Subsistence Response to Market Shocks

Microeconomic models posit that transaction costs isolate subsistence producers from output market shocks. We integrate microeconomic models of many heterogeneous households into a general equilibrium model and show that supply on subsistence farms may respond, in apparently perverse ways, to changes in output market prices. Price shocks in markets for staple goods are transmitted to subsistence producers through interactions in factor markets. In the case presented, a decrease in the market price of maize reduces wages and land rents, stimulating maize production by subsistence households; however, real incomes of subsistence households fall. Copyright 2006, Oxford University Press.