In the Feb. 22 edition of North American Market Preview, I addressed the findings of the recently released Livestock and Meat Marketing Study by USDA's Grain Inspection, Packers and Stockyards Administration (GIPSA). The report has been a topic of widespread discussion since its release, but a number of those discussions have misinterpreted the results.
A perfect example came up in a discussion with University of Missouri agricultural economist Ron Plain earlier this week. Both Ron and I believe it is important enough to warrant attention in this week's column.
One of the findings highlighted in the study's executive summary was this:
". . . the estimated elasticities of industry-derived demand indicate a 1% increase in contract hog quantities causes the spot market price to decrease by 0.88%, and a 1% increase in packer-owned hog quantities causes the spot market price to decrease by 0.28%."
As background, an elasticity is a measure of the responsiveness of one economic variable to a change in another variable. Elasticities are expressed as percentages in order to remove the effect of the units of measurement (i.e. data using pounds has bigger numbers than data using tons).
These measures say that if the number of contracted hogs or packer-owned hogs changes by 1%, the spot market price will move 0.88% and 0.28%, respectively, in the opposite direction.
Some have interpreted that to mean: "If we reduce the proportion of hogs sold under contracts by 1%, we will increase spot market prices by 0.88%." Or, similarly, "If we reduce the proportion of hogs owned by packers by 1%, spot market prices will increase by 0.28%." By that logic, if we just eliminate the 25% or so of hogs owned by packers, we will increase spot market prices by 0.25 x 0.28 = 0.07 or 7%. Better yet, if we just outlaw the contracts used to sell 60-65% of all hogs, we would increase prices by 0.60 x 0.88 = 0.528 or nearly 53%. Wouldn't that be great?
But those numbers are wrong. The research does not address changing the proportion of hogs sold under these arrangements. It used the number of hogs sold through the various methods. So, a change in the number of hogs sold under contracts would affect the total supply of hogs. No wonder the effect is negative -- it is a demand elasticity that measures the change in total quantity on price.
In addition, each elasticity applies only to the amount of hogs sold under those methods. So, a 1% change in the number of hogs sold under marketing contracts is 1% of roughly 60% or 0.6% of the total supply. Similarly, a 1% change in the number of hogs owned by packers amounts to 1% of about 25% = 0.25% of total supply.
GIPSA's data indicated that, for the study period of October 2002 through March 2005, 59% of hogs were sold through contracts, 11% were sold through negotiated trades, and 30% of hogs were packer-owned. Given these shares, the correct way to use the estimated elasticities is: