Prices ; Food prices ; Economic conditions

Brye Steeves

English

Research Papers in Economics

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13 SUMMER 2008 • TEN
ack in 2002, when milk was just 
a dollar a gallon and Bobby and 
Debbie Sturgill had two children, 
their  grocery  bill  was  around   
$300  a  month. Today,  milk  is  usually  more 
than $3 a gallon and, with four children and a 
new baby, groceries are about $800 a month.
“Bread,  cereal,  eggs  have  all  gone  up 
significantly,” says Debbie, 33, who maintains 
the family’s budget. “Even apples are getting 
really expensive.”
Living in western Missouri, Debbie first 
noticed  significant  increases  in  almost  every 
aisle  of  the  grocery  store  about  a  year  ago, 
which, according to data, is when soaring food 
prices  had  the  highest  gains  nationwide  in   
nearly  two  decades.  In  2007,  food  price   
inflation rose twice as fast as overall inflation, 
with  prices  increasing  4  percent  above   
levels  from  the  year  prior.  A  2.5  percent 
increase  is  the  norm  most  years,  according   
to federal data.
Another  sharp  gain  is  expected  this 
year,  says  Jason  Henderson,  an  economist 
and  the  Omaha  Branch  executive  of  the   
Federal  Reserve  Bank  of  Kansas  City.  He 
recently researched factors driving food price 
inflation.
Henderson  says  more  expensive  grocery 
bills and restaurant tabs are the result of several 
factors, including: 
• larger populations and larger incomes: 
people  are  eating  more  meat,  which  means 
more grain is needed to raise livestock;
•  biofuels:  ethanol  and  other  renewable 
fuels mean fewer crops for food use;
• weather: droughts devastated Australian 
crops last year as did other conditions in Europe;
• weak dollar: the low value of currency 
buys less overseas and sends more food overseas;
• high input costs: rising labor and energy 
expenses  affect  every  aspect  of  food,  from 
fertilizer to packaging.
“Today’s momentum in food prices may 
be  signaling  a  new  era  of  even  higher  food 
prices in the future,” Henderson says. “Keeping 
food prices in check will depend on whether 
agriculture can increase supplies. With global 
food demand projected to rise, the agriculture 
sector will be tested.”
   B
After the number of hungry little mouths in the 
Sturgill household doubled, the family assumed their 
grocery bill would, too. Instead, it nearly tripled.
Yes, the family buys more food, but what they’ve 
always eaten now costs significantly more. 14 SUMMER 2008 • TEN
Explaining the hike
Increases in food prices were seen across 
the board in the food industry, Henderson’s 
research shows.
Some of the largest gains were in meat   
and dairy: 
•Dairy  prices  rose  7.4  percent  in  2007 
after declining the year before. Strong export 
demand  for  dried  milk  underpinned  overall 
dairy prices.
•Poultry  and  pork  prices  spiked  after 
falling in 2006.
•Beef  price  increases  were  the  result  of 
robust demand.
•Fish and seafood prices were steady.
Crop-based  food  products  also  saw   
rapid gains:
•Cereal and bakery product prices jumped 
4.3 percent, after three years of increases.
•Fat  and  oil  product  prices  increased 
almost 3 percent as a result of strong national 
and international demand.
•Fruit and vegetable price gains eased after 
rebounding from freeze damage in 2006.
•Processed  fruit  and  vegetable  prices 
have inflated, which is a reflection of higher 
processing costs.
This year, the highest prices––with upwards 
of a 5 percent increase––are predicted for cereal 
and bakery products, and fats and oils. Meat, 
poultry, fish and dairy products are anticipated 
to increase less than 3 percent. 
Marketing costs are in large part driving 
food prices. This cost is the difference between 
what farmers receive and what the consumers 
spend at the grocery store or restaurant. These 
costs have risen significantly during the past 
several decades, biting into a larger share of   
15 SUMMER 2008 • TEN
the retail food dollar. In 1950, marketing costs 
made up 59 percent of total retail food costs. 
Today, these costs make up 80 percent, mostly 
as a result of rising labor and energy costs. 
Labor  costs  are  the  most  expensive 
component of processed and prepared foods. 
These costs have risen as people consume more 
of these types of food, as well as food eaten away 
from home. Additionally, food manufacturers 
and food service firms are increasingly paying 
employees higher wages, especially as minimum 
wage increases take effect.
Energy prices also are boosting food prices 
by raising the costs of processing, manufacturing 
and  transporting  products,  more  so  as  oil 
exceeds $100 per barrel and gasoline rises above 
$3 a gallon. 
“In the past, food prices have surged during 
times  of  high  crude  oil  prices,”  Henderson 
says. “Research shows energy prices are quickly 
passed on to food, with these prices rising half 
a percent for every 1 percent increase in energy 
prices. However, the volatility of energy markets 
makes the impact on food prices uncertain.”
Farm  commodities  have  remained  stable 
with  the  average  corn  price  from  2000  to 
2005 equaling the price farmers received in the 
1970s. Although their share of retail food prices 
has diminished, commodities still account for a 
substantial part of the retail food dollar. This 
does, however, vary by food type––commodities 
represent a smaller percentage of retail costs for 
foods requiring more processing, packaging or 
advertising.  For  example,  farmers  receive  19 
cents from every dollar spent on a bag of wheat 
flour, but just 4 cents from every dollar spent 
on a box of corn flakes cereal, according to the 
USDA.
Dining out
Not too long ago, Ryan Murphy noticed 
the  weekly  delivery  of  flour  to  Wheat  State 
Pizza restaurants was heftier than before. The 
key ingredient to the trademark crust is still in 
50-pound bags––it’s the bill that hit Murphy 
like a ton of bricks.
“It’s gone from $10 a bag to $30,” says 
Murphy, who is president of the Kansas-based 
franchise,  adding  that  higher  wheat  prices 
could mean an increase of as much as $400 
a month for flour. The higher costs of other 
ingredients—specifically  meat,  cheese  and 
vegetables––and the increased cost of labor also 
influence the bottom line, he says.
“It’s  affected  our  restaurants,”  Murphy 
says. “That has to be passed to the customer, 
and that’s the big fear of businesses.”
As a result, Wheat State raised the price of 
pizzas about a dollar, but Murphy isn’t worried 
about losing customers, or worse, closing shops. 
In  addition  to  the  10  regional  restaurants 
opened since 2004, at least two more eateries 
will open by the end of the year. 
The convenience and ease of dining out has 
busy families lining up at drive-thru windows 
and filling restaurant booths, where they are 
likely to see price increases, too.
“People  are  eating  more  processed 
foods and consuming more food away from 
home,” Henderson says. “Processed foods and 
restaurant meals have higher marketing costs as 
do packaged foods, contributing to lower farm 
costs per retail food dollar.”
From the farm
The price of wheat has more than tripled 
from a year ago, while both corn and soybeans 
are trading at about double the price from the 
year prior. On the heels of planting the most 
acres of corn since World War II, U.S. farmers 
plan to plant less corn and more soybeans this 
year, according to a USDA prospective planting 
report. Ethanol demand had prompted farmers 
to forgo soybeans for corn in recent years. This 
shift  back  to  soybeans  could  push  already-
high corn prices even higher. More expensive 
livestock feed and corn-based products mean 
even higher prices for everything from meat to 
corn flakes cereal.
“Nobody’s  seen  prices  like  these,  ever,” 
says Royce Schaneman, executive director of 
the Nebraska Wheat Board. “We’ve hit historic 
high prices. … It won’t last.” 
The  Nebraska  Wheat  Board  promotes 
wheat  breeding  research  and  consumer 
education,  among  other  related  efforts,  to 
ensure profitability for producers.
After  rising  sharply  in  the  1970s, 
the  INCReasING  Costs  of  INGReDIeNts—especially  cheese,  meat  and  flour—
has  led  to  higher  prices  for  customers  of  Wheat  state  pizza,  a  Kansas-based  franchise. 
Most  pizzas  are  about  a  dollar  more  and  chicken  wings,  for  example,  are  50  cents 
more.  however,  the  shop  in  Lawrence,  Kan.,  hasn’t  seen  a  slowdown  in  business,  making   
anywhere from 150 to 400 pizzas a day.commodity  prices  had  been  relatively  flat, 
according to Henderson’s research. The average 
prices of corn, wheat, soybeans, pork, beef and 
milk from 2000 to 2005 have been equal to the 
average prices during the 1970s. Schaneman 
says  today’s  soaring  prices  don’t  mean  that 
producers are cashing in. Some were able to sell 
significant amounts of their wheat crops early at 
high prices, but most sell at harvest time when 
the supply is abundant and prices are lower. 
The cost of production bites into producers’ 
profits, which are typically low for packaged and 
processed foods because the portion of wheat 
actually in these items is small. For example, 
only about 5 to 6 cents from the cost of a loaf 
of bread goes back to the farmer, Schaneman 
says. The price of these commodities is small 
compared  to  their  processing  costs,  such  as 
transportation. 
“The  United  States  is  used  to  a  cheap, 
reliable  food  supply,”  Schaneman  says.  “To 
have  this  safe,  abundant  food  supply,  we’ve 
got to pay for it. And that’s what we’re doing 
now.”
A new era of high prices?
Coupons and in-store specials add a little 
relief to the food budget for the seven-member 
Sturgill  family.  They  try  to  leave  expensive 
packaged items on the store shelves; Debbie 
makes baked goods from scratch; the family 
eats  all  its  leftovers  and  only  dines  out  on 
special occasions––even McDonald’s or pizza 
for everyone can cost $30.
One of Debbie’s biggest concerns is not 
sacrificing  the  family’s  nutrition  in  an  effort 
to lower the grocery bill. So this spring, the 
Sturgills planted a small vegetable garden to 
supplement fresh foods bought from the store. 
Regardless  of  price,  though,  Debbie  knows 
there are items they have to purchase, such as 
milk, eggs and fruit.
“It’s  extremely  challenging,”  she  says.  “I 
think that we have to cut back, but there’s not 
too much we can trim.”
There’s just not a lot consumers can do 
in response to high food prices, says Ephraim 
Leibtag, an economist with the Food Markets 
Branch of the USDA. 
“Food overall is like gas overall,” Leibtag 
says. Consumers notice price hikes, complain, 
but don’t change their behavior much. 
While consumers likely won’t eat less food, 
there may be some trade-offs, such as eating 
fast food rather than at a sit-down restaurant, 
or  substituting  a  cheaper  item  for  a  more 
expensive one, such as chicken in lieu of beef, 
at the grocery store. But because all food sectors 
are more expensive, these trade-offs likely will 
be limited, Leibtag says.
To  compensate,  “other  things  are  going 
to  be  cut  out  that  aren’t  necessary,”  Leibtag 
says. “And that’s a lot harder for lower-income 
households.”
The world’s most poor are already in crisis 
mode.  In  the  past  year,  food  shortages  have 
caused uprisings in Haiti, Pakistan and several 
countries in Africa. 
17 SUMMER 2008 • TEN
For  families  everywhere,  today’s  higher 
food costs may be the new norm, Henderson 
says.  High  demand  for  farm  commodities 
could overrun existing production capabilities, 
which strains food supplies and boosts prices. 
Additionally, population growth (up nearly 2 
billion from a decade ago) and rising incomes 
are changing food consumption worldwide, in 
effect  boosting  the  demand,  which  supports 
these higher prices.
Meanwhile, nonfood use of crops, such as 
biofuels,  is  affecting  global  crop  inventories, 
which are expected to drop to historic lows this 
year. Droughts worldwide also are trimming 
supplies.
Boosting agricultural productivity may be 
the best option for expanding the global food 
supply, but environmental concerns, water ac-
cess,  transportation  infrastructure,  financing 
and  other  issues  could  limit  crop  potential. 
These issues may be offset by evolving technol-
ogy, which historically has helped farmers meet 
rising demand.
“To meet growing demand, agriculture will 
need to put more acres to the plow,” Henderson 
says. “But, as in the past, stronger agricultural 
productivity will be needed to keep higher food 
price inflation at bay.”
IN  aN  effoRt  to  ease  the  faMILy’s  fooD  bUDGet,  Debbie  sturgill  plants  a  small   
garden  in  the  backyard  of  their  Missouri  home  with  the  help  of  her  three  oldest  children,   
Joshua,  elizabeth  and  Christine.  the  seven  family  members  have  seen  their   
grocery bill rise significantly in recent years.
BY BRYE STEEVES, SENIOR WRITER
T
commEnTS/QuESTionS are welcome  
and should be sent to teneditors@kc.frb.org.
fuRThER RESOuRCES
“WhaT iS dRiVing food pRicE inflaTion?”
By Jason Henderson
www.KansasCityFed.org/TEN
Transportation 4 %
Energy 3.5 %
Packaging 8 %
Profits 4.5 %
Rent 4.5 %
Depreciation 3.5 %
Labor 38.5 %
Farm value 19.5 %
Repairs 1.5 %
Interest 2.5 %
Taxes 3.5 %
Other costs 2.5 %
Advertising 4 %
Source: USDA
Components of  
retail food costs

Feeding high prices: a number of factors are driving food price inflation

http://www.kansascityfed.org/publicat/TEN/PDF/Summer2008/FeedingHighPrices.pdf

Feeding high prices: a number of factors are driving food price inflation

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