Economic theory tells us that a consumer looks at his or her utility function (a relationship that says “consuming X, Y and Z quantities of goods that A, B and C provides me with various units of utility or satisfaction to choose the given bundle of goods that maximizes total utility subject to his or her budget constraint. In so doing, the consumer chooses amounts of each good that he/she will consume at the prices offered, since the prices and quantities of all goods determine just how far the budget will go.

Quantities consumed vary as prices vary, thus establishing each consumer’s demand function for each good. The demand function tells us how much of the product the consumer will buy at each alternative price. Add up the quantity of each good consumed by each consumer at each price and you have a “market demand” function for the good in question. At each price, firms provide the quantity of goods demanded by consumers.

You probably didn’t even realize you were doing all of that, did you?

That’s because, when it comes to most food products – meats in particular – you are not. The relationship is reversed simply because output decisions are made far ahead of consumption decisions. While most readers of this newsletter know the process, the individual steps are worth reviewing:

• Hog producers look at expected input and output prices, their production capabilities, long-range business plans and all other relevant factors and decide how many sows to breed.

• About four months later, some proportion of those sows farrow litters of various sizes, determining the number of pigs available for feeding.

• Six months after that, some proportion of those pigs reach acceptable market weights at which time producers decide exactly when to sell them to maximize short-run returns, also subject to facility constraints.

• The pork and pork by-products produced from the number of hogs (N) at a specified weight (W) are sold on the wholesale market for as much as they will bring, which more or less sets a maximum that packers will pay for hogs on subsequent days.

• Retailers and restaurants place as large of a markup on the product as possible, while still pricing through outputs at levels that will clear the shelves, freezers, and warehouses.
You get the difference: Quantity establishes price in meat markets. The key decision for pork markets is the first one – how many sows to breed. And that’s predicated on production capabilities, financial wherewithal and profit expectations, which include the expected levels of both inputs and outputs. When any of those are negative, the decision will be to produce less. When they are positive, output will rise.

So, what do “consumption” expectations for 2010 and 2011 say about consumer demand? Not much when taken as individual years.

Figure 1 shows historical levels of per capita consumption on a retail weight basis, as well as USDA’s June forecasts for 2010 and 2011. Figure 2 shows the same data for total per capita meat/poultry consumption, including veal, lamb and “other chicken,” which is comprised primarily of hens.

Does the 6.2% reduction in total meat consumption mean meat demand is down by 6.2%? No, it doesn’t. The 6.2% reduction in consumption has been caused by a reduction in domestic supply. Meat and poultry producers, faced with higher costs (i.e. lower profit expectations) and depleted financial resources, reduced output. The lower numbers of chicks, piglets, calves, poults, etc., eventually translated into less product available to U.S. consumers, thus reducing the quantity supplied which, by definition, reduced quantity demanded.

But the impact on demand (remember – that is the quantities purchased by consumers at alternative prices and is thus a set of quantity:price pairs for prices, at least theoretically, from zero to infinity) can only be determined by observing the consumer prices that result from these lower offerings.

Note also that chicken production declined first and is rebounding first. That isn’t a surprise since the planning horizon is shorter for chicken than for any other species. USDA sees the pork industry responding by 2011, but forecasts a continued decline in beef per capita quantity supplied and demanded.

Tempered Demand
While I have argued that we know little about the status of demand from these forecasted “quantities demanded,” I remain quite concerned about our ultimate conclusions. A host of forces are pushing against meat and poultry consumption. Some, like health concerns, are old hat. But others like environmental impact and animal rights are, while not new, far more important in terms of emphasis and magnitude than they once were. And governmental policies are falling almost exclusively on the “anti-meat” side. Put these negative factors into the equation and I fear that we may not see the level of retail prices that this reduction in supplies should result in, meaning demand has faltered.

Lower per capita supplies have already driven pork and turkey prices to record highs (Figure 3). Beef and chicken prices have risen as well. But record-high prices do not mean demand is stable. The record highs will have to be even higher to indicate meat and poultry demands are steady or growing.

Click to view graphs.

Steve R. Meyer, Ph.D.
Paragon Economics, Inc.
e-mail: steve@paragoneconomics.com