A Monetary Analysis of Food Price Determination

Abstract

Erratic food price movements during the 1970s have received much attention in recent literature. Salathe and Boehm found that movements in retail food prices since 1970 have been substantially more volatile than in earlier periods, and that the food component of the consumer price index (CPI) has often displayed an annual rate of change different from that of the total CPI. Such changes in agricultural prices reflect low price elasticities for food products and the difficulty of predicting weather patterns and their effects on farm output. Research interest stems from relatively larger recent price changes caused by persistent general inflation and unexpected supply disruptions.Several recent studies of retail food prices are based on cost-push theories. These models posit that as input costs faced by food manufacturers rise, the increases are "passed through" to consumers in the form of higher product prices. To model cost-push behavior, changes in components of the marketing bill-such as processing, packaging, and transportation costs-are measured and related to subsequent changes in retail product prices. Examples of such empirical studies are those by Lamm, Heien, and Lamm and Westcott. However, these models represent only one perspective of the pricing process. This paper suggests the use of a family of alternative models. In particular, by making a clear distinction between changes in nominal and real values, a different set of variables is selected to measure each component of overall price change. It is argued that not all models can explain behavior of both real and nominal price changes. The Distinction between Nominal and Real PricesConsider figure 1. On its axes we plot values for the non-food consumer price index (CPINF) and the food consumer price index (CPIF), each weighted by its expenditure share in the all-commodities CPI. With fixed weights, each ray drawn through the Journal referees for their helpful comments. All remaining errors are the responsibility of the authors. The views expressed do not necessarily reflect those of USDA. origin in this quandrant represents a unique relative price ratio, CPINF/CPIF. The ray labeled OA reflects an initial position where the weighted values of the food (0.2) and non-food (0.8) indices, each set equal to a base of 100, yield an all-commodities index also equal to 100: [0.8(100) + 0.2(100) = 80 + 20 = 100]. The initial position is labeled A in figure 1. Points on the 45-degree line drawn through point A represent pairs of CPINF/CPIF price indices which yield a CPI of 100. So long as observed prices fall on a given 45-degree line, any price change is a change in relative values only. On the other hand, only nominal prices will change if a movement is made along a ray of fixed slope from one 45-degree line to another (e.g., from point B to point C).Now consider a change in the CPI illustrated by a movement from A to C. This move consists of changes in both the relative and nominal values of the food and nonfood indices. The weighted food price index has inc...

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