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According to the Law of Supply, if price increases, there is an incentive for producers to produce more, and therefore the quantity supplied increases. However, for an inelastic good, if there is a supply shock and supply significantly increases, why is there a drop in price? Can't the suppliers sell their product at the same or a higher price to increase total revenue?

Low price elasticity of demand, together with fluctuations in supply over short periods of time, creates serious problems for primary commodity producers, because they result in large fluctuations in primary commodity prices, and these also affect producers’ incomes. A good crop resulting in a supply increase leads to lower prices and lower farmers’ revenues. We come, therefore, to the ironic conclusion that a poor crop may be good for farmers because it increases their revenues while a good crop may be bad for them. Can't the farmers sell their product at the same or a higher price to increase total revenue?

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You are describing a special (although very important) market where the short-run market supply function is vertical : farmers will attempt to sell whatever they have produced, irrespective of what that will do to the unit price. I am not saying this is not reasonable: many agricultural products are not really storable (or require special infrastructure in order to be stored), and there is certainly increased pressure to sell, compared to other products.

And indeed, in such a case, one can see a "good crop" bringing in lower total revenues, due to relatively inelastic demand. This is after all the core reason why government price subsidies in the agricultural sector (i.e. supplementing the farmer's income to compensate for low market price) is the rule rather than the exception, in virtually all market economies around the world, where very few other final products enjoy price subsidies (and only temporarily, while for the agricultural sector, it is essentially a permanent situation, of course not for all agricultural products).

Also, as another real-world remark, it is not uncommon for farmers to withhold and even destroy part of their crop in order to safeguard prices (and thus end up with higher total revenues compared to what they would have get if they have sold all the crop at a lower price).

I am not sure I understand the last sentence/question in your post. In what sense farmers "can" or "cannot", "sell at the same or higher price"? And "same" compared to what?

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  • $\begingroup$ Why do the farmers withhold or destroy a part of their crop? You said that this is in order to "safeguard prices" (which I do not really understand), and thus end up with higher total revenues compared to what they would have get if they have sold all the crop at a lower price. It seems to me that the farmers have decreased their prices as a result of this "good crop" - why are they pressurised to do so? Why can't the farmers sell their product at the same or a higher price to before the "good crop" to increase total revenue, as so happens for goods with inelastic demand? $\endgroup$ – GoodChessPlayer Oct 26 '15 at 21:43
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    $\begingroup$ Farmers do not set the final selling prices. They may ask for a price, but if quantity supplied increases at market level, they will not find wholesalers willing to pay it, but only a lower one (because in turn, the wholesalers expect that in order to push the increased quantity down the line, they will have to sell it for less than previously, especially if (final) demand elasticity is low (which cuts bot ways). Price adjusts to quantity here, not the other way around, because quantity must be sold. If "a good crop" happens only to a few farmers, then they may enjoy higher revenues. $\endgroup$ – Alecos Papadopoulos Oct 26 '15 at 22:59

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