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High prices reduce quantity demanded but do not destroy demand

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Processors must have an eye to the future. What might higher gasoline prices mean for bacon purchases? How about hog supplies this summer and finding labor? 

Which came first, the chicken or the egg? That's the classic question about the direction of causality but markets have a reasonable facsimile of this famous conundrum, complicated by some terminology issues that many overlook.

I've heard a lot of talk lately about high pork prices "destroying demand" and that phrasing always bothers me. The reason is that the price of a good is a critical part of the demand for that good, not some result or driver of demand. High prices reduce the quantity demanded of a good but they do not destroy demand. "Economics hocus pocus!" you proclaim. Well, perhaps, but it's an important distinction when thinking about markets.

A consumer's demand for a good is "the amounts of the good that a consumer is willing and able to buy at alternative price levels." Each buyer has such a set of price-quantity pairs that depend on his/her tastes and preferences and income levels. Each buyer weighs the price of a good against the prices of its competitors to allocate dollars (ie. income) among the alternatives in the marketplace. My set of price-quantity pairs is probably different from yours and yours is probably different from Joe down the street.

There is a quantity that each consumer will buy at each price level. Carnivores like me will buy lots of meat when it is cheap and plenty but perhaps not so much when it is expensive. Vera Vegetarian will buy no meat whatever the price. When we add the quantities that all of the consumers will buy at each alternative price we get another set of price-quantity pairs that represent the market demand for a product. This market demand would be the line D-Consumer in Figure 1.

Partners for Production AgricultureMeyer Fig 1 031422.JPG

Figure 1

If the supply of pork tightens (a move from S to S' in Figure 1), driving the price of pork higher (from P to P'), is demand destroyed or even damaged? Not at all. The market demand for pork is still D but the quantity demanded falls from Q to Q'. Whey did it fall? Someone didn't buy as much or, perhaps, someone else didn't buy any at all. In the latter case, demand was certainly destroyed but in the broader market sense, only the quantity demanded was reduced — and hardly destroyed since consumers as a group would still be purchasing Q' of the product. 

2021 was a banner year for pork demand. Pork supplies were lower but retail prices were higher than those lower supplies would have elicited had demand been steady. My calculations of real per capita expenditures indicate that pork demand was up 5.2% for the year. Beef demand was also 5.2% higher and chicken demand was up about 1%. Part of all of those increases was strong retail prices. So will those "destroy demand?"

As I point out above, they won't do so in the classic economic sense since those prices are part and parcel of demand itself. But what they can do is change people's habits (part of tastes and preferences) over time.  Having pork, beef and chicken prices all higher would suggest that not a lot of substitution will take place. But what about seafood? Turkey? Alternative proteins? More vegetables or pastas? Long term price changes can change habits and in that sense the "own-price" of a good can have some impact on demand. But such impacts usually occur over longer periods of time.

Intermediate markets like that for pork wholesale cuts are a different kettle of fish. Here, processors or re-sellers are purchasing product with one eye on the consumer demand of Figure 1 and one eye on the supply of product. An important feature of Figure 1 is that is instantaneous — ie. a virtual snapshot in time. 

Processors must have an eye to the future. What might higher gasoline prices mean for bacon purchases? How about hog supplies this summer and packers' labor situations? Any or all of these "expectations" can cause a middle man to decide that a price is too high at a given time and back out of the market. That buyer's demand would be "destroyed" I suppose — momentarily.  And a number of processors could make the same judgement at roughly the same time. 

But the very action of one reducing purchases at a given price level will lower the price and at some point cause another to either re-enter the market or buy more product. Not all judgements will be the same as decision makers all have different perspectives. 

Price determination is a complex process. Demand for wholesale cuts and hogs is derived from the D-Consumer curve of Figure 1. The pork supply curves S and S' in Figure 1 are derived from the farm-level supply of hogs. No one knows with certainly what is going on in the market. Some have better information than others. Some have better intuition. 

One thing, though, is a certainty: Everyone is better off — or at least has the possibility of being better off — when consumer-level demand is strong. In the presence of continued strong consumer demand last fall, wholesale pork and hog demand fell back to pre-2021 levels. And market prices showed it. But that strong consumer level demand has, since mid-January, allowed both wholesale and hog demands to move back toward those spring-summer 2022 levels. And prices are showing it now. 

If demand moves back to last year's levels and supplies are indeed lower going into this summer, those record prices of 2021 are once again in the cards. I'm still moderately concerned about both of those conditions but, pending the March Hogs and Pigs survey and report on March 30, it doesn't appear packers will find large hog supplies until at least the third quarter of 2022. The demand side is more questionable given inflation levels, some economic slowing and the uncertainty being wrought by Russia's brazen aggression in Ukraine. But for now demand appears to be holding well.

Now if we could just find some more affordable feed. 

Source: Steve Meyer, Partners for Production Agriculture, who are solely responsible for the information provided, and wholly owns the information. Informa Business Media and all its subsidiaries are not responsible for any of the content contained in this information asset. The opinions of this writer are not necessarily those of Farm Progress/Informa.

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