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Monday December 11, 2017

Why aren't meat prices behaving as expected?

"Why is beef demand growing as per-capita income shrinks?" BEEF magazine editor Wes Ishmael pondered in a Jan. 2014 column written to cattle ranchers. The gap between rich and poor has widened, income growth at the bottom is stalled, and beef prices are leading nagging food inflation. "None of that should be positive news for commodity products with a high price compared to substitutes;" he noted, "beef vs. chicken and pork in this case." Yet Ishmael is surprised to point out that annual retail demand for beef has continued to defy expectations and to rise during those developments. "There’s no simple explanation for this paradox between dwindling domestic per-capita wealth overall in tandem with growing demand for pricier beef."

Now, a study scheduled for publication in the journal Applied Economic Perspectives and Policy by Oklahoma State ag economist Jayson Lusk and Kansas State ag economist Glynn Tonsor has attempted to explain and quantify that paradox.

Why haven't expenditures for beef and pork fallen as much as some people expected given their high prices? Lusk and Tonsor's modeling, based on monthly consumer surveys conducted by Lusk's department which Farmer Goes to Market has reported on in the past, implies that the rules of meat demand may have changed. For one, although relative price swings have favored chicken over beef and pork, consumers don't seem to have switched to chicken to a high degree. Second, they suggest the elasticity of demand for meat, particularly beef, may not follow a straight line as traditionally predicted.

Here's a little Economics 101: Price elasticity is the measure of how much demand changes when price goes up or down. Inelastic products tend to be those goods and services that are necessities and used only in fixed amounts despite price swings, like utilities. If the price comes down, people don't necessarily increase consumption. In contrast, luxury goods consumption responds to price. Demand for those goods is known as elastic.

Lusk and Tonsor note in their study that past research has questioned the value of traditional demand models to accurately explain the elasticity of consumer demand for many commodities. Now, their work reveals non-linear demands for meat products, with demand being more inelastic at higher prices.

As their graphs for the competing meats point out, the demand plot for each product and income class is curved, not straight, implying that demand becomes more inelastic as prices rise. Price changes at the upper end don't change the quantity demanded as much as price changes in the lower end of the distribution. This phenomenon helps explain the surprise expressed by some analysts at the continued strength of beef and pork expenditures despite higher prices. In addition, elasticity of demand also varies by income level of the consumers. For some products, like pork chops, the demand curves for low-, middle-, and high-income consumers aren't markedly different, except at high price levels. But for other products like steak, income changes result in large shifts in demand. In all cases, but perhaps most easily seen for ground beef, the demand curves for high-income consumers are more inelastic than that for low-income consumers.

Demand curves for meat behave unexpectedly

The ag economists point out several implications of their work. Although it's common to use estimated elasticities of demand not only for market research, but also to set policy and to forecast long-term prices, net farm income, government expenditures and other statistics, most may be over-reliant on traditional straight-line demand elasticities. In many applications, analysts assume constant elasticities over all price ranges, and as a result may over- or under-estimate economic impacts if elasticities actually behave as their modeling suggests. Even setting retail beef prices may need rethinking based on the work: The old assumption that holding retail prices high hurts demand across the board for beef may not be as cut-and-dry as assumed in the past.

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