Food demand and price volatility

In Mankiw's Principles of Microeconomics textbook, he poses students the following paraphrased question: Your friend notes that food has a very high demand elasticity and comments that it would be a good source of tax revenue. In what sense is your friend right about it being a "good" tax and in what sense is the tax "not good"?

Most students successfully answered that it was "good" in the sense that it would generate a lot of tax revenue, (missed the part of it being "good" in the sense that there would be very little deadweight loss), and that it is "not good" in the sense that it will hurt the poor who may not have enough to eat more than the wealthy.

FAO in its new High Level Panel of Experts report on food price volatility takes that excellent point one step further in rigor. As societies and individuals become wealthier, their demand for food becomes less sensitive to price (less elastic). This means when any price change occurs, it is the poorer consumers who will change their consumption pattern most. When all food prices increase and it isn't because of an increase in demand*, the poor have less to eat while the non-poor are still able to have enough food.

Food price volatility increases the inequality of food consumption. They also show that biofuel policies increase the inequality of food consumption even further, shaping a food system designed to hurt the poor more when food prices rise.

Best tweets of the protests

This is another post I will be updating occasionally: some entertaining tweets about the fuel subsidies (in some cases, spelled out further for the Twitter-impaired)

On economics:
This is the point where I wish I concentrated during those classes on Economics
There are 3 groups of Nigerians at the moment: 1, those fighting for the fuelsubsidy; 2, those fighting against the fuel subsidy, 3. Those who don't even know what subsidy is. I'm no. 3.
The market for high heels have died with the market for cabs.

On cars:
If he puts on the AC in his car for you, marry him!
Abuja Bigboy spotted Oppressing as he left his engine on while waiting for girlfriend

Tried on a new shirt. Kinda tight. I'm not there yet but I'm on my way. My Fuel subsidy "strolls" should do the rest!
Lol! We be blaming everything on the fuel subsidy. Employer: "why are you 2 hours late to work" Employee's reply: fuel subsidy.

Taking things too seriously at lunchtime

This PhD Comic from two years ago presents a model of predicting how good food will taste. As the cost of the food approaches 0, it doesn't matter how hungry you are or what quality the food is, it's going to taste really good. So far, so sensible.

BUT. This flies in the face of research that tells us people think wine (for instance) tastes better when people are told it costs more - even though the wine tasting was free. If both relations hold, then, this one only holds for some foods or for foods below a certain cost.

Let us study the other implied relationships to see if this is a reasonable formulation of the relationships between variables. If you hear someone describing how good some food was and you want to determine its actual quality, you might try transforming the above equation to read:

Quality = Taste * Cost / Hunger

This would lead you to ask the person how much the food cost and how hungry they were. If they were particularly hungry, you would discount their tasty tale appropriately. Sounds pretty reasonable. If you also ask the person about the cost, you're playing a game well-known to The Little Prince (see quotes 6 and 7). This is probably the most sensible transformation of the equation.

Now let's pretend instead you are a perfect monopolist who is able to prevent anyone from reselling your food and you wish to extract the maximum consumer surplus possible. You know how hungry your customers are and how good the food will taste to them. By using the Law of Free Food, you derive

Price = Quality * Hunger / Taste

You should charge your customers more for high quality food than for less and you charge them more when they are hungry. Sensible enough. The better tasting the food, the ... Lower the price?? If this were true, you would serve everyone very high quality petroleum products and caster oil.

Let's try this again. Suppose you are trying to decide if you are hungry enough to eat the food in front of you. You must be at least as hungry as:

Hunger > Taste * Cost / Quality

This tells us that you have to be very hungry before you consume expensive food but cheap food is fine for snacking when you have the munchies. Okay, this is about not wasting high cost food, I can maybe see that. In a similar vein, you have to be very hungry to eat trash while you don't have to be very hungry before you eat high quality food, all else equal. However, the better tasting the food is, the hungrier you have to be before you're willing to eat it. Hunh? I would say the opposite is truer: you have to be very hungry to eat terrible food but you don't have to be that hungry for someone to convince you to have a chocolate.

These applications show us that the Law of Free Food is a quite troublesome relationship as specified. It may be the case that Taste = F(quality, hunger, cost) and that the first derivatives go in the hypothesized directions over a certain space. But the inverse functions clearly demonstrate that the particular specification is rejected by economic research, theory, and common sense. At best, the author needs to claim over what (limited) variable space the above equation is expected to hold.

Lit in review: 3 on meat markets

Anderson and Hudson "Acquisitions and Integration in the Beef Industry" [Policy Issues, Sept 2008] discuss the growth of Brazilian beef processor JBS, who bought up Swift, National Beef, and Smithfield to become the largest beef processor in the US [more recent, unfavorable, views on further expansion here and here]. In the process, they also gained control of the largest feeding operation in the US, vertically integrating these for the first time. The percent of "cattle obtained through non-price methods increased from 20.5% to 40.4% between 1988 and 2006". The factor driving the acquisitions is low cattle numbers and resulting overcapacity. Since 2002, each Congress has considered (without taking action) limiting packers' ability to own cattle directly.

Gunderson, Lusk, and Norwood (2005), "Getting Something from Nothing: An Investigation of Beef Demand Expansion and Substitution," Review of Agricultural Economics, Vol. 31, No. 1, 68-87.
In order to do a proper choice experiment, you have to give participants the option to buy nothing. Most of the time, economists have ignored the nothing, but the authors believe there can be significant information in it (so we can get something from nothing ... clever). Specifically, they investigate how consumers substitute between nothing and new products to identify whether the introduction of a new product increases total demand for the class of products or whether demand is largely stolen from other products in the same class. They find that for a new "natural" steak, total steak demand increases with significant differences in the negative impact between USDA Choice steak (larger negative impact) and ungraded beef (smaller).

In the same issue, Rude and Gervais (2005) consider "Biases in Calculating Dumping Margins: The Case of Cyclical Products."
Dumping is identified by exporting goods at a price below "normal" in the home market. But if you have a cyclical product, the trough periods by definition feature below normal prices. And if you have a case like the US/Canada hog industry, the cycles are very well matched. So US hog producers are upset at Canadian imports just at the same time that prices are low (because prices are low) and so cry "dumping!" The authors find an 11% dumping bias that could only be partially addressed by estimating costs over short time periods.

The perils of buying more ... or less!

Bangladesh has announced that the minimum wage for garment industry workers will be doubled, from $18/month to $35. This would - potentially and eventually - bring some 2.5 million people above the $1/day poverty measure ... but it's actually $1.25 these days, so nevermind. Workers had asked for $55, so the move hasn't stopped the riots. Apparently, a coalition of NGOs and trade unions have decided that the "Asia floor wage" should be about $140/month. Reading a little further into the AFW website shows that even this is pretty low: it would need to be around $250/month to match the $5/hour minimum wage rate we used to have once different prices are included (PPP).

Johnstone discusses fair trade clothing and laments that "many employers will take months or years to implement it or fiddle the figures by imposing impossible production targets that can be met only by unpaid overtime." Western customers can get invigorated by occasional, brand-specific boycotts, but aren't willing to make the connection between cheap clothing and the low wages that made it possible. The recession has moved even more customers into the cheaper clothing, "so the budget fashion industry has had a good recession."

Between that and the 6kg of C02 reportedly released in the creation and transportation of jeans, she decided not to buy any clothes in 2010. "So far I have managed to stick to my resolve. Of course, this is the last thing that my garment worker in Dhaka wants. After all, if she wasn't paid tuppence a piece to make T-shirts, how else might she be obliged to make her living?"

Food Security in Bhutan

IFPRI ran a conference on food self-sufficiency and security in Bhutan, with a number of short papers available here. The conference was called in order to compare food self-sufficiency and food security as goals. Census and survey data found that "food self-sufficiency is negatively correlated with all four indicators of food security," as is self-sufficiency in cereals.

The implication of these findings is some households may be forced into food self-sufficiency by lack of market opportunities, but encouraging household food self-sufficiency is not a useful strategy for achieving food security or reducing poverty.

In order to achieve rice self-sufficiency, it is estimated that Bhutan would need a tariff of 150%, which would also increase the price of rice by 150%. This would increase rice farmer incomes by 2.3 billion Nu/year while costing rice consumers 3.7 billion Nu. Investments that doubled rice productivity, however, would not harm consumers while increasing farmer incomes by 1.3 billion Nu.

They further estimate that current trends in production, land use, yield growth, consumption, and population and income growth would tend to decrease rice self-sufficiency until 2015 when diet transition catches up so that demand begins shrinking again. Bhutan would be 64% rice self-sufficient by 2050, up from 49% today and 43% by 2015.

The other papers provide a decent summary of the state of Bhutan's agriculture, further summarized below the fold:

Quick Lit: Retirement Consumption

One of the minor difficulties for the permanent income hypothesis is that consumption drops significantly when people retire. If people are fully rational, they should anticipate retirement and make small adjustments to their consumption well in advance of retirement so they can live the same lifestyle. Battistin, Brugiavini, Rettore, Weber show that the reason for a 10% drop in consumption is not liquidity problems, but reduced consumption of work-related expenses and leisure substitutes (meals out, clothing, transportation) and a drop in the number of grown children living with their parents. These changes alone count for more than half of the drop in consumption and what's left is not statistically different from 0.

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."

Path dependence and the sugar tax

John Cawley, one of Cornell's many economists, doesn't think NY State's proposed tax on sugared soda will amount to much. At 1 penny per ounce, he says it won't change prices enough to change behavior significantly, it won't raise enough money relative to the state's budget deficit, and it won't cause unemployment because "consumers that stop drinking soft drinks tend to switch to diet drinks, juices and even water often bottled by the same company." In econ-speak, even if the change is statistically significant, he argues it isn't economically significant: 1) a small drop in a big ocean; 2) the demand for sugared sodas is extremely price inelastic.

I tend to doubt #2. So I can buy a 20 ounce Real Coke for $1.95 or a 20 ounce Diet Coke for $1.75 that's sitting right there next to it with their price tags right next to each other. Is Diet Coke such a poor substitute for Real Coke that the sugar is worth more than 10 percent price premium? Even he admits that customers switch to products by the same company, and price is one of those factors that moves people.

But if #2 is true, that means it generates more revenue and undermines his other point. New Yorkers drink a lot of sugared soda. A couple million here, a couple million there, pretty soon you're talking about real money.

Even granting that both arguments could exist simultaneously, there is an institutional reason for going for this. Policy tends to be pathway dependent. Taxes in the door may go up, they may go down, but they rarely leave the building. I doubt that 1 penny per ounce is going to suddenly stop the spread of obesity. But it's a much easier sell to go for 1 penny per ounce now (it's so little) and then 2 pennies and then 5 or 10 or whatever the socially optimal value (t*) is than to go from 0 to t*.

In fact, it's arguments like Cawley's that will help get it passed: it's so small, what harm could it do? So those of us in favor of it (like Adam Smith) should ... probably stop criticizing his argument.

Yes, the effect will be small. Very small. Miniscule. You won't even notice.


[Edit: I since spoke with Cawley and asked him for his more nuanced views than news will provide. Yes, he understands all these points very well. He has yet other concerns that the news didn't even touch.]

Revealed Food Preference: A Tangled Web

Time for me to demonstrate why they call it a degree in the PHilosophy of economics. In part, this is an esoteric problem that very few people should care about. In part, it's fundamental to what we as economists can say about the world based on the data we have available. Last week I learned that the relationship between what I buy at the store, what I would say on a survey are my food preferences, what I would tell a bunch of Econ101 students about my food demand, and what shows up in experimental data as my food preferences all give very different answers to my food preferences. Even if we are careful about definitions, it's a terrible mess.

... Edit Update: I spoke to the experimenters and decided that I couldn't describe the economic lessons I wanted to without potentially compromising their future runs if a future test subject read my post. I will re-post it when the sessions have ended, which should be before the summer.

Lit in Review: Food Demand

Roberts and Schlenker (2009), "World Supply and Demand of Food Commodity Calories,"  American Journal of Agricultural Economics November, 1235-42, ungated January version.
They use 2SLS to provide what they term "a useful reality check for whether microcomplexities add up to patterns that are observable in the aggregate data." They gather data on corn, wheat, rice, and soybean production in any country that produces more than 1% of the total (plus one "country" to take care of the remainder) to calculate individual country trends and weather shocks. These are then converted in calories so that there is a single aggregated term.

They assume that demand for calories is unrelated to current weather shocks that affect supply, so current weather shocks trace out the demand curve. There is nothing revolutionary in this, as they point out. The unique idea is that past weather shocks shift the demand for calorie storage but not supply. They is sadly undefended, but if farmers know that demand will be higher the year following a bad one to replenish stocks, there ought to be a supply response too. If their assumption holds, though, they can trace out supply curves too. They estimate a supply elasticity of 0.1 and a demand elasticity of -.04 that may or may not be significantly different from 0. These lead them to conclude that US biofuel policies increased each commodity price by 35%

Toler, Briggeman, Lusk, and Adams (2009), "Fairness, Farmers Markets, and Local Production," American Journal of Agricultural Economics, November, 1272-78.
They perform an experiment at farmers markets and local grocery stores in Oklahoma. Participants write down offers to purchase four tickets, one of which is randomly selected as binding. The tickets pay off:
A) $4 to themselves and $7 to a local farmer
B) $4 to themselves and $7 to an out-of-state farmer
C) $4 to themselves and $1 to a local farmer
D) $4 to themselves and $1 to an out-of-state farmer

The folks at farmers markets were willing to pay a little more for every ticket, but otherwise there was no difference between the groups, nor was there a difference based on how often one went to a farmers market. The average willingness to pay for ticket A was between $3-4; for B and C were $2.50-3, with 54% willing to pay more than $3 for ticket C [giving more to the farmer than themselves in essence]; and $2 for D. They fail to reject the notion that the shoppers at each venue have different concern for inequity or for local farmers. But there was a significant willingness to benefit local farmers over out-of-state farmers, and a significant preference for letting others have the better end of the deal.

Zheng and Henneberry (2009), "An Analysis of Food Demand in China: A Case Study of Urban Households in Jiangsu Province," Review of Agricultural Economics, Vol. 31, No. 4, 873-93.
Uses the update to the Chinese National Bureau of Statistics household surveys to examine basic food consumption elasticities for ten food products. Prices are household specific (amount paid divided by amount consumed according to diary entries). Most of the data is based on 900 households in 2004, and only in-home consumption. Highlighted series of results:

• 1990-2004: Rural households (60% of China) decreased annual grain consumption (262 kg to 219kg) and increased animal consumption (28 kg to 42kg).
• 1990-2004: Urban households decreased grains by more (131kg to 78kg) and increased animals by more (41kg to 73kg).
• Demographics: Average per capita income is $1,286, households usually of 3, it is more likely the third person is a senior than a child, 7% college educated.
• The most price-sensitive foods are grains, oils and fats, dairy, and "other" (tubers, alcohol, cakes, etc.)
• The least price-sensitive foods are aquatic
• As incomes increase, dairy, aquatic, other, poultry, and meats will increase their share of expenditures while fruits, eggs, vegetables, grains, and oils and fats lose share.
• "Pork accounts for more than 70% of ... total meat expenditures."
• Overall, diets are converging to those of Japan, S. Korea, Taiwan, and Hong Kong.
• Poultry consumption was rising steadily, but food safety concerns slowed this process recently.
• Dairy consumption is pretty low, and lower than other estimates have shown, but has increased by 400% percent.
• Half of the cross-price elasticities are significant: meats are substitutes for grains and eggs, but a complement to fish and dairy; vegetables are substitutes for poultry and dairy but complement eggs and fish. If you compensate demand, most everything is a substitute.
• Large portions of meat consumption (over half of poultry) are done outside the home.
• Demand for feed grain will outstrip demand for food grain as incomes increase, requiring an increase in imports from the US. China's land devoted to corn and soy have increased significantly (16% and 25%) with small decreases for rich and wheat (7% and 9%).

Lit in Review: Livestock

One of the things I have looked forward to in starting a work blog was writing up brief summaries of some of the research others' have done with comments. In part I hope to provide a service for others, bringing you a summary of recent research. In part though it's a convenient place for me to keep my notes about research I've read so when I scratch my head trying to remember who said what, I've got my notes most readily available and searchable for my own benefit. Please feel free to debate particular papers or to bring more on a particular topic to my attention.

Review of Agricultural Economics Fall 2009: Livestock articles

"The Economics of Dairy Anaerobic Digestion with Coproduct Marketing" by Bishop and Shumway. Descriptive, single firm. One of the solutions to the pollution livestock produce is to install some machines to turn methane into electricity (anaerobic digestion technology). But is this economical? The authors find that the main private benefits in the first two years of operation for dairy farms in Washington state come from producing and selling electricity to public utilities and in receiving payments for turning other people's organic waste [salmon carcasses, cheese whey, inedible eggs] into electricity. Average profits for running these machines were $75k and $140k in year 1 and 2, but they cost $1.1mil to set up. The authors emphasize that location - proximity to coproduct markets - matters. Regulations would need to be changed to synch up the incentives of farm-energy-producers and public utilities. - Note for Chapter 8. (picture: CalPoly anaerobic lagoon, from Wiki)

"Agricultural Trade among NAFTA Countries: A Case Study of US Meat Exports" by Henneberry and Mutondo. Demand analysis, 1995-2005. US meat exports doubled to both Canada and Mexico since NAFTA [correlation is not causation] and account for 40% of beef, 35% of pork, and 17% of US poultry exports 2002-05. This is despite the 2003 BSE outbreak and increased competition from other countries. Poultry and beef from your own country are substitutes if you don't account for country of origin and complements if you do (Yang and Koo, 1994), so the distinction matters in demand analysis. Canadian meat buyers are not very price sensitive to US meat prices, so increasing meat prices likely means increasing revenues from Canada, but the opposite is true for Mexico. - Meatpacking book

"Costs of Adopting a [HACCP] system: Case Study of a Chinese Poultry Processing Firm" by Wang, Yuan, and Gale. Descriptive, single firm - Beijing Dafa. As part of its accession to the WTO, China has pushed to improve exported meat quality since Dec 2001. Setup cost the firm $4.2mil or 2% of gross income, with ongoing monthly costs of $0.3mil - half of that is sanitation. Benefits were characterized as long-term, strategic, and intangible [reduced inferior and adulterated products, improved reputation, consumer loyalty, and product consistency, and increased exports]. The authors are concerned that the costs may be very difficult for small, domestic producers to recoup, who would likely face higher costs and less ability to increase prices to make up for it. - Meatpacking book