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Wednesday, October 9, 2013

Farm-to-Food Price Dynamics

Randy Schnepf
Specialist in Agricultural Policy

Heightened commodity price volatility since 2008—driven by major market-shifting events including increased demand for corn under strong federal biofuels incentives, a prolonged surge in China’s soybean import demand, and the severe U.S. drought of 2012—has generated many questions about linkages between farm commodity prices and U.S. food price inflation from Members of Congress and their constituents. This report responds to those concerns by addressing the linkage between farm and retail food prices. Retail food price inflation is addressed in CRS Report R40545, Consumers and Food Price Inflation.

Price is the primary mechanism that links raw farm commodities through the various levels of the market system to the retail food product. The nature of price transmission between farm and retail levels depends, in general, on the size of the farm share of the retail price and the degree of market competition at each stage of the marketing chain. For example, the farm share represents nearly 54% of the retail value of a dozen eggs. Similarly, it ranges from 30% to 50% for most fresh meat retail product prices. In contrast, the farm share is only about 8% of cereal and bakery product prices.

An array of costs is layered on top of the price of a raw agricultural commodity at each stage of the marketing chain as it moves to the consumer. As a result, the farm share of a food product’s price declines as it moves to the retail outlet. Since 1950, the average farm share has been declining as a share of total consumer food expenditures, falling from about 41% in 1950 to 15.5% in 2011. This has important implications for farm-to-retail price linkages because the smaller the share of farm value in the retail product, the smaller will be the effect of a change in farm price on the retail price.

Economic analysis of farm-to-retail price transmission leads to three generalizations: first, causality usually runs from changes in farm prices to changes in retail prices; second, time lags in retail price response to farm price changes are generally months in length, even for perishables like milk, meat, and fresh fruits and vegetables; and third, retail prices appear to respond asymmetrically, with adjustments to increases in farm prices occurring faster and with greater pass-through than adjustments to decreases in farm prices. This last generalization is often referred to as “sticky” retail food prices—that is, retail prices follow commodity prices upwards rapidly, but fall back only slowly and partially when commodity prices recede.

“Sticky” retail price behavior is supported by empirical evidence; however, economic theory does not fully explain the observed phenomenon. Economists have noted that certain aspects of consumer behavior, as well as store inventory management and retailing strategies, may limit retail prices from adjusting fully to downward farm price movements. As a result, the presence of asymmetric price transmission alone does not necessarily imply abnormal or excessive market power.

Comparisons of price data for major food groups confirm that farm-to-retail price transmission behaves slowly, with substantial lags and asymmetry. For example, the rise in farm prices that occurred between 2006 and mid-2008 was substantially larger and occurred about six months earlier than the rise in corresponding retail food product prices. Similarly, the subsequent fall in farm prices from their 2008 peaks preceded the downturn in corresponding retail food prices by several months.

Date of Report: September 27, 2013
Number of Pages: 45
Order Number: R40621
Price: $29.95

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