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2
The Economics of Food Prices1
A
mericans spend about 9 percent of after-tax disposable personal in-
come on food—less than anywhere else in the world. That is an “ex-
traordinarily small amount,” in Katherine Smith’s opinion. Smith,
vice president of programs and chief economist at the American Farmland
Trust, provided some background on how U.S. market prices of foods are
determined and an overview of the types of costs not included in market
prices. She also offered some reminders when delving into a discussion
on external costs because the average external costs mask a tremendous
amount of variation in production methods and geography.
DETERMINING THE MARKET PRICE OF FOOD
What U.S. consumers spend on food is tracked through the Consumer
Price Index (CPI), which measures changes in the price level of consumer
goods and services purchased by households. Food usually makes up about
one-seventh of the CPI (15.256 percent in December 2011), with a substan-
tial change in food prices making a significant difference in the overall CPI.
Because food prices are so volatile, with fluctuating food prices masking
long-term trends in CPI, food is often removed from the CPI so that longer
trends can be observed. The same is true of energy. For example, between
January 2009 and January 2012, total CPI fluctuated considerably, falling
and rising over time. But when food and energy prices are removed, those
1 Thissection summarizes the keynote presentation by Katherine Smith and the discussion
following her presentation. For more information, please consider USDA/ERS, 2011a,b,c.
7
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8 EXPLORING HEALTH AND ENVIRONMENTAL COSTS OF FOOD
fluctuations disappear, and CPI appears relatively stable over the same time
period.
Food prices were forecasted to increase by about 3.5-4.5 percent in
2012, which Smith said is within the high end of the normal range.2 Most
of that increase was among animal products (meats, poultry, fish, and fats
and oils), as well as cereals/bakery and fruits/vegetables; most of it was a
result of increasing commodity and energy prices. Commodities serve as
the basis for production, which itself accounts for about 10 percent of the
U.S. “food dollar” (i.e., a breakdown of expenditures for a dollar of food)
(Figure 2-1). Energy accounts for another 5 percent. Together, changes in
production and energy costs “really move” food prices from year to year.
Commodity prices themselves are affected by many variables, including
energy prices, stocks-to-use ratio, and weather. For example, between 2000
and 2011, fluctuations in the index price of food more or less paralleled
fluctuations in the index price for crude oil. With respect to stocks-to-use
ratio, which is a measure of how much of a particular commodity is stored
in comparison to how much is being used, the lower the ratio, the less stable
the prices of food and the more likely that a widespread unexpected event,
such as a flood or a drought, impacts those prices. The stocks-to-use ratio
for total world grain and oilseeds has been dropping every month since June
2010, exacerbating other factors affecting prices. Finally, weather is another
major driver of commodity price fluctuation. For example, a 2010 drought
in Russia damaged about 25 percent of the global supply of wheat, driving
wheat prices up. Additionally, some longer term trends could affect com-
modity prices in the future. Prime among these factors are climate change
and water scarcity.
In addition to commodity and energy prices impacting short-term fluc-
tuations in food prices, there are other underlying factors impacting long-
term trends in food prices. A key one is that the global population is not
only growing, but it is also becoming more affluent, driving a greater de-
mand for high-value foods, like meats. When demand goes up, prices go up.
A second key trend is the growing demand for biofuels. In the United States,
an increasingly larger proportion of the corn crop is being used to produce
ethanol. In other countries, an increasingly larger proportion of sugar cane
crops is being used for the same reasons. Ethanol production was expected
to increase by 333 percent between 2005 and 2030. Likewise, production
of biodiesel is rapidly increasing worldwide. In the United States, most
biodiesel production uses soybean oil. Again, as demand goes up (i.e., the
demand for corn, soybeans, etc.), so too does price (i.e., of corn, soybeans,
2 This number reflects the forecasted price inflation at the time of the workshop. Given the
extreme drought that occurred between the time of the workshop and the publication of this
report, a much higher increase in food prices is expected.
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THE ECONOMICS OF FOOD PRICES 9
10.1¢ 21.7¢ 3.9¢ 3.4¢ 12.8¢ 34¢ 4.8¢ 5.2¢ 4.1¢
FIGURE 2-1 The industry group food dollar series illustrates the distribution of
the food dollar among 10 food supply chain industry groups, demonstrating that
the cost of food equals the sum of value added by all supply chain industry groups.
NOTE: “Other” includes two industry groups: advertising and legal & accounting.
SOURCE: USDA/ERS, 2010. Figure 1-1 new
and other crops). Also underlying these longer term trends in food prices
are stagnating investments in agricultural research and development, which
slow growth in agricultural productivity.
THE CONCEPT OF EXTERNALITIES: COSTS AND
BENEFITS NOT REFLECTED IN MARKET PRICES
Costs not included in the market price of food are called external costs,
or externalities. The technical definition of an externality, according to
Smith, is “a cost or benefit not transmitted through prices that is incurred
by a party who did not agree to the action causing the cost or benefit.”
General types of externalities associated with food include ecological ef-
fects, environmental quality, GHG emissions, animal welfare, social costs
associated with labor, and public health effects.
These costs can occur anywhere in the food life cycle, from animal
feed crop production through food waste disposal. For an example at the
input stage, Smith mentioned potential ecological costs to using genetically
engineered crop seeds for animal feed. They include the evolution of newer,
more vigorous pests; harm to nontarget species (e.g., butterflies); disruption
of biotic communities; and irreparable loss of species diversity or genetic
diversity within a species (Snow et al., 2005). The actual crop and animal
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10 EXPLORING HEALTH AND ENVIRONMENTAL COSTS OF FOOD
production stages yield a variety of potential external environmental costs.
These can include soil erosion and sedimentation; impaired water quality;
overdrawn aquifers; loss of biodiversity; air pollution; and GHG emissions.
In some cases, the production stage can include potential external health
costs, including pesticide exposure, exposure to pathogens in water systems,
inhalation of dust, consumption of chemical residues (e.g., antibiotics and
growth hormones), and exposure to antibiotic resistant bacteria. Accord-
ing to Smith, however, this pales in comparison with the direct and indirect
health costs associated with food consumption patterns later in the food
life cycle.
Even though they have no market value, monetary estimates can be as-
signed for some of these costs. For example, sedimentation could be valued
based on the cost of removing sedimentation from reservoirs and water-
ways. Or, the cost of pollination services could be used as a proxy for the
cost of a loss of biodiversity. Some health costs can be assigned monetary
value based on loss of lifespan, loss of work, or related measures.
THINGS TO KEEP IN MIND ABOUT THE
EXTERNAL COSTS OF FOOD
Smith offered four “cautions” to the workshop audience—thoughts to
keep in mind when discussing externalities of the food system:
1. Everything is relative. Costs and benefits are relative. For example,
one could argue that agriculture provides a benefit by filtering rain-
fall and cleaning water. But in comparison to what? That benefit
is in comparison to development, not in comparison to a natural
ecosystem. The same is true of costs. A cost is only a cost relative to
something else.
2. The average external cost masks variability among producers, con-
sumers, and geography. For example, one farmer could be doing
everything possible to minimize soil erosion, water contamination,
and other environmental consequences of production, while his or
her “bad actor” neighbor is doing the opposite. Geography plays a
role as well. For example, Smith remarked that animal production in
dry climates may result in fewer externalities than animal production
next to the Chesapeake Bay.
3. While not in the price of food, we could be paying through the
price of other things. For example, while we may not be paying for
sedimentation in the cost of food, we may be paying dredging costs
through our water bill. “They can show up in other places,” Smith
said.
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THE ECONOMICS OF FOOD PRICES 11
4. Food and agriculture also have positive externalities. While the focus
of the workshop was on negative externalities, that is, costs, Smith
thought it was important to keep in mind that food and agriculture
also yield many benefits that are not reflected in the market price of
food.
QUESTIONS
Smith fielded several questions on externalities. An audience member
asked whether some of the externalities that she mentioned, such as the
health costs associated with pesticide exposure, are in fact reflected in the
price of food given that organic foods, for example, have higher prices.
Smith explained that the higher price for organic foods typically reflects
the cost to producers (e.g., the higher cost of allowable practices to control
pests).
There was a question about whether the costs of diet-related diseases,
such as obesity, can be considered externalities. Smith responded that while
those costs are external costs to food, society might be paying for them
through health insurance premiums, personal expenses for health and well-
being, or other means. An audience member added that the Danish “fat
tax” is one way to internalize the external cost of obesity. Smith agreed that
taxes can be used to internalize external costs, but cautioned that a food tax
typically has to be very high in order to change consumer behavior enough
to affect the targeted health outcome.
Another question was about how energy costs should be factored into
an analysis of the cost of food given that the actual cost of energy in the
United States does not reflect the “true” cost of energy. Smith replied that
the actual price of energy used during food production is in fact reflected
in the cost of that food. While the discrepancy between the actual and
true cost of energy may represent an externality, whether to include that
externality in an analysis of the cost of food depends on how far back one
wants to go in the life cycle and how many intersecting life cycles one wants
to consider. Smith’s response led into some further discussion about where
to draw the line when thinking about externalities. For example, another
audience member wondered whether the profits that other people earn from
obesity (e.g., profits from medications prescribed for obesity-related condi-
tions) would be accounted for in an analysis of the external costs of food.
Smith replied that it is more manageable to analyze only direct externalities.
She said, “Because everything is related to everything else, there are indirect
externalities. You can go as far as you want. . . . It gets harder and harder
the farther out you go.”
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12 EXPLORING HEALTH AND ENVIRONMENTAL COSTS OF FOOD
REFERENCES
Snow, A. A., D. A. Andow, P. Gepts, E. M. Hallerman, A. Power, J. M. Tiedje, and L. L.
Wolfenbarger. 2005. Genetically engineered organisms and the environment: Current
status and recommendations. Ecological Applications 15:377-404.
USDA/ERS (U.S. Department of Agriculture/Economic Research Service). 2010. Food Dollar
Series. http://www.ers.usda.gov/data-products/food-dollar-series/food-dollar-application.
aspx (accessed September 10, 2012).
———. 2011a. A revised and expanded food dollar series: A better understanding of our food
costs, ERR-114. Washington, DC: USDA.
———. 2011b. Have food commodity prices risen again?, WRS 1103. Washington, DC:
USDA.
———. 2011c. Impacts of higher energy prices on agriculture and rural economies, ERR-123.
Washington, DC: USDA.
