1. Executive Summary
This paper provides an overview of the current situation with regards to food prices, outlines the main factors behind recent trends and considers the future for food prices.
Price rises
- Recent spikes in agricultural commodity prices point to increased volatility and uncertainty in the market for commodities and food.
- The rise in prices has happened for nearly all major food and feed commodities which make this price spike different from those in the past which were limited to only a few commodities.
- Agricultural commodities are not the only input into production of food. Within the EU, processed food prices (e.g. bread and cheese) increased more dramatically than unprocessed food prices (e.g. fruit and fish), possibly due to higher use of energy inputs, prices for which reached very high levels earlier in 2008.
- UK food prices peaked in August 2008 but in February 2009, food inflation in the UK was still the highest in the EU. This could be because the UK food supply chains have passed more of the increasing production costs and the weakening of the pound keeping the prices high. Overall, price increases in Scotland have been similar to those in the rest of the UK.
Factors determining food price rises
- As with all prices, prices on food are determined by the interaction of demand and supply forces and the recent increases have been driven by a combination of factors, supply and demand related.
- On the demand side, there has been a shift on the global level, driven by high economic growth in developing countries. The booming economies of China and India led to increases in demand for food, in particular protein such as meat of animals fed on grains such as corn and soybeans.
- On the supply side, several factors have had an effect. Shortages in supply have been caused by bad harvests in several parts of the world, result of adverse weather conditions. This has been further exacerbated by the growing production of biofuels, limiting the availability of crops for food production.
- Overall several factors lead to food price increases. Temporary factors are likely to have had greater immediate impact that structural ones.
Price transmission
- Depending on the market structure, all of the cost increases could be passed on to the consumer or some of these increases could be absorbed somewhere else in the supply chain.
- It is widely accepted that prices are sticky, i.e. they do not respond to market changes immediately and the speed of adjustment can vary. The extend to which they stick is dependent on a number of factors, such as competition, labour market structure, customer behaviour patterns and whether they are operating in foreign markets.
- In Euro area countries, consumer food prices appear to have come down quicker following the recent decline in agricultural price levels whilst in the Newer Member States consumer prices have reacted more slowly.
- Market power can allow some firms in some sectors to raise prices on food over and above the rise in the cost of production.
- Overall, there is limited evidence on how costs are being passed on along the supply chain.
Consumer response to food price increases
- Generally, food is a necessity, so when all food prices rise uniformly, the consumer is limited in the extent to which they can change their behaviour. Faced with higher cost of food, consumer can either cut down on their levels of food consumption or substitute products within the food category.
- Evidence shows that consumers have responded to higher prices by switching to cheaper produce. This has taken form of both switching to a different type of retailer and trading down food quality categories.
- There may be health effects of consumers switching to economy ranges, as consumers could be on a worse diet than before, if nutritional standards of economy range food products are lower.
- Evidence shows that whilst the purchasing power of all consumers fell rather dramatically, it is those on low incomes that have been hit the worst, due to the proportion of their income that they spend on food.
Market failures in food and drink consumption and production
- Consumers may often be unaware of the extent of the positive and negative impacts on their own health of consumption of different foods. This is due to lack of information about food qualities or inability to analyse it. Thus some food products could be merit goods and others de-merit goods, if benefits and costs associated with their production are not fully recognised resulting in their under- or over-consumption.
- Consumers also often fail to take into account the costs and benefits from their consumption that are external and as a result under-consumption of healthy food and drink and over-consumption unhealthy food and drink can occur.
- Externalities can be corrected in the food markets by taxing products the consumption of which is linked to certain illnesses and subsiding those that are claimed to be good for health. Such adjustment of final prices could steer consumption towards healthier diet. Merit and de-merit good consumption can also be adjusted by providing information about the products.
- On the production side, the price mechanism does not take the external costs such as pollution and waste into account and so prices do not reflect the true costs of production.
Food price outlook
- It is difficult to predict what will happen to food prices in the forthcoming months as well as in long-term. Whilst the pressures of increasing production costs from rising commodity prices have eased off and the harvest forecasts are looking more promising, UK food prices are still increasing, albeit at a slower rate.
- The weakening of the pound could also limit retail price falls over the coming months.