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Ed Lotterman: Rising egg prices provide lesson in markets’ elasticity

Every cloud has a silver lining. While the avian flu epidemic hurts virtually all consumers and many producers, it has teachers of introductory economics positively chortling in delight. Examples of real-world resource allocation decisions in response to changing incentives are what economics is all about.

We are now a few months into this, and so we are getting the concrete data to illustrate the key economic concept of “elasticity.” This deals with how percentage changes in the price of an item are associated with percentage changes in the quantities sold or bought. For eggs, this would be the “own-price elasticity of supply” and the “own-price elasticity of demand” respectively.

(”Own-price” as opposed to “cross-price,” such as how ground beef sales may rise as chicken becomes more expensive or corn production may drop when the price of soybeans goes up.)

The price and sales comparisons are always measured as percentages, because this solves several practical problems of comparability. This applies to so many situations that there are dozens of different “elasticities” in economics.

News reports as of June 9 indicate that weekly egg production has dropped 18 percent since the flu started to hit laying flocks. The national wholesale price has increased about 105 percent, from $1.13 per dozen to $2.40 last week.

Plug that into the formula: Divide -18 percent by +105 percent and you get an elasticity of -0.17. That is an extremely low one and indicates that a relatively small decrease in quantity can motivate a proportionately much larger increase in price.

That is the general idea, but in econ there always are qualifications. Are we talking about an 18 percent change in “quantity demanded” or in “quantity supplied?” And in which direction does the causation run? These issues are not always clear.

It also would be dangerous to take this calculated elasticity of -0.17 and assume that it could be a predictor of egg markets in other situations.

First, there is uncertainty about the exactness of the data.

In a fast-moving situation like a flu epidemic, tabulating the exact numbers of dead birds is difficult. Recording exact quantities of eggs sold is more difficult than getting price quotes from regional markets. The dates of the data on bird deaths may not be from exactly the same dates as the price data.

Moreover, there always are lags in changing prices, both on the way up and on the way down.

Not all produce changes hands in the spot markets used as sources for USDA reports. You simply need more reliable and numerous data points to estimate an elasticity.

There also is the issue of the time period for buyers and sellers to adjust.

Both supply and demand usually are most “inelastic” in the very short run. Producers cannot ramp up egg production from one day or week to another, and very little even in a period of a few months.

Commercial egg users such as specialized bakeries don’t cut purchases immediately, nor do they raise their prices at the onset of a price spike. Restaurants don’t cut eggs from their menus and don’t get new menus printed right away. But over time they do make such adjustments.

As the time to make adjustments gets longer, the quantity changes get larger. Long-run elasticities always are higher than short-run ones.

In any time frame, the degree of elasticity of demand for a product depends on two factors.

To what degree is the product a “necessity” versus a “luxury?” And does its purchase constitute a large fraction of the buyer’s total budget?

Demand for painkillers and gasoline tend to be inelastic, because they are necessities. Demand for party balloons and landscaping is more elastic. Demand for toothpicks tends to be inelastic, because they are cheap and bought infrequently, while that for meat is more elastic.

The fraction-of-total-cost issue comes up in restaurant meals.

Doubling the price of eggs may increase the ingredient cost of a $7 breakfast combo by 30 cents. Doubling the price of top sirloin could increase the ingredient cost of a $16 steak dinner by $3.75. The increase for the egg breakfast is 4 percent; for the steak it’s 24 percent.

Elasticity on the supply side depends in great part on the make-up of the costs of production. This involves the “production function” and “marginal cost curve,” which makes students’ eyes glaze over.

When most eggs came from flocks of a few hundred hens, higher egg prices could motivate farmers to increase by 50 or 100 hens. The limiting factor was the seasonality of egg hatching.

Now that the industry is much more capital intensive, with huge investments in facilities but little labor, the ability to boost production has a much longer lead time. And few will want to make a long-term investment in response to a short-term emergency.

Not all producers are suffering.

Those whose flocks have been hit by the disease may suffer severe financial losses, although insurance and government programs may offer some compensation.

Those with healthy birds may be implementing every sanitary measure scientists can imagine, and perhaps knocking on wood like crazy, but they are making a lot of money right now.

Paradoxically, for the egg sector as a whole, the value is rising. A doubling of price combined with a drop in sales of less than a fifth means that overall revenues are up even if some producers are suffering.

The farmers who tend the birds may not benefit at all; many do it on very thin-margin contracts.

For the poultry sector as a whole, the value of sales isn’t falling nearly as much as output, because the positive effect of higher prices offsets some of the negative effect of lower sales.

The econ lessons could go on and on, as may the epidemic.

In the long term, the disease will be curbed or die away. In the medium term, we may have to adjust our eating patterns. But in the next days and weeks, our economic and culinary lives will go on pretty much as normal.