Wednesday, February 9th, 2011

Why is the price of food rising?

Paul Krugman has an excellent analysis here of the rising prices of grains. He argues it’s essentially due to bad weather and failed harvests in countries of the former Soviet Union. The problem is exacerbated by bad weather and failed harvests in China too.

As Krugman points out, a relatively modest decline in grain production can induce a large increase in prices because demand for grains is price-inelastic. People don’t stop eating grains when their price goes up. Instead, they cut back on other things. So it takes a huge increase in prices to bring demand down in line with supply.

In Argentina, a price elasticity of demand of breads and cereals of  -.199 means you need the price of cereals to rise more than 5 percent for demand to fall 1 percent. In the United States, where people spend a smaller share of their daily budget on food, you would need prices to rise 25 percent to get the same reduction in demand.

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