. Puslitbangtan. Hal Adnyana, M.O. dan A.K. akaria Dampak Kebijaksanaan Penghapusan Subsidi pada Sarana Produksi Terhadap Keragaan Usahatani Padi di Jawa Barat (Impacts of Input Subsidy Removal on Rice Farm Business Performance in West Java).. Risalah Hasil Penelitian Sosial Ekonomi dan Pengembangan. Puslitbangtan. Hal Lantican, F.A. 99. Present and Future Market Supply and Demand for Diversified Crops. Paper Presented During The Training Course on Diversified Crops. Irrigation Engineering held at DCIEC Building, NIA Compound, EDSA. Quezon City. Nov. 9 2, 99, Dalam Swastika, D.K.S Penerapan Model Dinamis dalam Sistem Penawaran dan Permintaan Beras di Indonesia. Informatika Pertanian. Vol. 8/ Des 999. Nerlove, M The Dynamics of Supply: Estimation of Farmers Response to Price. Baltimore: Johns Hopkins Press, cit Gemmill, Gordon Estimating and Forecasting Agricultural Supply from Time-series: A Comparison of Direct and Indirect Methods. European Research of Agricultural Economy. Vol. 5/No. 2: 75 9 Pp. ANALISA KESEIMBANGAN SISTEM PENAWARAN DAN PERMINTAAN BERAS DI INDONESIA Sri Nuryanti 9

10 Reutlingler, S Analysis of A Dynamic Model, with Particular Emphasis on Long term Projections. Journal of Farm Economics. Vol. 48. Simatupang, T.M Teori Sistem Suatu Perspektif Teknik Industri (System Theory A Perspective of Industrial Engineering). Andi Offset. Yogyakarta. Hal. 74. Sutrilah, Ken Suratiyah, S. Hardyastuti, Diah I., Bayu S., and Slamet H. 2. Analisis Strategi Pemasaran Pasca Pencabutan Subsidi dan Tata Niaga Bebas (Marketing Strategy Analysis after Subsidy Removal and Free Marketing Channel). Laporan Hasil Penelitian Kerjasama antara Lembaga Penelitian Universitas Gadjah Mada dengan PT Pusri. Swastika, D.K.S Decomposition of Total Factor Productivity Growth: The Case of Irrigated Rice Farming in West Java, Indonesia. PhD Thesis. University of The Philippines Los Banos. Philippines. Swastika, D.K.S Penerapan Model Dinamis dalam Sistem Penawaran dan Permintaan Beras di Indonesia (Dynamic Model Application in Rice Supply and Demand System in Indonesia). Informatika Pertanian. Vol. 8/Des 999. Laporan Hasil Penelitian Kerjasama antara Lembaga Penelitian UGM dengan PT Pusri. Swastika, D.K.S. dan A.M. Fagi Analisa Efisiensi Pemupukan N pada Padi Sawah IR36 dan Implikasinya Terhadap Kebijaksanaan Harga Pupuk dan Gabah (Analysis of Nitrogen Fertilizer Application Efficiency and Its Implication on Fertilizer and Rice Price Policy). Risalah Hasil Penelitian Sosial Ekonomi dan Pengembangan. Puslitbangtan. Hal Tomek, W.G. and K.L. Robinson. 99. Agricultural Product Prices. 2 nd edition. Cornell University Press. Ithaca and London. Widodo, S Ekonomika Mikro (Microeconomics). Program Studi Ekonomi Pertanian. Program Pascasarjana Universitas Gadjah Mada. Yogyakarta. Jurnal Agro Ekonomi, Volume 23 No., Mei 25 : 7-8

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