Food Prices, Inflation, and Government Policy: Understanding Current

Food Prices, Inflation, and Government Policy: Understanding Current

Food Prices, Inflation, and Government Policy: Understanding Current Events Using Supply and Demand Professor Norman Cloutier, Director UW-Parkside Center for Economic Education Wisconsin Money Smart Week Green Bay, October 16, 2008 Madison, October 17, 2008 What has been happening to consumer prices? 12-month CPI Change Inflation Rate 12-month CPI D

4.5 4 3.5 3 2.5 2 1.5 1 0.5 0 99 ec- -01 r p A 02 p

Se 04 n Ja 5 y-0 a M Time -06 t c O 08 b

Fe 09 l u J Overall vs. Core CPI CPI Core CPI= Energy and Food CPI Core CPI 130 125 Price Index 120 115

110 105 100 -99 c e D -01 r p A -02 p e S -04 n

a J 5 y-0 a M Time -06 t c O -08 b e F

09 l u J World Wheat and Maize Price Wheat Maize 600 500 Price Index 400 300 200 100

J 0 8 ul-9 9 c-9 e D 1 r-0 p A -02 p e S

-04 n a J Time 5 y-0 a M -06 t c O -08 b

e F -09 l u J Percentage of Household Budget Devoted to Food Country Food Share Tanzania 73.2 % Vietnam

64.7 % Bangladesh 56.0 % Japan 14.9 % United States 9.7 % Haiti Philippines Somalia

Mexico Economic Forces Behind Rising Food Prices The Good. . . The Bad. . . and the Ugly Demand and Supply Shifters Demand Supply Tastes Technology Income

Input costs Number of buyers Number of sellers Price of related goods Price of related goods Expectations Expectations Government policy Government policy The Good Worldwide economic growth has lifted

millions of people out of poverty Worldwide Poverty Poverty Measure 1981 2005 Number < $1/day (mil) Percentage < $1 day 1,528.3 41.7% 869.0 16.1% Number < $2/day (mil) Percentage < $2 day

2,541.5 69.4% 2,597.8 47.6% China and India continue to experience extraordinary economic growth Projected Real GDP Growth Rates 2008 2009 China 9.3% 9.5% India 7.9% 8.0% Rising income has increased the demand for food, and changed the diet of people in developing economies. Price

Supply of Food P2 P1 D Demand for Food Q1 Q2 Quantity The demand for food and the short run supply of food are highly inelastic. In the short run, even small increases in demand can cause large increases in price. Elastic Supply P Inelastic Supply S

P S Demand Increases Q Demand Increases Q

The Bad Supply shocks have increased the cost of producing cereals Bad Weather Six year drought in Australia Flooding in Argentina and the U.S. Rising Input Prices Increase fuel prices Increase fertilizer prices Supply shocks have increased the cost of production. Price S Supply P3

P2 P1 D Demand Quantity The demand for food is also highly inelastic. In the short run, even small decreases in supply can cause large increases in price. Elastic Demand P Supply Decreases Inelastic Demand P Supply Decreases

D D Q Q The Ugly Government policy has contributed to the hike in worldwide food prices

The US government subsidizes the production of ethanol made from maize (corn). US refiners using corn-based ethanol receive a $0.51/gallon subsidy from US taxpayers. Government subsidy increases the demand for corn, directly raising its price. As more land is devoted to corn production the supply of production substitutes, like soybeans, shifts to the left. P Corn P S Soybeans S1 S1

P2 P2 P1 P1 D1 Q1 Q2 D2 D Q Q2 Q1 Q Between April 2007 and April 2008, the US expanded corn acreage 23%,

resulting in a 16% decline in soybean acreage, and a 75% rise in soybean prices. - World Bank, July 2008 Corn Ethanol Subsidy Facts Maize used for ethanol accounted for 70% of worldwide increase in maize production 2004-2007. Today about 33% of the US corn crop is used in ethanol production. Filling the 25-gallon tank of an SUV with pure ethanol requires 450 pounds of corn which contains enough calories to feed on person for a year. How Biofuels Could Starve the Poor, Foreign Affairs, May/June, 2007. US Ethanol Production Plans Energy Policy Act of 2005 US Ethanol Production (millions of gallons) 40000 35000 30000 25000

20000 15000 10000 5000 0 1975 1980 1985 1990 1995 2000 Ethanol Production 2005

2010 2015 2020 Other Government Policies Contributing to Higher Food Prices US $0.54/gallon tariffs on imported ethanol Conservation Reserve Program Weak US dollar Changing world trade policy on food Student Exercise 1 Why are there are significant differences across countries in price and income elasticities of food demand? Given these differences, what impact will future price and income changes have on peoples lives?

Go to USDA Economic Research Service and find food budget information for 114 countries: http://www.ers.usda.gov/Data/InternationalFoodDemand/Index.asp?view=PEB#IFD Example: Food price elasticity How sensitive are consumers to rising food prices? p= % quantity demanded % price Example: US= - 0.082 Bangladesh= - 0. 372 Food income elasticity How sensitive is consumer demand to rising income? = % quantity demanded % income Example: US= .103 Bangladesh= 0.733 Student Exercise 2 Who exactly gets US farm subsidies? Go to the Environmental Working Group:

http://farm.ewg.org/sites/farmbill2007/ Find the largest recipients of farm subsidies in your area. Using demand and supply, model the Conservation Reserve Program. Example Largest crop subsidy recipients 2003-2005, by area: Wisconsin Mitchell Melms, Orfordville ,WI $477,976 Brown County David Stencil, Denmark, WI $190,911 Dane County Kurt Wileman, Edgerton, WI $396,172 Student Exercise 3

What effect do rising food prices have on the standard of living in different countries? Go to USDA Economic Research Service and find food budget information by country and calculate a simple Consumer Price Index. Example % of total budget devoted to food: US 9.7% Bangladesh 56.0% Current CPI 100= (Wf)x(Pf) + (Wo)x(Po) US 100= (.097)x(100) + (.903)x(100) Bangladesh 100= (.560)x(100) + (.440)x(100) Impact of 100% increase in food price and 5% increase in other prices US 114.2= (.097)x(200) + (.903)x(105)

Bangladesh 158.2= (.560)x(200) + (.440)x(105) US standard of living would decline 14.2% while the Bangladesh standard of living would decline 58.2% 2007 GDP per capita: US $45,800 price adjusted= $40,105 Bangladesh $1,400 price adjusted= $885 Questions? Contact Info: Professor Norman Cloutier, Director Center for Economic Education University of Wisconsin-Parkside 900 Wood Road Kenosha, WI 53406 Phone: 262.595.2572 Email: [email protected]

UW-Parkside Center for Economic Education Web site: http://www.uwp.edu/departments/economics/cee/

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