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A food system firm faced with a change in the cost of an input has
several options. If the input cost increases, the firm can (1) absorb
the higher costs by keeping its prices steady and accepting a lower
profit level, (2) pass on at least some of the higher costs by raising
the price of products, or (3) adjust its production process and employ
fewer units of the higher cost input by substituting one or more other
inputs. If the input cost decreases, the firm has the opposite options—higher
profits, lower output prices, or expanded input use. Of the three
options, the last two can directly affect food prices either by the
firm raising the price of its food products or by food production
adjustments that influence the amount of food available and thus its
price.
Several key factors influence how an input cost increase might
affect the prices of food and kindred products under conditions
of competition among numerous firms. For a given increase in an
input's cost, the larger will be an increase in the food product's
price when:
- The share of the input in the total cost of producing food
products is larger.
- The input has fewer good substitutes in the food production
process—that is, few other inputs or processes could be used
to produce the food product.
- Consumers have few good substitutes for the food product, in
which case consumers do not decrease purchases substantially when
the price is higher.
- A short period of time is considered, as a rule of thumb. For
example, weather or transportation problems can temporarily cause
sharp price increases, with prices returning to previous levels
once the problem ends. If instead an input cost increase is permanent,
two types of long run responses affect the product's price. On
the one hand, consumers more readily find and use substitute food
products as more time passes, which would tend to make the price
increase of a particular food larger in the short run than in
the long run (mimicking the earlier case of weather or transportation
problems). On the other hand, the input cost increase can affect
some firms' ability to remain in business. As those firms leave
the market, the price increase would be larger in the long run
than in the short run. The relative strengths of the consumer-side
and firm-side changes determine the ultimate path of the product's
price.
All these forces may be exerting pressures for higher prices when
the cost of an input in food production increases. Retail food prices
are more volatile than the prices of other goods and services. Market
conditions, such as whether a market has relatively few firms, can
play an important role. Yet, casual observation of food price patterns
reveals that food prices do not change every time an input cost
changes. Rather than using general rules of thumb to explain the
relationship between food input cost increases and retail food prices,
it is often better to examine such effects on a case-by-case basis.
Three such special studies are:
Effects of taxes on food markets. ERS studied a
flat income tax system—that is, a system that would have a
single Federal income tax rate and no exemptions, deductions, credits,
and deferrals. If such a system replaced the current one, several
food market indicators would change. Our findings support the widely
held view that even though a flat income tax system would increase
national income, gains for consumers would be modest. Furthermore
economic growth would not benefit all parties. A flat tax structure
would lead to smaller and slower growing farm industries, larger
and faster growing food industries, higher food production costs
but unchanged consumer food prices, reduced net farm exports, and
reduced net food imports. Some of these indicators vary substantially
by region. If States were to enact similar reforms, consumer food
prices would drop 1.5 percent nationally and over 4 percent in the
Delta, Appalachia, and Southern Plains regions. For more information,
see the ERS report, How
Do Taxes Affect Food Markets?
Minimum wage and food prices. Will increasing the minimum
wage increase food prices as well? This study shows that a simulated
$0.50 increase in the minimum wage, which was 12 percent of the
$4.25 minimum wage at the time, if entirely passed on to consumers,
would increase food prices by less than 1 percent for most of
the foods at food stores and by 1 percent at eating and drinking
places. Because these estimates were simulated using an economic
model that assumed that firms did not alter their production processes
when faced with higher minimum wages, these estimates are likely
to be "upward bounds" of the price effects of a minimum wage increase.
For more information, see the ERS report, How
Much Would Increasing the Minimum Wage Affect Food Prices?
Energy prices. ERS uses a variety of economic models to estimate
the impact of higher input prices on consumer food prices. ERS compares
three models. Two models are referred to as "short run" models in which
neither consumers nor food producers respond to market prices. In the
"long run" model, both consumers and food producers respond to changing
prices. The authors simulated the impact of a higher energy price on
consumer food prices. The empirical findings are consistent with expected
market responses. In the short run, the effect of an increase in the
price of energy is fully (or nearly fully) passed on to consumers because
neither food producers nor consumers can immediately respond to changing
prices. In the long run, however, the price response of food producers
and consumers serves to mitigate the increase in consumer food prices. For more information, see the ERS report, Changing Consumer Food Prices: A User's Guide to ERS Analyses.
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