Economic Policy & Analysis

Week Four – Case Study:

Food Cost Crisis

1. When the relative price of food to other goods and services increases, how do consumers respond?

As the price of commodity foods rise other related foods also rise. This causes food prices to rise in general. When the cost of food rises more quickly than the cost of other common goods, people and markets must adjust. One of the immediate adjustments made is that people purchase food with lower quality or just lower quantity (Ki-Moon). Consumers will most likely opt to reduce quality first because the marginal cost of purchasing the added unit of quality is not worth the benefit (McKenzie & Lee, 319). However, in some cases the consumer is already purchasing the lowest level of quality so must, by lack of other options, reduce the quantity (Ki-Moon). To further demonstrate this point Ki-Moon states:

When people are that poor, and inflation erodes their meager earnings, they generally do one of two things: They buy less food, or they buy cheaper, less nutritious food. The U.N. World Food Program is seeing families that previously could afford a diverse, nutritious diet dropping to one staple and cutting their meals from three to two or one a day.

Consumers will also look to find substitutes. When the food they normally purchase has an increased cost, they may look to find a close substitute that can take its place at a lower cost (McKenzie & Lee, 277).

We must ask why the price has increased disproportionately. One interesting point that should be considered is that since the last major food cost increase, 1974, “global food prices tumbled dramatically; from 1974 to the early 2000s, real food prices, on average, fell 75 percent” (Garber). This is not a cause of the recent increase but only a notable point of reference. Ki-Moon and Garber all point to three major contributors; higher oil prices, ethanol production and increased demand from overseas. Higher oil prices increase the cost of shipping crops, food and fertilizers; Ethanol production competes with food and reduces the supply; higher demand by emerging countries, namely China and India. One additional factor as noted by Ki-Moon, is the weather related crop problems of recent years, destroying crops and reducing the supply.

2. What role does increasing wealth in developing nations play in increasing the demand for such commodities as corn?

The complexity of the economics of demand on this food issue run from ethanol production to cattle feed to cars. As countries such as China and India gain more wealth, the demand for raw commodities, such as corn, increase locally. The demand for more high quality foods like beef, pork and chicken increase (Garber). Chicken and beef demand increases cause the supplies needed to raise them to also increase. In this case beef, pork and chicken all need corn and grain to be produced at a high quality. They will also demand more food in general. As more food is demanded the cost is pushed higher. Middle class consumers who are now demanding more food do not necessarily use it efficiently. For example in the U.S. we waste large amounts of food because it is considered a luxury to do so. This has likely been caused by the very low priced food supply we have been enjoying for many years (Garber).

Now the complexity is increased when we look at the developing nations now having more money to spend on luxury items like automobiles (Forney). With an increased demand for automobiles, the demand for fuel to operate them also increases. This added demand for fuel (along with many other reasons) has increased the cost of oil. Now the cost for oil is high enough that people are looking for substitutes (McKenzie & Lee, 277). What is the most popular substitute? Ethanol, made from corn, soybeans etc. Now the food and fuel are in competition, and people are willing to pay more for fuel than food.

3. What short-term effects and long-term effects can we anticipate in agriculture?

Some of the short term effects that we will see are already apparent; high priced commodities (Ki-Moon), increased profits for farmers (Washington Post), government price restrictions (Kingsbury) and a need for additional charitable contributions (Ki-Moon, Washington Post). Government price restrictions are probably the most harmful to the efficiency of the economic market (McKenzie & Lee, 64) because, unless there are additional government subsidies, there will be fewer suppliers willing to produce food at the lower price and will further reduce the supply. The charitable contributions may also pose a problem if the relative cost of food has increased. There may be people who were willing to give additional gifts to charity but must now redirect that money toward food.

Long term effects will be changed government policy (Washington Post), more farmers entering the food market, a drive to increase crop productivity in poor countries, develop programs to reduce the impact of natural disasters and improve market efficiencies (Ki-Moon). The last three suggestions will obviously increase the food supply and reduce prices. The more interesting effects are the drive for more farmers to start producing food crops. Because the price demanded now is higher the profit of farmers is up and therefore the marginal cost of producing another unit of that crop are lower. For this higher profit of each marginal unit produced, it is of higher benefit to produce more (McKenzie & Lee, 319-320). The effects of government policy change are sometimes counter intuitive. As mentioned above with price caps (implemented to reduce the cost on constituents) the cost will actually increase because the willing suppliers will be diminished. However, by subsidizing the appropriate crops (and their uses), it is possible to increase the supply of food stuffs and make the current suppliers more efficient in the US and around the world.

4. Is there an ethical dimension to the U.S. government subsidizing the use of corn for ethanol production? As Christians, what do we have to say about this program? Use Biblical references as well as economic theory to address the issues involved.

Again we are back to the question of substitutes. When looking only at the U.S., Where food is still relatively low priced, corn is valued less. However, fuel prices are very high. So the shortsighted government saw that it was in the best interests of our country trade some of the (low cost) corn for (high cost) fuel. Now the ethical question comes because at the cost of having reduced fuel cost hundreds of thousands of people in other countries (the closest being Mexico) not able to feed themselves. This means that you and I will save several cents each time we fill our tanks and other people (women, children and elderly people) eat only one meal each day in place of three (Ki-Moon).

What is the responsibility of us, as believers? Titus 3:1 tells us to be subject to our rulers and Romans 13:1 encourages us that God appointed the rulers. That is only one side though, the other side is our responsibility to feed the hungry. Jesus reminds us in Mathew 25:35 “For I was hungry, and you gave me something to eat.” This is an avenue for us to display our love for Christ.

Forney, Mathew (October 18, 2004). China's quest for oil. Time. Retrieved March 14, 2008 from: http://www.time.com/time/magazine/article/0,9171,501041025-725174,00.html.

Garber, Kent (2008). The Growing Food Cost Crisis: Sharp price hikes are hurting the poor and sparking violence. U.S. News & World Report. March 7, 2008.

Kingsbury, Kathleen (November 16, 2007). After the Oil Crisis, a Food Crisis? Time. Retrieved March 14, 2008 from: http://www.time.com/time/business/article/0,8599,1684910,00.html.

Ki-Moon, Ban (March 13, 2008). Food price crisis grows. The Hartford Courant. Retrieved March 14, 2008 from: http://www.courant.com/news/opinion/op_ed/hc-ki-moon0313.artmar13,0,5949087.story.

McKenzie and Lee (2006). Microeconomics for MBA's: the economic way of thinking for managers. New York: Cambridge University Press.

Washington Post (March 14, 2008). Food Crisis. Washington Post (online) Retrieved March 14,2008 from: http://www.washingtonpost.com/wp-dyn/content/article/2008/03/13/AR2008031303347.html.