Food Prices

Food Prices

In early 2008 there is a lot of talk about the rising price of food. This seems like a good opportunity to talk about what determines price. See this New York Times article about the effect of drought on rice production in Australia1 Here's the video that goes with the story.

The Chicago Board of Trade is a market for many agricultural commodities, including "rough rice". Click on one of the chart symbols in the embedded page below to see how rough rice prices have changed over the last year.

Chicago Mercantile Exchange Rough Rice Prices

Rough Rice Futures quotes

The New York Times on 4/19/08 had an article called Sticker Shock in the Organic Aisles, about rapidly rising organic food prices. According to the article the price rise is due to lower incentives for farmers to switch to organic farming due to high prices of conventional commodities.

Amartya Sen contributed an Op-Ed to the New York Times on May 28, 2008, where he explained that a major cause of the "world food crisis" was uneven growth rates in poor countries. People in those countries get wealthier and increase their demand for food, pushing prices up. People in those countries who did not share in the growth face higher food prices without higher incomes. When some countries try to moderate the rise in food prices by restricting exports, that reduced global supply pushes prices still higher in other countries.

You might think high commodity prices would benefit farmers in small countries. But - as the Guardian newspaper points out in an August 12, 2008 article - many of these farmers have no access to markets, either because they consume all their own crops (called subsistence farming) or they lack roads, transportation and other infrastructure to get their product to a market. So while these poor country farmers do not benefit from high product prices, they suffer from high fertilizer prices. The article suggests that fertilizer prices are high because of high demand - including demand for biofuels - and limited supply. It takes time for supply to adjust. Until it does prices will be high. The price acts as a signal that more supply is needed, and provides an incentive for fertilizer producers to invest in increasing output. This time factor is not emphasized enough in most introductory microeconomics courses.

Tyler Cowen argued in an April 2008 Op-Ed that restrictions on international trade and government-controlled markets have contributed to the increase in food prices.

According to a June 10, 2008 story in the New York Times, farmers (suppliers) are working to respond to high prices by increasing production. There would be something very wrong if they weren't. That's how markets work. High prices provide an incentive for producers to increase production. The high price acts as a signal: "please produce more rice." The U.S. Department of Agriculture forecasts a small but steadily increase in U.S. rice production over the next decade.

Speculators are Not the Problem

It seems everybody has an opinion. Speculators are the latest target of lawmakers (as of June 2008). Speculators are investors who buy something that they think will increase in price or sell something that they think will fall in price, hoping to make a profit if they are right. In June 2008 Paul Krugman of the New York Times (and a Nobel Prize-winning economist) explained that speculation was very unlikely to be the cause of rapid increases in oil prices and that the talk of speculators manipulating the market is nonsense. He noted that iron ore prices had risen a similar amount, and you can't speculate in iron ore because it's not traded on an exchange. He points to increased demand as the most likely explanation, and notes that politicians are eager to blame speculators because it saves them from having to make unpopular decisions about energy usage. The Chicago Mercantile Exchange (where many commodities futures are traded) produced an analysis which shows that index speculation is not correlated with high commodity prices. Note this informed comment about the role of speculators.

Volatility in commodities prices make it difficult for farmers to plan, as prices change rapidly but crops takes months to plant and grow. When demand for milk falls, dairy farmers cannot just stop producing milk, because to do that they would need to cull their herd.

Farm Subsidies

There's an overview of analysis on farm subsidies in the Freakonomics column in the New York Times. The bottom line is that there's no justification for them. Despite that, the European Union spreads agricultural subsidies far and wide.

Commodities Markets

Scene at a commodities exchange from the movie "Trading Places" starring Eddie Murphy, Dan Aykroyd and Jamie Lee Curtis:


Market manipulation happens in real life, too. The Dairy Farmers of America Inc. was allegedly caught trying to manipulate milk futures prices.

Biofuels

According to the Guardian newspaper of 4/19/08, the European Union is set to scrap biofuels targets. Mandatory biofuel requirements shift the demand curve for corn and other crops to the right. However, the supply of farmland is limited, so the market price increases, increasing the price of food. A 2009 study suggests that one quarter of grain crops feed cars, not people.

Sugar

Import quotas on sugar artificially increase the price for sugar in the U.S. According to a Wall St Journal article, U.S. firms can pay nearly double the world price for sugar.

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