Kub's Den

You go to the grocery store. At the top of your shopping list, you have written: "ground beef," for which you expect to pay about $3 per pound. But when you get to the meat counter, it's actually $7 per pound! "Skip it," you say. "We'll just have to feed the kids chicken nuggets instead of tacos. Or maybe a nice vegetarian lentil stew."

The difference between $7 ground beef and $3 ground beef is pretty stark and many American shoppers would make a clear choice there. But where is the cutoff? Consider hamburger at $3.50 per pound? Or $5? Or $6? Rather than skip the product entirely, a family may just consume somewhat less at those higher price points.

More interestingly, what happens as prices get cheaper? Consumers can afford to buy more of their favorite stuff. Live cattle futures are running about 13% cheaper than they were two years ago at this time. Wheat is similarly 13% cheaper than it was at the start of 2016. Corn and soybean futures have slowly crawled 3% and 5% lower, respectively, during the past year. There must be some good to come from this low-price environment. Economic theory, at least, suggests that consumers should consume more as prices decline.

A previous Kub's Den column illustrated the annual per capita consumption of various agricultural commodities -- 174 pounds of flour per American, more than a ton of corn (in all its various uses), 54.4 pounds of boneless beef, 47 pounds of boneless pork. These numbers struck a chord with several readers, who felt optimistic that this is an ideal time to be showing off the ag industry's affordably priced products to new end-users all across the globe.

But price elasticity of demand -- the concept that a change up or down in price leads to a change down or up in the quantity purchased -- is more than just a concept. It's a number that can be calculated for any product. If economists have done this math for our grains and meat products, then perhaps we could make a good guess for how much extra demand -- in terms of bushels and tons -- we can expect in the current low-price environment.

Of course, it's never quite that easy. Decades' worth of studies published in economics journals have tried to calculate numbers for the price elasticity of demand for various food commodities, with varying results. Data from the USDA, data from national household surveys and data from retail grocery store scanners can show how shoppers' choices change when prices change, but these results assume only the price changes and all other things remain equal (a difficult assumption to make in the reality of household budgeting and food trends and human susceptibility to advertising).

The numbers can't really predict what will happen in more complex scenarios. During broad economic shocks, when consumers' overall incomes fall, their demand for food overall may change, to say nothing of any single category of food or beverage. And what about cross-price elasticities, which reflect changes in demand for one commodity when other commodities' prices change? And what about foreign end-users of food commodities -- do they behave like the U.S. shoppers described in these data sets?

Developing East Asia, especially, has become the biggest destination for U.S. agricultural exports after North America, accounting for 23% of the total value of our exports (2011-2015 average). Fifteen years ago, this region accounted for only 8% of U.S. agricultural exports. I wish I could have found the price elasticity of demand for wheat flour and flour-based products in East Asia in the late 2010s.

But alas, the only available, reliable estimates of price elasticity of demand describe consumer behavior in the United States, which we will just have to assume that Asian, South American and Middle Eastern consumers will gradually continue to mimic, with ever more fast-food restaurants popping up on street corners. Still, there are interesting lessons in the domestic data. Food shoppers are more sensitive to price changes in some kinds of food than in others.

The food category with the most inelastic demand was eggs. For every 10% increase in the price of eggs, the quantity purchased is expected to decrease only 2.7%. (Tatiana Andreyeva, Michael W. Long, Kelly D. Brownell, "The Impact of Food Prices on Consumption: A Systematic Review of Research on the Price Elasticity of Demand for Food", American Journal of Public Health 100, no. 2, Feb. 1, 2010: pp. 216-222.)

The food category with the least inelastic demand was "food away from home," including restaurant meals and fast food. For every 10% increase in those prices, consumption is expected to decrease 8.1%.

That fits with the conventional understanding of consumer behavior. People will tend to always buy a few staple groceries, pretty much no matter what. But life's little luxuries, like a meal in a restaurant, are much more likely to be cut from a family's budget if they're seen as unaffordable.

Now where do the grains and meats fit on that staples-to-luxuries spectrum? Mostly in the middle.

Cereals and milk had price elasticity estimates anywhere from 0.4-to-0.79, averaging about 0.6% change in purchased quantity for each 1% change in price (in the opposite direction). Poultry (price elasticity 0.68) was closer to these staples than fruit, pork, beef or soft drinks were. Pork's price elasticity in most studies has been pegged around a 0.72% change in purchased quantity for each 1% change in price (in the opposite direction). Beef was the most "luxurious" of all studied food categories other than soft drinks or juice. For each 1% change in the price of beef, the purchased quantity of beef is expected to change (in the opposite direction) by 0.75%, with one study's estimated price elasticity of demand as high as 0.83%.

This is good news, frankly, for the livestock sector. Beef and pork producers can expect to see the retail and wholesale markets respond quickly, and reliably, to changes in price, modulating any trends we may notice on the futures charts. So April live cattle prices are $10 per hundredweight lower than they were a few months ago? Well, at least the lower prices are likely to be met with robust demand from beef consumers, eventually sparking a chart reversal toward the upside.

It's not such good news for the grains. Major consumers of feed grains -- the dairy and egg industries -- themselves can't expect to see a major boost in grocery consumption just because U.S. shoppers may be feeling economically hopeful in 2018. People's consumption of these staple goods is relatively unchanging, regardless of price. So, too, is the direct human consumption of grain in cereal or flour products.

The latest Quarterly Grain Stocks report was a good reminder not to get too excited about lower prices boosting grain demand. If overall corn and wheat consumption played along with the economic theory, and showed price elasticities of demand similar to grocery-store cereal, then we might calculate that the year-over-year 13% price decrease in wheat should lead to an 8% increase in demand.

It hasn't.

Instead, it turns out that the most recent quarterly wheat disappearance was actually down 16% from the same period (September to November) a year ago.

Same for corn. From theoretical elasticity numbers, maybe we would guess a 3% year-over-year price decline would imply a 1.8% increase in the purchased quantity of corn. Nope. The quarterly grain stocks report showed that corn disappearance was down 2.6% from the same period a year ago.

The theory is good; and it may ultimately pay off with some slow growth in overall demand for feed grains and the industries that rely on feed grains (dairy, poultry, meat, ethanol, etc.). But unfortunately, it's too complex, too convoluted, with too many variables interrelated between too many data sets to ever give us a simple answer. Price elasticity considerations do imply that slightly cheaper grain could spark greater grain demand, but there's a lot of wiggle room in the calculations.

Elaine Kub is the author of "Mastering the Grain Markets: How Profits Are Really Made" and can be reached at elaine@masteringthegrainmarkets.com or on Twitter @elainekub.

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