The Economics of Food Prices

Run on rice at the supermarkets? Food rationing? Luckily these were short-lived phenomena, at least here in the US. Average food prices dropped over 30% in the past twelve months according to the food price index compiled by the Food & Agriculture Organization of the United Nations. However, they are still about 20% over what they were five years ago. For certain food groups such as cereals (including wheat, maize, rice) and oils, the increase is more significant.

Food commodity prices had periods of increase in memorable history. However, this recent increase is more heartfelt. For one, it is lasting for a long period. And it came at a time when many people globally were already in distress due to the increase in energy prices and the collapse of the financial market. Food is a basic ingredient of life. This price increase has caused more hardship for the lower income and poor who need to spend proportionately more of their income on daily necessities.

So why the increase? According to a study conducted by the USDA, the increase was contributed by the following factors. The report did not go into detail about the relative significance of these factors on prices.

Long-term Trends Affecting Food Prices

  • Slowing agricultural production: While food production is still growing, the rate has been slowing due to the decrease in yield growth. In recent years, agriculture research has been leaning more towards cost-reduction than yield-enhancement.

  • Continued increase in food demand: The growth in world population, while at a slowing rate, creates additional demand for food.

  • Shift in food demand: The increase in wealth in the developing countries creates demand for both staple and diversified foods such as meat and dairy products. The latter in turn creates additional demand for grains.

Short-term Trends Affecting Food Prices

  • Adverse weather conditions: Droughts in many parts of the world, as well as flooding and frost, in 2006 and 2007 reduced agricultural harvest.

  • Changing stock-to-use ratio: In early 2000s, there was a drop in food buffer stock as food supply had been readily available, prices were relatively stable, and trade barrier was dropping. However, the low harvest in 2006 and 2007 created panic about potential food shortage and drove up demand for food stock.

  • The growth of the biofuel market: The need for feedstock used for biofuel production is putting upward pressure on demand and hence prices. For example, the percentage of corn output used in ethanol production in the US increased from 10% in the 2002/03 crop year to 24% in 2007/08. The biofuel usage target set by various governments globally for the next few years will continue to put pressure on demand.

  • Protective government policies: Many governments restricted export and encouraged imports in order to secure food supply internally. These actions tend to raise prices in the global market.

  • Depreciation of US dollar: Except the increase in recent months, the US dollar (USD) has been depreciating against other currencies for the past 5 years. The drop in value has two effects. First, The US is a major food producer with products priced in USD. So the depreciation of USD makes US products cheaper for other countries. This effect encourages exports and puts upward pressure on food demand and prices. Secondly, many food commodities are priced in USD in the world market. The drop in USD value artificially increases prices. For example, if a European apple is worth 1 euro (EUR). When 1 EUR = 1 USD, the apple is priced at 1 USD in the world market. When USD depreciates to 1EUR = 2 USD, the apple is priced at 2 USD in the world market.

  • Rise in energy prices: The rise in production cost associated with the use of energy-related products is passed onto consumers.

  • Financial market activities: Speculation and trading from hedge funds and investors may have added short-term price volatility.

In summary, the increase is a direct result of the balance between supply and demand, the fundamental of economics. However, this supply and demand is largely influenced by government policies and market activities. These include trade policies, energy policies, national security policies, central bank/treasury actions, and financial market activities. As we learned from the recent financial crisis, the world economies are very much intertwined. This food crisis underpinned the importance of having coordinated policies both within and among nations.

For more information, visit the Food & Agriculture Organization of the United Nations site (www.fao.org/worldfoodsituation/FoodPricesIndex/en/) and USDA site (www.ers.usda.gov).

  © Natural Choice Network 1996-2020 | Bellevue, WA  |   Phone 425.373.1987