Factor Market Allocative Disequilibrium
Observational StudyReview
Smallholder farms exhibit severe allocative inefficiency across factor markets due to credit and cash liquidity constraints, resulting in underutilization of yield-enhancing cash inputs alongside excess family labor.
Picture this
Imagine a small bakery that packs ten bakers inside a tiny kitchen but can only afford enough flour to bake two loaves of bread a day. The bakers spend most of their time standing around idle because flour is too expensive, even though buying an extra dollar of flour would yield four dollars in fresh bread revenue.
What the evidence says
The marginal product of purchased cash inputs is 4.5 (statistically different from market price 1.0 at p < 0.05), indicating severe input underuse. The marginal product of labor is 484 Birr/month versus a market wage of 1,176 Birr/month (p < 0.01), indicating surplus family labor.
- Who was studied
- N = 2,232 rural smallholder households across 120 Kebeles in Amhara, Ethiopia (2011 baseline survey).
- How
- Instrumental variables (IV) Cobb-Douglas crop production function estimation with Kebele-fixed effects, comparing the Value of Marginal Product (VMP) to Marginal Factor Cost (MFC).
What to do
Inject targeted liquid credit or input subsidies to enable smallholders to scale cash inputs until the value of marginal product equals marginal factor cost.
From the source
"For purchased inputs, the average marginal product is 4.5, which is far above the 'market' value of 1. This implies that inputs are used at levels much below their optimal values."
Productivity, credit, risk, and the demand for weather index insurance in smallholder agriculture in Ethiopia