Thursday, April 29, 2010

Lit in review: 5 and 6 of 7 on Food Prices

About time I got back to this series. Both papers consider food series from supermarket scanners, from 2006-2008 and 2003-2005 respectively, to discuss what happened during the recent food price crisis.

(5) Richards and Pofahl (2009), "Commodity Prices and Food Inflation," Nov, 1450-55.

"Pass-through rates from farm to retail price are likely to vary depending on the nature of the production process, the competitiveness of the vertical supply channel, the number of products sold, and even the direction of the price change." Their structural model studies multiple food firms producing one food each which are offered under contract to a single retailer who chooses whether to accept the contract or not and then sets retail prices for consumers (generalized extreme value discrete choice demand). They compare inflation/deflation pass-through for apples and cereal brands (low processed and high processed).

They find that when commodity prices rise, wholesale and retail margins fall in order to maintain market share - only 75% of the apple price increase is passed on. When commodity prices fall, margins increase temporarily. For cereals, however, wholesale margins rise when prices rise: retailers and consumers expect that prices will rise, so it's an easy time for extra profit even though total costs do not increase much. Retailer margins shrink when cereal prices increase and rise again when prices fall. They conclude that policies to address price changes need to take into account these different reactions: "multiproduct, strategic pricing considerations will not only be important but may dominate the argument."

(6) Berck, Leibtag, Solis, and Villas-Boas (2009), "Patterns of Pass-through of Commodity Price Shocks to Retail Prices," Nov, 1456-61, ungated.

They consider the pass through rates for cereal and chicken from increases in corn, wheat, and gasoline price increases in California. Chicken represents the more grain-intensive food product and has a less concentrated market. Approximately 32% of each is sold by promotions with an average 12-15% discount. "There is considerable variation in price from store to store, despite the fact that all these stores belong to the same chain." Corn makes up 1% of the value of a corn cereal.

Log-log estimation on both gross price and price net of promotions are run with a lagged dependent variable. They find that the frequency of all sales goes down when gas prices go up; the frequency of cereal sales goes down when corn or wheat prices go up; and that corn prices do not change the frequency of chicken sales. Hence, it is important to consider net prices rather than gross prices for understanding price pass-through. Lagging the dependent variable to account for price stickiness and omitted variables shows that pass through is underestimated otherwise for chicken and overestimated for cereals. They claim this is because of storage costs.

Some other studies: Hosken and Reiffen (2004) - "retail promotions account for 20-50% of the annual variation in prices."

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