Abstract
This paper examines the relationship between the price of an aggregate of agricultural outputs and raw material price in two situations: (i) when product heterogeneity within the product group arises from aggregation over heterogeneous commodities of different competitive industries, and (ii) when product heterogeneity arises from product differentiation among similar products in a monopolistically competitive industry. We show that a positive relationship between the aggregate price spread and the agricultural raw material price could result from input substitution between the raw material input and other inputs in response to changes in the relative raw material price. Indeed, within a composite product group there is likely to be significant input substitution, in response to changes in relative input prices, because of the increased opportunities for efficiency gains from altering the composition of the heterogenous commodities within the composite product. Therefore, when analysing aggregate price spread behaviour of agricultural commodities using data on composite product, one should be cautious in attributing observed markup pricing behaviour to market power resulting from imperfect competition.
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